As derivatives always have to be recognised at fair value on the balance sheet, an 'exit price' therefore always has to be determined for them.
IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (IFRS 13.9).
As derivatives always have to be recognised at fair value on the balance sheet, an 'exit price' therefore always has to be determined for them. Therefore, if a measurement method for over-the-counter derivatives (OTC derivatives) is applied, the value thus determined must be adjusted for credit risk in particular. This is done in practice by multiplying the expected exposure with the probability of default and loss given default. Depending on whether the exposure is positive or negative, the counterparty's credit risk or one's own credit risk is used.
For recognition at fair value, the values determined mathematically are therefore still adjusted for credit risk (credit risk adjustment). It should be noted in particular that for measuring hedge effectiveness, the entire fair value, including the credit risk adjustment, has to be used for hedge accounting. In practice, however, a method is frequently used in which the credit risk adjustment is not recognised until after the measurement of hedge effectiveness in the case of a perfect hedging relationships, as it is expected that the credit risk adjustment will not fall outside the range of 80% to 125%.
However, credit risk usually is not assessed for each transaction, as this generally is not required under framework agreements such as the German Master Agreement or ISDA agreements, which permit netting of assets and liabilities in the event of insolvency. Therefore, for calculating the credit risk adjustment, typically all receivables and liabilities of a counterparty are first netted in practice.
However, a recent judgment of the German Federal Court of Justice on 9 June 2016 (file ref. IX ZR 314/14) has created uncertainty with respect to this practice. In the judges' opinion, the above netting is in violation of German insolvency law, which is designed to protect assets involved in insolvency proceedings. The German Federal Financial Supervisory Authority [BaFin] reacted quickly and created a solution which however only applied to financial institutions. A clear decision remains outstanding for industrial enterprises.
However, the uncertainty for industrial enterprises will soon be over. The German Federal Ministry of Justice and Consumer Protection [BMJV] published a draft bill for amendment of Section 104 of the German Insolvency Act [InsO] at the end of July regarding the above issue of netting in the case of financial futures. As the general ruling of BaFin only applies for a limited period of time until 31 December 2016, it is generally assumed in the market that the amendment will take effect (retroactively) before the end of the year.
Source: KPMG Corporate Treasury News, Edition 60, October 2016
Author: Andrea Monthofer, Manager, Finance Advisory, firstname.lastname@example.org
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