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GENPRU 1.3 Valuation

Application

GENPRU 1.3.1R

  1. (1)

    [deleted]14

    1
  2. (2)

    This section of the Handbook applies to a BIPRU firm.

  3. (3)

    [deleted]14

Purpose

GENPRU 1.3.2G

This section sets out, for the purposes of GENPRU and BIPRU14, rules and guidance as to how a firm should recognise and value assets, liabilities, exposures, equity and income statement items.

GENPRU 1.3.3G

  1. (1)

    In the case of a BIPRU firm, this section implements Articles 64(4) and 64(5)9 of the Banking Consolidation Directive (Own funds) and Article 33 and Part B of Annex VII of the Capital Adequacy Directive.

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  2. (2)

    [deleted]13

    13

General requirements: Accounting principles to be applied

GENPRU 1.3.4R

Subject to GENPRU 1.3.9 R to GENPRU 1.3.10 R and GENPRU 1.3.36 R, except where a rule in GENPRU, BIPRU or INSPRU provides for a different method of recognition or valuation, whenever a rule in GENPRU or BIPRU14 refers to an asset, liability, exposure, equity or income statement item, a firm must, for the purpose of that rule, recognise the asset, liability, exposure, equity or income statement item and measure its value in accordance with whichever of the following are applicable:

  1. (1)

    [deleted]14

  2. (2)

    Financial Reporting Standards15 issued 15by the Financial Reporting Council15;

  3. (3)

    Statements of Recommended Practice, issued by industry or sectoral bodies recognised for this purpose by the Financial Reporting Council15;

  4. (4)

    [deleted]11

    11
  5. (5)

    international accounting standards;

    6
  6. (6)

    the Companies Act 1985; and 6

  7. (7)

    the Companies Act 2006;6

as applicable to the firm for the purpose of its external financial reporting (or as would be applicable if the firm was a company with its head office in the United Kingdom).

GENPRU 1.3.5G

Except where a rule in GENPRU or BIPRU makes a14 different provision, GENPRU 1.3.4 R applies whenever a rule in GENPRU or BIPRU14 refers to the value or amount of an asset, liability, exposure, equity or income statement item, including:

  1. (1)

    whether, and when, to recognise or de-recognise an asset or liability;

  2. (2)

    the amount at which to value an asset, liability, exposure, equity or income statement item; and

  3. (3)

    which description to place on an asset, liability, exposure, equity or income statement item.

GENPRU 1.3.6G

In particular, unless an exception applies, GENPRU 1.3.4 R should be applied for the purposes of GENPRU or BIPRU14 to determine how to account for:

  1. (1)

    netting of amounts due to or from the firm;

  2. (2)

    the securitisation of assets and liabilities (see also GENPRU 1.3.7 G);

  3. (3)

    leased tangible assets;

  4. (4)

    assets transferred or received under a sale and repurchase3 or stock lending transaction; and

  5. (5)

    assets transferred or received by way of initial or variation margin under a derivative or similar transaction.

General requirements: Adjustments to accounting values

GENPRU 1.3.9R

For the purposes of GENPRU or BIPRU14, except where a rule in GENPRU or BIPRU14 provides for a different method of recognition or valuation:

  1. (1)

    when a firm, upon initial recognition, designates its liabilities as at fair value through profit or loss, it must always adjust any value calculated in accordance with GENPRU 1.3.4 R by subtracting any unrealised gains or adding back in any unrealised losses which are not attributable to changes in a benchmark interest rate;

  2. (2)

    in respect of a defined benefit occupational pension scheme:

    1. (a)

      a firm must derecognise any defined benefit asset;

    2. (b)

      a firm may substitute for a defined benefit liability the firm's deficit reduction amount.

GENPRU 1.3.10R

An election made under GENPRU 1.3.9R (2) must be applied consistently for the purposes of GENPRU or BIPRU14 in respect of any one financial year.

GENPRU 1.3.11G

A firm should keep a record of and be ready to explain to its supervisory contacts in the appropriate regulator the reasons for any difference between the deficit reduction amount and any commitment the firm has made in any public document to provide funding in respect of a defined benefit occupational pension scheme.

GENPRU 1.3.12G

The provisions of GENPRU 1.3.9 R to GENPRU 1.3.10 R and GENPRU 1.3.36 R apply only to the extent that the items referred to in those paragraphs would otherwise be recognised under the accounting requirements applicable to the firm. Some of those requirements may only be relevant to a firm subject to international accounting standards.

General requirements: Methods of valuation and systems and controls

GENPRU 1.3.13R

  1. (1)

    Except to the extent that GENPRU or BIPRU14 provide for another method of valuation, GENPRU 1.3.14 R to GENPRU 1.3.34 R (Marking to market, Marking to model, Independent price verification or Valuation adjustments14) apply:

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    1. (a)

      for the purposes set out in GENPRU 1.3.41 R;

    2. (b)

      for the purposes set out in GENPRU 1.3.39 R; and

    3. (c)

      to any balance sheet position measured at market value or fair value.

  2. (2)

    A firm must establish and maintain systems and controls sufficient to provide prudent and reliable valuation estimates.

  3. (3)

    Systems and controls under (2) must include at least the following elements:

    1. (a)

      documented policies and procedures for the process of valuation, including clearly defined responsibilities of the various areas involved in the determination of the valuation, sources of market information and review of their appropriateness, frequency of independent valuation, timing of closing prices, procedures for adjusting valuations, month-end and ad-hoc verification procedures, and, in the case of a BIPRU firm, guidelines for the use of unobservable inputs reflecting the firm's assumptions of what market participants would use in pricing the position; and9

    2. (b)

      reporting lines for the department accountable for the valuation process that are:

      1. (i)

        clear and independent of the front office; and

      2. (ii)

        ultimately to a main board executive director.

General requirements: Marking to market

GENPRU 1.3.14R

Wherever possible, a firm must use mark to market in order to measure the value of the investments and positions to which this rule applies under GENPRU 1.3.13 R and GENPRU 1.3.38 R to GENPRU 1.3.41 R. Marking to market is valuation (on at least a daily basis in the case of the trading book positions of a BIPRU firm) at readily available close out prices from independent sources.

GENPRU 1.3.15R

For the purposes of GENPRU 1.3.14 R, examples of readily available close out prices include exchange prices, screen prices, or quotes from several independent reputable brokers.

GENPRU 1.3.16R
  1. (1)

    4When marking to market, a firm must use the more prudent side of bid/offer unless the firm is a significant market maker in a particular position type and it can close out at the mid-market price.

  2. (2)

    4When calculating the current exposure value of a credit risk exposure for counterparty credit risk purposes:

    1. (a)

      a firm must use the more prudent side of bid/offer or the mid-market price and the firm must be consistent in the basis it chooses; and4

    2. (b)

      where the difference between the more prudent side of bid/offer and the mid-market price is material, the firm must consider making adjustments14.

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General requirements: Marking to model

GENPRU 1.3.17R

Where marking to market is not possible, a firm must (in the case of a BIPRU firm, conservatively)9use mark to model in order to measure the value of the investments and positions to which this rule applies under GENPRU 1.3.13 R and GENPRU 1.3.38 R to GENPRU 1.3.41 R. Marking to model is any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input. GENPRU 1.3.18 R to GENPRU 1.3.25 R apply when marking to model.

GENPRU 1.3.18R

When the model used is developed by the firm, that model must be:

  1. (1)

    based on appropriate assumptions which have been assessed and challenged by suitably qualified parties independent of the development process;

  2. (2)

    independently tested, including validation of the mathematics, assumptions, and software implementation; and

  3. (3)

    (in the case of a BIPRU firm) developed or approved independently of the front office.

GENPRU 1.3.19R

A firm must ensure that its senior management are aware of the positions which are subject to mark to model and understand the materiality of the uncertainty this creates in the reporting of the performance of the business of the firm and the risks to which it is subject.

GENPRU 1.3.20R

A firm must source market inputs in line with market prices so far as possible and assess the appropriateness of the market inputs for the position being valued and the parameters of the model on a frequent basis.

GENPRU 1.3.21R

A firm must use generally accepted valuation methodologies for particular products where these are available.

GENPRU 1.3.22R

A firm must establish formal change control procedures, hold a secure copy of the model, and periodically use that model to check valuations.

GENPRU 1.3.23R

A firm must ensure that its risk management functions are aware of the weaknesses of the models used and how best to reflect those in the valuation output.

GENPRU 1.3.24R

A firm must periodically review the model to determine the accuracy of its performance.

GENPRU 1.3.25R

Examples of periodical review are assessing the continued appropriateness of the assumptions, analysis of profit and loss versus risk factors and comparison of actual close out values to model outputs.

General requirements: Independent price verification

GENPRU 1.3.26R

In addition to marking to market or marking to model, a firm must perform independent price verification. This is the process by which market prices or model inputs are regularly verified for accuracy and independence.

GENPRU 1.3.27G

For independent price verification, where independent pricing sources are not available or pricing sources are more subjective (for example, only one available broker quote), prudent measures such as valuation adjustments may be appropriate.

GENPRU 1.3.28R

In the case of the trading book positions of a BIPRU firm, while daily marking to market may be performed by dealers, verification of market prices and model inputs must be performed by a unit independent of the dealing room, at least monthly (or, depending on the nature of the market/trading activity, more frequently).

General requirements: Valuation adjustments9

GENPRU 1.3.29R

The recognition of any gains or losses arising from valuations subject to GENPRU 1.3.13 R and GENPRU 1.3.38 R to GENPRU 1.3.41 R must be recognised for the purpose of calculating capital resources in accordance with GENPRU 1.3.14 R to GENPRU 1.3.34 R (Marking to market, Marking to model, Independent price verification or Valuation adjustments14). However if GENPRU or BIPRU14 provide for another treatment of such gains or losses, that other treatment must be applied.

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GENPRU 1.3.30R

A firm must establish and maintain procedures for considering valuation adjustments14. These procedures must be compliant with the requirements set out in GENPRU 1.3.33 R.

9
GENPRU 1.3.31R

A firm using third-party valuations, or marking to model, must consider whether valuation adjustments are necessary.

GENPRU 1.3.32R

A firm must consider the need for making adjustments14 for less liquid positions and, on an ongoing basis, review their continued appropriateness in accordance with the requirements set out in GENPRU 1.3.33 R. Less liquid positions could arise from both market events and institution-related situations e.g. concentration positions and/or stale positions.

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GENPRU 1.3.33R

  1. (1)

    This paragraph sets out the requirements referred to in GENPRU 1.3.30 R and GENPRU 1.3.32 R.

  2. (2)

    A firm must consider the following adjustments14: unearned credit spreads, close-out costs, operational risks, early termination, investing and funding costs, future administrative costs and, where appropriate, model risk.

    9
  3. (3) 9
    1. (a)

      In the case of a BIPRU firm, a firm must establish and maintain procedures for calculating adjustments to the current valuation of less liquid positions. Those adjustments must, where necessary, be in addition to any changes to the value of the position required for financial reporting purposes and must be designed to reflect the illiquidity of the position.9

    2. (b)

      A firm must consider several factors when determining whether a valuation adjustment14 is necessary for less liquid positions. These factors include the amount of time it would take to hedge out the position/risks within the position; the average and volatility of bid/offer spreads; the availability of market quotes (number and identity of market makers); the average and volatility of trading volumes; market concentrations; the ageing of positions; the extent to which valuation relies on marking to model and the impact of other model risks.9

  4. (4)

    With regard to complex products including, but not limited to, securitisation exposures and nth-to-default credit derivatives, a BIPRU firm must explicitly consider the need for valuation adjustments for model risk arising from using a valuation which may be incorrect or the risk from using unobservable calibration parameters in the valuation model.9

GENPRU 1.3.34R

If the result of making9 adjustments14 under GENPRU 1.3.29 R to GENPRU 1.3.33 R is a valuation which differs from the fair value determined in accordance with GENPRU 1.3.4 R, a firm must reconcile the two valuations.

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GENPRU 1.3.35G

Reconciliation differences under GENPRU 1.3.34 R should not be reflected in the valuations under GENPRU 1.3 but should be disclosed to the FCA14 in prudential returns.10 Firms which are subject to the reporting requirement under SUP 16.16 should disclose those reconciliation differences in the Prudent Valuation Return which they are required to submit to the FCA14 under SUP 16.16.4 R.

Specific requirements: BIPRU firms

GENPRU 1.3.36R

Adjustments to accounting values

  1. (1)

    For the purposes of GENPRU and BIPRU, the adjustments in (2) and (3) apply to values calculated pursuant to GENPRU 1.3.4 R in addition to those required by GENPRU 1.3.9 R to GENPRU 1.3.10 R.

  2. (2)

    A BIPRU firm must not recognise either:

    1. (a)

      the fair value reserves related to gains or losses on cash flow hedges of financial instruments measured at amortised cost; or

    2. (b)

      any unrealised gains or losses on debt instruments held, or formerly held,8 in the available-for-sale category.

  3. (3)

    A BIPRU firm12 must deduct any asset in respect of deferred acquisition costs and add back in any liability in respect of deferred income (but exclude from the deduction or addition any asset or liability which will give rise to future cash flows), together with any associated deferred tax.

    12
  4. (4)

    The items referred to in (2) and (3) must be excluded from capital resources.

GENPRU 1.3.37G

Provisions for equity instruments held in the available-for-sale category can be found in GENPRU 2.2.185 R.

Trading book and other fair-valued positions, and revaluations9

GENPRU 1.3.38R

to GENPRU 1.3.40 R apply only to a BIPRU firm.

GENPRU 1.3.39R

Both trading book9 positions and other fair-valued positions9are subject to prudent valuation rules as specified in GENPRU 1.3.14 R to GENPRU 1.3.34 R (Marking to market, Marking to model, Independent price verification,Valuation adjustments or, in the case of an insurer or a UK ISPV, valuation adjustments9 or reserves). In accordance with those rules, a firm must ensure that the value applied to each of its trading book positionsand other fair-valued positions9 appropriately reflects the current market value. This value must contain an appropriate degree of certainty having regard to the dynamic nature of trading book positions, the demands of prudential soundness and the mode of operation and purpose of capital requirements in respect of trading book positions and other fair-valued positions.9

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GENPRU 1.3.40R

Trading book positions must be re-valued at least daily.