JP Morgan Chase 2015 Annual Report Download - page 219

JPMorgan Chase & Co./2015 Annual Report 209
Accounting for derivatives
All free-standing derivatives that the Firm executes for its
own account are required to be recorded on the
Consolidated balance sheets at fair value.
As permitted under U.S. GAAP, the Firm nets derivative
assets and liabilities, and the related cash collateral
receivables and payables, when a legally enforceable
master netting agreement exists between the Firm and the
derivative counterparty. For further discussion of the
offsetting of assets and liabilities, see Note 1. The
accounting for changes in value of a derivative depends on
whether or not the transaction has been designated and
qualifies for hedge accounting. Derivatives that are not
designated as hedges are reported and measured at fair
value through earnings. The tabular disclosures on pages
212–218 of this Note provide additional information on the
amount of, and reporting for, derivative assets, liabilities,
gains and losses. For further discussion of derivatives
embedded in structured notes, see Notes 3 and 4.
Derivatives designated as hedges
The Firm applies hedge accounting to certain derivatives
executed for risk management purposes – generally interest
rate, foreign exchange and commodity derivatives.
However, JPMorgan Chase does not seek to apply hedge
accounting to all of the derivatives involved in the Firm’s
risk management activities. For example, the Firm does not
apply hedge accounting to purchased credit default swaps
used to manage the credit risk of loans and lending-related
commitments, because of the difficulties in qualifying such
contracts as hedges. For the same reason, the Firm does not
apply hedge accounting to certain interest rate, foreign
exchange, and commodity derivatives used for risk
management purposes.
To qualify for hedge accounting, a derivative must be highly
effective at reducing the risk associated with the exposure
being hedged. In addition, for a derivative to be designated
as a hedge, the risk management objective and strategy
must be documented. Hedge documentation must identify
the derivative hedging instrument, the asset or liability or
forecasted transaction and type of risk to be hedged, and
how the effectiveness of the derivative is assessed
prospectively and retrospectively. To assess effectiveness,
the Firm uses statistical methods such as regression
analysis, as well as nonstatistical methods including dollar-
value comparisons of the change in the fair value of the
derivative to the change in the fair value or cash flows of
the hedged item. The extent to which a derivative has been,
and is expected to continue to be, effective at offsetting
changes in the fair value or cash flows of the hedged item
must be assessed and documented at least quarterly. Any
hedge ineffectiveness (i.e., the amount by which the gain or
loss on the designated derivative instrument does not
exactly offset the change in the hedged item attributable to
the hedged risk) must be reported in current-period
earnings. If it is determined that a derivative is not highly
effective at hedging the designated exposure, hedge
accounting is discontinued.
There are three types of hedge accounting designations: fair
value hedges, cash flow hedges and net investment hedges.
JPMorgan Chase uses fair value hedges primarily to hedge
fixed-rate long-term debt, AFS securities and certain
commodities inventories. For qualifying fair value hedges,
the changes in the fair value of the derivative, and in the
value of the hedged item for the risk being hedged, are
recognized in earnings. If the hedge relationship is
terminated, then the adjustment to the hedged item
continues to be reported as part of the basis of the hedged
item, and for benchmark interest rate hedges is amortized
to earnings as a yield adjustment. Derivative amounts
affecting earnings are recognized consistent with the
classification of the hedged item – primarily net interest
income and principal transactions revenue.
JPMorgan Chase uses cash flow hedges primarily to hedge
the exposure to variability in forecasted cash flows from
floating-rate assets and liabilities and foreign currency–
denominated revenue and expense. For qualifying cash flow
hedges, the effective portion of the change in the fair value
of the derivative is recorded in OCI and recognized in the
Consolidated statements of income when the hedged cash
flows affect earnings. Derivative amounts affecting earnings
are recognized consistent with the classification of the
hedged item – primarily interest income, interest expense,
noninterest revenue and compensation expense. The
ineffective portions of cash flow hedges are immediately
recognized in earnings. If the hedge relationship is
terminated, then the value of the derivative recorded in
accumulated other comprehensive income/(loss) (“AOCI”) is
recognized in earnings when the cash flows that were
hedged affect earnings. For hedge relationships that are
discontinued because a forecasted transaction is not
expected to occur according to the original hedge forecast,
any related derivative values recorded in AOCI are
immediately recognized in earnings.
JPMorgan Chase uses foreign currency hedges to protect
the value of the Firm’s net investments in certain non-U.S.
subsidiaries or branches whose functional currencies are
not the U.S. dollar. For foreign currency qualifying net
investment hedges, changes in the fair value of the
derivatives are recorded in the translation adjustments
account within AOCI.