Financial derivatives include options, futures/forwards, swaps, FRAs, caps, floors, collars, warrants and certain credit derivatives; they do not include spot foreign exchange trades.
They are recorded at market value or where this is not available fair value. Fair value is defined as the value at which the contract could be exchanged in an arms length transaction between informed and willing parties. Market value may differ from fair value as it will encompass bid/offer spreads, commissions and the effects of supply and demand upon the price of the derivative.
Changes in the gross marked to market value of derivatives contracts will be influenced by three main factors:
- Revaluations due to changes in the underlying instrument: When derivatives contracts are traded, their marked to market value will typically be zero, except for options. Changes in the expectations of underlying variables of contracts at the time of valuation, away from expectations of those variables at the time of trading will generally cause the marked to market value of a derivative to tend away from zero.
- Transactions in financial derivatives: Because the marked to market value of a derivative is equal to the net present value of future payment streams, whenever a payment is made with respect to a contract the marked to market valuation will be affected.
- Changes in the number of contracts held: The more contracts that are traded, the higher we would expect gross marked to market positions to be.
The relative importance of these factors varies depending upon market conditions.
Foreign currency positions are converted to sterling using end-period exchange rates.
These data include any positions the reporting bank has with the Bank of England.
Positions are reported gross, separating assets from liabilities, except for complex or structured trades, where, if the Bank of England agrees, they can be reported net if this improves the overall accuracy of the data. If derivative contracts comprise more than one risk category they are allocated according to the risk category which primarily determines the price of the contract.
Embedded derivatives within an underlying instrument (e.g. convertible bonds) are excluded from these data if the two are inseparable.
Until 2007 Q3 certain types of Credit Derivative were excluded from this dataset. For National Accounts statistics banks were asked to exclude credit default products, which are defined here as products which only transfer the credit default risk, rather than the whole market risk. These products were treated as being analogous to traditional banking instruments such as letters of credit or guarantees and which covered within other returns.
However, from 2007 Q4, the definition has been revised to recognise changes in the market and in international statistical standards. These standards regard instruments as credit derivatives rather than, say, insurance products or guarantees, if they are recognisable as derivatives, tradable or capable of being offset in the market, and capable of being given an arms-length value. Therefore, a much wider range of credit derivative instruments are now included within this dataset.
The "Other" risk category comprises credit derivatives, commodity derivatives and equity derivatives.
FRAs are Forward Rate Agreements.