IBRC annual report for 2011 - Irish Bank Resolution Corporation ...

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Notes to the financial statements continued21. Derivative financial instrumentsWith the exception of designated hedging derivatives, as defined by IAS 39, derivatives are treated as held for trading. The heldfor trading classification comprises corporate sales derivatives, economic hedges which do not meet the strict qualifying criteriafor hedge accounting and derivatives managed in conjunction with financial instruments designated at fair value. The Bankenters into new derivative transactions for the purposes of balance sheet risk management.The notional amount of a derivative contract does not necessarily represent the Group's real exposure to credit risk, which islimited to the current replacement cost of contracts with a positive fair value to the Group should the counterparty default. Toreduce credit risk on interbank derivatives the Group uses a variety of credit enhancement techniques such as master nettingagreements and collateral support agreements ('CSAs'), where cash security is provided against the exposure. Derivatives arecarried at fair value and shown in the statement of financial position as separate totals of assets and liabilities.Details of the objectives, policies and strategies arising from the Group's use of financial instruments, including derivativefinancial instruments, are presented in note 50.The following tables present the notional and fair value amounts of derivative financial instruments, analysed by product andcategory.Derivatives held for trading2011The GroupContractContractnotional Fair values notional Fair valuesamount Assets Liabilities amount Assets Liabilities€m €m €m €m €m €mInterest rate contracts 41,125 991 (1,568) 103,930 1,665 (2,211)Foreign exchange contracts 11,019 46 (310) 15,016 168 (98)Equity index options - held and written 161 12 (11) 234 11 (7)Total trading derivatives 52,305 1,049 (1,889) 119,180 1,844 (2,316)2010Derivatives held for hedgingFair value hedges 5,251 47 (300) 7,120 82 (60)Cash flow hedges - - - 1,887 10 -Total hedging derivatives 5,251 47 (300) 9,007 92 (60)Derivatives held in respect of liabilities tocustomers under investment contracts(note 40) 711 - (60) 1,075 - (84)Total derivative financial instruments 58,267 1,096 (2,249) 129,262 1,936 (2,460)72
Irish Bank Resolution Corporation LimitedAnnual Report & Accounts 2011Derivatives held for tradingThe Bank2011 2010ContractContractnotional Fair values notional Fair valuesamount Assets Liabilities amount Assets Liabilities€m €m €m €m €m €mInterest rate contracts 46,068 1,113 (1,568) 114,370 1,793 (2,340)Foreign exchange contracts 12,599 208 (310) 23,720 281 (596)Equity index options - held and written 161 12 (11) 234 11 (7)Total trading derivatives 58,828 1,333 (1,889) 138,324 2,085 (2,943)Derivatives held for hedgingFair value hedges 5,251 47 (300) 7,120 82 (60)Cash flow hedges - - - 1,887 10 -Total hedging derivatives 5,251 47 (300) 9,007 92 (60)Total derivative financial instruments 64,079 1,380 (2,189) 147,331 2,177 (3,003)Derivatives are carried in the statement of financial position at fair value. The decrease in the Group’s derivative assets andderivative liabilities during the year is primarily attributable to the impact on foreign exchange contracts of the depreciation ofthe euro against both sterling and the US dollar and the impact on fair value hedges of a decrease in euro interest rates.Maturities and the Bank’s deleveraging initiatives have also contributed to the decrease.Interest rate contracts include interest rate swaps that customers have entered into with the Bank to manage their exposure tochanges in interest rates. The fair value of these derivative assets includes a credit valuation adjustment ('CVA') to reflect theimpact of customer credit quality (note 6). The CVA measures the potential cost of replacing the existing derivative should thecustomer default. Including the CVA, the fair value of customer derivatives included within interest rate contracts is €435m(2010: €1,156m). The Bank manages the interest rate risk arising on customer derivatives with offsetting interbank derivatives.The significant decrease in the notional amount of interest rate contracts is due to maturities and ongoing deleveraginginitiatives.Foreign exchange contracts comprise cross currency swaps and forward foreign exchange contracts transacted to managecurrency mismatches that may arise. In March and April 2011 the Bank entered into two cross currency swaps with the NTMAon market terms. The principal amounts of the swaps are €2.3bn / $3.2bn and €0.6bn / £0.6bn respectively and these amountswere exchanged between the parties. The swaps have an amortising profile and contractual maturity of 2021. The interest rateson the swaps are market-based plus an agreed spread over the respective currency interbank benchmark rate. The decrease inthe overall notional amount of foreign exchange contracts during the year is attributable to a decrease in the US dollar fundingrequirement following the sale of the majority of the Bank's US loan portfolio (note 15). If needed, the Bank has the ability toexchange US dollar amounts for sterling amounts with interbank counterparties.The majority of the Bank’s derivative transactions with interbank counterparties are covered by CSAs, with cash collateralexchanged on a daily basis (notes 22 and 37). This significantly reduces the credit risk on interbank derivatives. Were the Bankto net outstanding derivative contracts with counterparties covered under CSAs, this would lead to a reduction in derivativeassets and derivative liabilities of €0.6bn (2010: €1.8bn).Hedging activitiesThe Group uses derivatives for hedging purposes to mitigate the market risk exposures arising from its banking and otheractivities. For accounting purposes the Group uses derivatives which may qualify as fair value hedges or cash flow hedges.Fair value hedgesThe Group uses interest rate swaps and cross-currency interest rate swaps to hedge the interest rate risk and foreign exchangerisk resulting from potential changes in the fair value of certain fixed rate assets and liabilities. Hedged assets include thepromissory note and fixed rate investment securities held. Hedged liabilities include fixed rate debt securities in issue.The Group recognised a net gain of €234m (2010: €53m) in net trading expense in respect of fair value movements on hedginginstruments designated as fair value hedges. The corresponding net loss attributable to the hedged risk on the hedged itemsalso recognised in net trading expense was €234m (2010: €53m).73
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Irish Bank Resolution Corporation L
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ContentsIrish Bank Resolution Corpo
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Chairman’s statementIrish Bank Re
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Group Chief Executive’s reviewIri
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Group Chief Executive’s review co
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Business review continuedIrish Bank
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Board of DirectorsIrish Bank Resolu
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Corporate Responsibility continuedI
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Principal risks and uncertainties c
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Page 25 and 26: Report of the DirectorsIrish Bank R
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Page 33 and 34: OpinionIn our opinion:• the Group
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Irish Bank ResolutionCorporation Li
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