ING Direct 2015 Annual Report Download - page 202

Contents
Who we are
Report of the
Management
Board
Corporate
Governance
Consolidated
annual accounts
Parent company
annual accounts
Other
information
Additional
information
Notes to the Consolidated annual accounts of ING Bank - continued
In general, positions are valued taking the bid price for a long position and the offer price for a short position. In cases where positions
are marked at mid-market prices, a fair value adjustment is calculated.
ING Bank has aligned existing fair valuation adjustments with the regulatory standards for fair valued instruments issued by EBA,
hence where possible it follows a unified valuation framework which meets both IFRS and CRR requirements. This approach is
supported by a bank-wide valuation policy framework, which specifies detailed methodologies for fair valued instruments per product
and degree of liquidity. Benefits of this framework and chosen approach are a significant increase in consistency and transparency of
the fair valuation of financial instruments across different locations and books. For compliance with EBA regulatory standards an
additional valuation adjustment through capital on the concentrated positions (the Concentration AVA) of EUR 44.1 million after tax is
booked for ING Bank in 2015.
To include credit risk in the fair valuation, ING Bank applies both credit and debit valuation adjustments (hereafter referred to as
respectively, CVA and DVA). Own issued debt and structured notes that are valued at fair value are adjusted for credit risk by means of
an own credit adjustment. Additionally, derivatives valued at fair value are adjusted for credit risk by a credit valuation adjustment.
This credit valuation adjustment is of a bilateral nature; both the credit risks on the counterparty as well as on ING Bank are included in
the adjustment. All market data that is used in the determination of the CVA is based on market implied data. Additionally, wrong-
way risk (when exposure to a counterparty is increasing and the credit quality of that counterparty decreases) and right way risk
(when exposure to a counterparty is decreasing and the credit quality of that counterparty decreases) are included in the adjustment.
ING Bank applies CVA also for pricing credit risk into new external trades with counterparties. Risk limits and controls are in place to
monitor and anticipate CVA risk on a daily basis. The CVA is managed by global risk governance, where the risk limits and controls for
CVA are managed and monitored on a global level. Our approach on CVA risk management is driven by increased control, cost
efficiency and the global scope of CVA.
To address the risk associated with the illiquid nature of the derivative portfolio, ING Bank applies an additional ‘liquidity valuation
adjustment’. The adjustment is based on the market price of funding liquidity and is applied to the uncollateralised derivatives. This
additional discounting is taken into account in both the credit and debit valuation adjustments.
Credit & Trading Risk has the role to identify and challenge market data and pricing sources that determine the parameters that will
be used in the valuation models, and to calculate necessary value adjustments. The identified market data and sources used in the
valuation models are independently challenged, reviewed and validated on a regular basis, most of it daily. Price testing and valuation
results are reviewed and validated by local and global parameter committees.
To ensure segregation of duties between Front Office and Credit & Trading Risk, the systems for pricing and price testing are secured in
order to prevent unauthorised access.
Reference is made to Note 36 ‘Fair value of assets and liabilities’ for the basis of the determination of the fair values of the financial
instruments and related sensitivities.
Model disclosure of trading risk measures
Value at Risk
Credit & Trading Risk uses the historical simulation Value at Risk (VaR) methodology as its primary risk measure. The VaR for market
risk quantifies, with a one-sided confidence level of 99%, the maximum overnight loss that could occur due to changes in risk factors
(e.g. interest rates, equity prices, foreign exchange rates, credit spreads, implied volatilities) if positions remain unchanged for a time
period of one day. Next to general market movements in these risk factors, VaR also takes into account market data movements for
specific moves in e.g. the underlying issuer of securities. The impact of historical market movements on today’s portfolio is estimated,
based on equally weighted observed market movements of the previous year. ING Bank uses VaR with a 1-day horizon for internal risk
measurement, control and backtesting, and VaR with a 10-day horizon for determining regulatory capital.
Limitations
VaR has some limitations, such as the following: VaR uses historical data to forecast future price behaviour. Future price behaviour
could differ substantially from past behaviour. Moreover, the use of a one-day holding period (or ten days for regulatory capital
calculations) assumes that all positions in the portfolio can be liquidated or hedged in one day. In periods of illiquidity or market
events, this assumption may not hold. Also, the use of 99% confidence level means that VaR does not take into account any losses
that occur beyond this confidence level.
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