SEC Form 20-F - Deutsche Bank Annual Report 2012

Deutsche Bank Notes to the Consolidated Financial Statements F-41
Annual Report 2010 on Form 20-F 02 – Critical Accounting Estimates
In other markets or for certain instruments, observable prices or inputs are not available, and fair value is
determined using valuation techniques appropriate for the particular instrument. For example, instruments
subject to valuation techniques include: trading loans and other loans or loan commitments designated at fair
value through profit or loss, under the fair value option; new, complex and long-dated OTC derivatives; transactions
in immature or limited markets; distressed debt securities and loans; private equity securities and retained
interests in securitizations of financial assets. The application of valuation techniques to determine fair value
involves estimation and management judgment, the extent of which will vary with the degree of complexity and
liquidity in the market. Valuation techniques include industry standard models based on discounted cash flow
analysis, which are dependent upon estimated future cash flows and the discount rate used. For more complex
products, the valuation models include more complex modeling techniques, parameters and assumptions,
such as volatility, correlation, prepayment speeds, default rates and loss severity. Management judgment is
required in the selection and application of the appropriate parameters, assumptions and modeling techniques.
Because the objective of using a valuation technique is to establish the price at which market participants would
currently transact, the valuation techniques incorporate all factors that the Group believes market participants
would consider in setting a transaction price.
Valuation adjustments are an integral part of the fair value process that requires the exercise of judgment. In
making appropriate valuation adjustments, the Group follows methodologies that consider factors such as bidoffer
spread valuation adjustments, liquidity, and credit risk (both counterparty credit risk in relation to financial
assets and the Group’s own credit risk in relation to financial liabilities which are at fair value through profit or
loss).
The fair value of the Group’s financial liabilities which are at fair value through profit or loss (e.g., OTC derivative
liabilities and structured note liabilities designated at fair value through profit or loss) incorporates the change
in the Group’s own credit risk of the financial liability. For derivative liabilities the Group considers its own creditworthiness
by assessing all counterparties’ potential future exposure to us, taking into account any collateral
provided, the effect of any master netting agreements, expected loss given default and the Group’s own credit
risk based on historic default levels. The change in the Group’s own credit risk for structured note liabilities is
calculated by discounting the contractual cash flows of the instrument using the rate at which similar instruments
would be issued at the measurement date. The resulting fair value is an estimate of the price at which the
specific liability would be exchanged at the measurement date with another market participant.
Under IFRS, if there are significant unobservable inputs used in the valuation technique as of the trade date
the financial instrument is recognized at the transaction price and any trade date profit is deferred. Management
judgment is required in determining whether there exist significant unobservable inputs in the valuation technique.
Once deferred the decision to subsequently recognize the trade date profit requires a careful assessment of
the then current facts and circumstances supporting observability of parameters and/or risk mitigation.