Demystifying derivatives: A commercial and accounting perspective

Introduction

Heightened market volatility, a sharp rise in global interest rates and increased flexibility for restructuring derivatives has reignited queries from our clients about derivative valuations and restructuring or unwind costs. Large swings in the value of derivative portfolios have put ever more scrutiny on accounting valuations and how these are presented in accounts.

In this refresh of the original 2017 white paper, we take a refreshed look at derivative valuations: 

1. Mark-to-Market of a derivative or ‘mid MtM’, represents the Net Present Value of all future projected cashflows to be received and paid, discounted at a risk-free rate (SONIA, SOFR, €STR). This is valued on the same basis as that typically received in valuation reports from banks and is still often used for accounting purposes.

2. Transaction value of a derivative is the ‘Mark-to-Market’ taking into account credit, bank funding, regulatory capital implications as well as trading costs. It may also factor in the bank’s (or corporate’s) wider derivative portfolio, wider strategy, and commercial considerations. These factors may impact a derivative valuation when unwinding or restructuring a derivative prior to maturity.

3. Accounting value of a derivative can be the same as the ‘Mark-to-Market’ described previously, but increasingly often takes into account certain accounting valuation adjustments that depend on the relevant accounting standard. 10 years on from its implementation, IFRS13 puts a greater emphasis on credit valuation adjustments to the ‘Mark-to-Market’ for accounting purposes which mirror a transaction value.  In some cases a funding valuation adjustment is required too.

Read the full whitepaper below:

For more information, please contact Adrian Li, Managing Director – Centrus

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