CFM INDOSUEZ Wealth Management - 2019 annual report

recorded in other comprehensive income. For hedged items measured at amortised cost, which were hedged against interest rate risk, the revaluation difference is amortised over the remaining life of the hedged items; • cash flow hedges: the hedging instrument is valued at fair value through profit or loss. The amounts accumulated in other comprehensive income in respect of the effective portion of the hedge remain in other comprehensive income until the hedged item affects income. For items that were hedged against interest rate risk, the impact on income is recorded as interest is paid. The revaluation difference is therefore amortised over the remaining life of these hedged items. Embedded derivatives An embedded derivative is the component of a hybrid instrument that qualifies as a derivative. This term applies only to financial liabilities and non-financial contracts. Embedded derivatives must be accounted for separately from the host contract if the following three conditions are met: • the hybrid contract is not measured at fair value through profit or loss; • when considered separately from the host contract, the embedded item has the characteristics of a derivative; • the characteristics of the derivative are not closely related to those of the host contract. Determination of the fair value of financial instruments The fair value of financial instruments is determined by maximising the use of observable inputs. It is presented according to the hierarchy defined by IFRS 13. 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, in the main market or the most advantageous market, at the measurement date. Fair value applies to each financial asset or financial liability on an individual basis. By exception, it can be estimated by portfolio, if permitted by the risk management and monitoring strategy and if it is subject to appropriate documentation. As a result, certain fair value inputs are calculated on a net basis when a group of financial assets and financial liabilities is managed on the basis of its net exposure to market or credit risk. The Group believes that the best indication of fair value is the use of quoted prices in an active market. In the absence of such quotations, fair value is determined by the application of valuation techniques that maximise the use of relevant observable inputs and minimise the use of unobservable inputs. When a liability is measured at fair value through profit or loss (by default or option), the fair value takes into account the issuer’s own credit risk. Counterparty risk on derivatives The Group includes counterparty risk in the fair value measurement of derivative financial assets (Credit Valuation Adjustment or CVA) and, under a symmetrical approach, non-performance risk for the fair value measurement of derivative liabilities (Debit Valuation Adjustment or DVA or own credit risk). The CVA is used to determine expected losses on the counterparty from the Group’s point of view; the DVA is used to determine expected losses from the Group from the counterparty’s point of view. The CVA/DVA calculation is based on an estimate of expected losses based on the probability of default and loss given default. The methodology employed maximizes the use of observable inputs. It is primarily based on market inputs such as single name CDS or index CDS in the absence of a registered CDS for the counterparty. Under certain circumstances, historical default inputs may be used. Fair value hierarchy The standard classifies fair values into three levels based on the observability of inputs used in the assessment. • Level 1: fair values corresponding to (unadjusted) prices in active markets Level 1 includes financial instruments that are directly quoted in active markets for identical assets and liabilities that can be accessed by the entity at the measurement date. These include stocks and bonds quoted on an active market (such as the Paris Stock Exchange, the London Stock Exchange, the New York Stock Exchange, etc.), units of investment funds listed on an active market and derivatives contracted on an organised market, including futures. A market is considered active if prices are readily and regularly available from a stock exchange, broker, trader, pricing service or regulatory agency and these prices represent actual transactions that regularly occur on the market under normal conditions. For financial assets and liabilities with offsetting market risks, the Group uses mid-prices as a basis for determining the fair value of these positions. For net short positions, bid prices are used and for net long positions, offer prices are used. • Level 2: fair values calculated using directly or indirectly observable data, other than level 1 These data are directly observable (i.e. prices) or indirectly observable (derived from price data) and generally meet the following conditions: they are non-entity-specific data that are publicly available/accessible and based on a market consensus. The following are presented in level 2 of the fair value hierarchy: • shares and bonds quoted on a market that is considered inactive, or not quoted in an active market, but for which the fair value is determined using a valuation method commonly used by market participants (such as discounted cash flows, the Black & Scholes model) and based on observable market data; • instruments traded over-the-counter for which valuation is performed with models that use observable market data, i.e. that can be obtained from multiple sources independent of internal sources and on a regular basis. For example, the fair value of interest rate swaps is generally determined using yield curves based on market interest rates prevailing at the reporting date. When the models used are based particularly on standard models, and on observable market parameters (such as yield curves or implied volatility tables), the initial margin generated on the instruments thus valued is recognised in the income statement from the outset. • Level 3: fair values for which a significant portion of the inputs used for their determination do not meet the observability criteria The determination of the fair value of certain complex market instruments not traded in an active market is based on valuation techniques using assumptions that are not supported by observable market data for the same instrument. These products are presented in level 3 in the fair value hierarchy. These are essentially complex rate products, equity derivatives and structured credit products whose valuation requires, for example, correlation or volatility inputs that are not directly comparable to 66 CFM Indosuez Wealth Management