The global financial crisis was the catalyst for a myriad of changes in the regulatory environment of derivatives. From Hedgebook’s perspective it is the changes that relate to the fair value of financial instruments that is particularly of interest. Although banks have been reporting CVA and DVA for a number of years, it is only over the last couple of years that we have seen greater numbers of end users/companies doing so.
Alongside CVA and DVA within the family of derivative valuation adjustments sits FVA (Funding Valuation Adjustments). FVA is an adjustment to the risk-free valuation of financial instruments and reflects the bank’s funding and liquidity cost of a trade. Until recently, the reporting of FVA was only for the bank side and not included in mark-to-markets sent to the customer. However, as of March 2016 Westpac has been including FVA within the valuations of interest rate swaps sent to the customer.
Hedgebook’s understanding of the accounting standard (IFRS 13) is that end users are not required to report FVA in the accounts, therefore, for those companies relying on Westpac’s valuations they may be reporting incorrect valuations. It is a question for the auditors, although it is fair to say that there is even less audit consensus (understanding?) on FVA than there is on CVA/DVA. It will be interesting to see if any of the other trading banks follow Westpac’s lead and include FVA into derivative valuations and what it means for companies relying on these valuations for financial reporting purposes.