Consider the following examples:

Example 1 (fair value hedge accounting (“FVHA”) – Micro hedge)

(Date t_0) The Bank A wants to hedge a debt instrument (a security or a loan – hedged instrument) at amortized cost of 100 (= 100 fair value). The security is a fixed rate instrument. The hedge is classified as a “fair value hedge accounting (FVHA)”.

The bank stipulates an OTC derivative (hedging instrument) plain-vanilla (fixed rate paid; floating rate received) for nominal 100. At inception the fair value of the derivative is 0.

The hedge is specific, 1 to 1, so it is a micro-hedge.

(Date t_1) At the first date of reporting:

• The derivative has a fair value of –2 (delta fair value – 2 = – 2 – 0). The value of 2 is registered in profit & loss (P&L) statement (expense) versus a negative derivative (liability on balance sheet (BS)).

Date

Description

Amount

Credit/Debit

t_1

P&L – Fair value adjustment of derivative (hedging instrument)

2

Debit (DARE)

BS – Negative derivatives FVHA

2

Credit (AVERE)

• The debt instrument has a fair value adjustment (variation) of +2,1 (delta fair value 2,1 = 102,1 – 100). The value of 2,1 is registered in profit & loss (P&L) statement (income) versus a variation of the value of the debt security (asset variation on balance sheet (BS))

Date

Description

Amount

Credit/Debit

t_1

BS – Debt securities – Fair Value Adjustment “FVA” [01598.98]

2,1

Debit (DARE)

P&L – Fair value adjustment of the security (hedged instrument)

2,1

Credit (AVERE)

FinRep references on balance sheet – Financial Statement:

• {F 01.01; r0181, c0010} “Financial assets at amortised cost” value 102,1
• {F 01.02; r0150, c0010} “Derivatives – Hedge accounting” value 2

QUESTION: What is the right treatment of the FVA of the debt instrument (security or loan) in the prudential credit risk framework? Possible answers:

1. The FVA is added to the value of the debt security and weighted with the bond (value of 102,1 in the “exposures to corporates” class 100%). Refer to art. 111 CRR (Standardised Approach) and art. 166 CRR (IRB approach) where is said that the exposure value of an asset item shall be its accounting value.
2. The FVA is treated as an independent risk in the “other items” class (value of 2,1 in the “other items” class 100%) while the bond continues to be risk-weighted in the “corporate” class (value of 100 in the “exposures to corporates” class 100%). Refer to art. 113(5) CRR (Standardised Approach).
3. FVAs should not be risk-weighted under the current CRR credit risk framework. The FVAs arise as a result of applying FVHA to mitigate interest rate risk. They present the fair value changes due to movements in the interest rates. They do not represent in any way a claim on the borrowers of the hedged exposures. The application of FVHA does therefore not alter the credit risk that is associated with the hedged items.

Example 2 (fair value hedge accounting (“FVHA”) – Macro hedge)

(Date t_0) The Bank A wants to hedge 3 debt instruments (securities or loans – hedged instruments) at amortized cost of, respectively, 50, 30 and 20 (= 50, 30, 20 fair values). The securities are fixed rate instruments. The hedge is classified as a “fair value hedge accounting (FVHA)”.

The bank stipulates an OTC derivative (hedging instrument) plain-vanilla (fixed rate paid; floating rate received) for nominal 100. At inception the fair value of the derivative is 0.

The hedge is concerning a group of items, “n” to 1, so it is a macro-hedge.

(Date t_1) At the first date of reporting:

• The derivative has a fair value of –2 (delta fair value – 2 = – 2 – 0). The value of 2 is registered in profit & loss (P&L) statement (expense) versus a negative derivative (liability on balance sheet (BS))

Date

Description

Amount

Credit/Debit

t_1

P&L – Fair value adjustment of derivative (hedging instrument)

2

Debit (DARE)

BS – Negative derivatives FVHA

2

Credit (AVERE)

• The debt instruments have fair value adjustments (variation) of, respectively, +1,05; +0,63; +0,42 for a total amout of +2,1. The value of 2,1 is registered in profit & loss (P&L) statement (income) versus a variation of fair value changes of the hedged items in portfolio hedge (specific line in the balance sheet (BS) assets)

Date

Description

Amount

Credit/Debit

t_1

BS – Fair value changes, hedged items – Macro H (“FVA” [01598.90])

2,1

Debit (DARE)

P&L – Fair value adjustment of the security (hedged instrument)

2,1

Credit (AVERE)

FinRep references on balance sheet – Financial Statement:

• {F 01.01; r0181, c0010} “Financial assets at amortised cost” value 100
• {F 01.01; r0250, c0010} “Fair value changes of the hedged items in portfolio hedge of interest rate risk” value 2,1
• {F 01.02; r0150, c0010} “Derivatives – Hedge accounting” value 2

QUESTION: What is the right treatment of the FVA of the debt instruments (securities or loans) in the prudential credit risk framework? Possible answers:

1. The FVA is treated as an independent risk in the “other items” class (value of 2,1 in the “other items” class 100%) while the bonds continue to be risk-weighted in the “corporate” class (value of 100 in the “exposures to corporates” class 100%). Refer to art. 113(5) CRR (Standardised Approach).
2. FVAs should not be risk-weighted under the current CRR credit risk framework. The FVAs arise as a result of applying FVHA to mitigate interest rate risk. They present the fair value changes due to movements in the interest rates. They do not represent in any way a claim on the borrowers of the hedged exposures. The application of FVHA does therefore not alter the credit risk that is associated with the hedged items.