15 April 2021

Funding Valuation Adjustments Cloud Bank Valuations

Hedgebook takes a look at FVA (Funding Valuation Adjustments) that sit alongside CVA and DVA within the family of derivative valuations. Is it immaterial? Or are you over-investing in being compliant?

The global financial crisis was over a decade ago.  It was the catalyst for a myriad of changes in the regulatory environment of derivatives. For Hedgebook it was the focus on CVA and DVA, plus FVA and the impact to the fair value of financial instruments, that was relevant.  Although banks had been reporting CVA and DVA for a number of years, greater focus was given to how corporates were (or more accurately, weren’t) reporting it.

Audit inconsistencies still apparent

IFRS 13 requires fair value to include the impact of credit, however, 10 years on and we are still waiting for it to be enforced in a meaningful way. Auditors remain inconsistent with the requirement for a credit calculation to be carried out, often citing immateriality as the reason to not do it.

For a mid-sized importer/exporter using short-dated FX forward contracts for hedging, then immateriality is probably fair enough. Not so much for organisations hedging out longer (beyond six months) and using more complex, option based hedging products.

How do you determine the impact as immaterial if you don’t first of all calculate the value? We are surprised that we do not see more of our user base asked to report CVA/DVA, as many are hedging longer term and using options.

Introducing FVA

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.

Historically, the reporting of FVA was only for the bank side and not included in mark-to-markets sent to the customer. However, in recent years we have seen banks 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 bank valuations, they may be reporting fair value incorrectly.

For companies that continue to rely on valuations provided by their bank it would be prudent to ask  whether there is an FVA charge included. We would also ask why these companies are relying on bank provided valuations? They are clearly not “independent” – a requirement of the standard.

In our experience, auditors fall into two camps with regards CVA/DVA – those that dismiss it as immaterial and those that over engineer the requirements. Hedgebook provides a low-cost, easy to use module to calculate CVA/DVA.

Hedgebook  has a mission to help businesses of all sizes make sense of treasury and FX risk, devise profit-protecting strategies and collaborate more efficiently with their bank and broker via our market-leading SaaS platform.
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