appropriately illustrated application of the portfolio approach.21
As discussed at 5.1.2 above, in April 2015, after considering responses to this proposal
from constituents, the IASB concluded that it was not necessary to add the proposed
illustrative example to IFRS 13. However, in reaching this decision, the Board noted that
the proposed illustrative example appropriately illustrated the application of the
portfolio approach. ‘That is, if an entity elects to use the exception in paragraph 48 of
IFRS 13, the appropriate fair value measurement of the net risk exposure arising from a
group of financial assets and financial liabilities whose market risks are substantially the
same, and whose fair value measurement is categorised within Level 1 of the fair value
hierarchy, would be determined by multiplying the financial instruments included in the
resulting net position by the corresponding unadjusted Level 1 price’.22 [IFRS 13.48].
While the proposed non-authoritative example provides one approach to consider, in
light of the above discussion, entities will need to use judgement to determine the most
appropriate approach to employ when applying the portfolio exception.
When measuring fair value using the portfolio approach, IFRS 13 also requires that the
market risks be substantially the same (see 12.2.1 below) and that the fair value
measurement must take into consideration any exposure to the credit risk of a particular
counterparty (see 12.2.2 below).
It is also important to note that when applying the portfolio approach, entities may offset
credit and market risks at different levels of aggregation. This approach is consistent
with risk management practices employed by many entities. Such an approach may be
required because it is unlikely that all of the financial assets and liabilities giving rise to
the net exposure for a particular market risk will be with the same counterparty. The
example below illustrates this concept.
Example 14.20: Calculating net exposure
Entity XYZ holds a portfolio of long and short derivative positions (USD interest rate swaps and USD/JPY
foreign currency forwards) with various counterparties as follows:
• Counterparties A, B and C: only interest rate swaps.
• Counterparty D: interest rate swaps and foreign currency forwards.
• Counterparties E, F and G: only foreign currency forwards.
Fair value measurement 1027
Entity XYZ has executed master netting agreements in respect of credit risk with each of its counterparties
except counterparty G. In addition, the agreement in place with counterparty D can be applied across products.
Interest Rate Risk
Foreign Currency Risk
(Net Long Interest Rate Exposure)
(Net Long Foreign Exchange Exposure)
Counterparty
Counterparty
A
E
net long credit exposure
net long credit exposure
Counterparty
Counterparty
B
Counterparty
F
D
net long credit
net long credit
exposure
net long credit exposure
exposure
Counterparty
Counterparty
C
G
net short credit exposure
short
long
positions
positions
Using the measurement exception, Entity XYZ may consider its credit risk exposure to each individual
counterparty except counterparty G on a net basis (i.e. net long credit exposure to Counterparty A, net short
credit exposure to Counterparty C, etc.).
At the same time, the entity may consider its net long exposure to USD interest rate risk from its portfolio of
derivatives with counterparties A, B, C and D. The entity may also consider its net long exposure to foreign
currency risk (Japanese yen risk) from its portfolio of derivatives with counterparties D, E, F and G.
12.2.1
Exposure to market risks
When measuring fair value using the measurement exception for offsetting positions,
the entity is required to ensure the following in relation to market risks:
• Market risk (or risks), to which the entity is exposed within that portfolio, is
substantially the same. For example, combining the interest rate risk associated
with a financial asset with the commodity price risk associated with a financial
liability would not be appropriate because it would not mitigate the entity’s
exposure to interest rate risk or commodity price risk.
The standard requires any basis risk resulting from the market risk parameters not
being identical to be taken into account in the fair value measurement of the
financial assets and financial liabilities within the group; [IFRS 13.54]
• The duration of the entity’s exposure to a particular market risk (or risks) must be
substantially the same. [IFRS 13.55].
The standard gives the example of an entity that uses a 12-month futures contract
against the cash flows associated with 12 months’ worth of interest rate risk
exposure on a five-year financial instrument. The futures and five-year financial
instruments are within a group that is made up of only those financial assets and
financial liabilities. The entity measures the fair value of the exposure to 12-month
interest rate risk on a net basis and the remaining interest rate risk exposure (i.e.
years 2-5) on a gross basis.
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Management selects the price within the bid-ask spread that is most representative of
fair value in the circumstances to the entity’s net exposure to the particular market
risk(s) (pricing within the bid-ask spread is discussed further at 15.3 below). [IFRS 13.53].
12.2.2
Exposure to the credit risk of a particular counterparty
In some cases, an entity might enter into an arrangement to mitigate the credit risk
exposure in the event of default, for example, a master netting agreement with the
counterparty or the exchange of collateral on the basis of each party’s net exposure to
the credit risk of the other party.
An entity is not required to prove that such agreements will be legally enforceable in all
jurisdictions to use the measurement exception. Instead, an entity should consider
market participant expectations about the likelihood that such an arrangement would
be legally enforceable in the event of default when valuing the net credit exposure.
[IFRS 13.56].
When market participants would take into account any of these existing arrangements,
the fair value measurement (using the measurement exception for offsetting positions)
must include the effect of the entity’s net exposure to the credit risk of that counterparty
and/or the counterparty’s net exposure to the credit risk of the entity.
13
FAIR VALUE AT INITIAL RECOGNITION
13.1 Exit price versus entry price
IFRS 13 defines fair value as the price that would be received to sell the asset or paid to
transfer the liability; this is an exit price notion. When an entity acquires an asset, or
assumes a liability, the price paid (or the transaction price) is an entry price.
Conceptually, entry prices and exit prices are different. E
ntities do not necessarily sell
assets at the prices paid to acquire them. Similarly, entities do not necessarily transfer
liabilities at the prices received to assume them. This distinction is significant and can
have important implications on the initial recognition of assets and liabilities at fair
value. However, IFRS 13 acknowledges that, in many cases, an entry price may equal an
exit price (e.g. when the transaction takes place in the entity’s principal market); since
one party is selling an asset, that transaction is also an exit transaction. [IFRS 13.57, 58].
13.1.1
Assessing whether the transaction price equals fair value at initial
recognition
Prior to the issuance of IFRS 13, it was common for entities to use the transaction price
as fair value of an asset or liability on its initial recognition. While IFRS 13 acknowledges
that in many situations, an entry price may equal an exit price, it does not presume that
these prices are equal. Therefore, an entity must determine whether the transaction
price represents the fair value of an asset or liability at initial recognition. [IFRS 13.59].
Paragraph B4 of IFRS 13 provides certain factors that an entity should consider in
making this determination. For example, a transaction price may not represent fair value
if the unit of account represented by the transaction price is different from the unit of
account for the asset or liability measured at fair value. [IFRS 13.B4(c)]. This may be the
Fair value measurement 1029
case with a complex financial instrument where the transaction price includes a fee for
structuring the transaction or when an entity acquires a block and the transaction price
includes a block discount.
Another factor to consider is whether the market in which an entity acquired the asset
(or assumed the liability) is different from the principal (or most advantageous) market
in which the entity will sell the asset (or transfer the liability). [IFRS 13.B4(d)]. For example,
a securities dealer may acquire an asset in the retail market but sell it in the inter-dealer
market. However, the fair value measurement should consider the fact that, while the
inter-dealer price (i.e. the exit price in a hypothetical transaction) may differ from the
retail price (i.e. transaction price), another dealer would also expect to earn a profit on
the transaction. Accordingly, a pricing model’s value should incorporate assumptions
regarding the appropriate profit margin that market participants (i.e. other dealers)
would demand when estimating the instrument’s fair value at inception.
Other examples identified by paragraph B4 of IFRS 13 include:
• the transaction is between related parties – although IFRS 13 does allow the price
in a related party transaction to be used as an input into a fair value measurement
if the entity has evidence that the transaction was entered into at market terms;
and
• the transaction takes place under duress or the seller is forced to accept the price
in the transaction – for example, if the seller is experiencing financial difficulty.
[IFRS 13.B4(a)-(b)].
In addition, the measurement of fair value in accordance with IFRS 13 should take into
consideration market participant assumptions about risk. Adjustments for uncertainty
associated with a valuation technique or certain inputs used to measure fair value are
required if market participants would incorporate such risk adjustments when pricing
the asset or liability. A measurement (e.g. a ‘mark-to-model’ measurement) that ignores
these market participant adjustments for risk is not representative of fair value.
While helpful in identifying the factors entities should consider in assessing whether a
transaction price would equal fair value, the examples provided in the standard are not
intended to be exhaustive.
13.2 Day one gains and losses
IFRS 13’s measurement framework applies to initial fair value measurements, if
permitted or required by another IFRS. At initial recognition, if the measurement of fair
value in accordance with IFRS 13 and the transaction price differ, the entity recognises
the resulting gain or loss in profit or loss unless the related IFRS (i.e. the IFRS that
permits or requires the initial measurement at fair value) specifies otherwise. [IFRS 13.60].
As noted in Example 14.21 below, IFRS 9 has specific requirements with regard to the
recognition of inception (or ‘day one’) gains and losses for financial instruments within
the scope of the standard (see Chapter 45). In developing IFRS 13, the IASB did not
change the recognition threshold in those standards in relation to day one gains or
losses. However, IFRS 9 was amended to clarify that an entity: (i) measures the fair value
of financial instruments at initial recognition in accordance with IFRS 13, then; (ii)
considers the requirements of IFRS 9 in determining whether (and when) the resulting
1030 Chapter 14
difference (if any) between fair value at initial recognition and the transaction price is
recognised. [IFRS 13.BC138].
13.2.1
Day one losses for over-the-counter derivative transactions
The definition of fair value as an exit price affects the accounting by retail customers as
much as financial institutions (i.e. dealers). For example, retail customers whose entry and
exit market for a financial asset (or financial liability) measured at fair value is with a
wholesaler (e.g. a dealer) could experience a day one loss, because the price at which a
wholesaler would sell a financial asset to a retail customer would generally exceed the price
a wholesaler would pay to acquire that financial asset from a retail customer (this difference
in price is commonly referred to as the bid-ask spread in many financial markets).
The following example from IFRS 13 discusses how an interest rate swap at initial
recognition may be measured differently by a retail counterparty (i.e. an end-user) and
a dealer. [IFRS 13.IE24-26].
Example 14.21: Interest rate swap at initial recognition
Entity A (a retail counterparty) enters into an interest rate swap in a retail market with Entity B (a dealer) for
no initial consideration (i.e. the transaction price is zero). Entity A can access only the retail market. Entity B
can access both the retail market (i.e. with retail counterparties) and the dealer market (i.e. with dealer
counterparties).
From the perspective of Entity A, the retail market in which it initially entered into the swap is the principal
market for the swap. If Entity A were to transfer its rights and obligations under the swap, it would do so with a
dealer counterparty in that retail market. In that case the transaction price (zero) would represent the fair value
of the swap to Entity A at initial recognition, i.e. the price that Entity A would receive to sell or pay to transfer
the swap in a transaction with a dealer counterparty in the retail market (i.e. an exit price). That price would not
be adjusted for any incremental (transaction) costs that would be charged by that dealer counterparty.
From the perspective of Entity B, the dealer market (not the retail market) is the principal market for the
swap. If Entity B were to transfer its rights and obligations under the swap, it would do so with a dealer in
that m
arket. Because the market in which Entity B initially entered into the swap is different from the
principal market for the swap, the transaction price (zero) would not necessarily represent the fair value of
the swap to Entity B at initial recognition. If the fair value differs from the transaction price (zero), Entity B
applies IFRS 9 to determine whether it recognises that difference as a gain or loss at initial recognition.
This example seems to indicate that a retail counterparty may not have any gain or loss
at initial recognition because the retail counterparty would likely be presumed to
transact both at inception and on disposal (i.e. a hypothetical exit) in the same principal
market (i.e. the retail market with securities dealers). However, this example does not
address the bid-ask spread.
The bid-ask spread is the difference between the price a prospective dealer is willing to
pay for an instrument (the ‘bid’ price) and the price at which the dealer would sell that
same instrument (the ‘ask’ price), allowing the dealer to earn a profit for its role as a
‘market maker’ in the over-the-counter marketplace. The bid-ask spread may differ by
dealer, as well as by the market and type of instrument that is being transacted.
IFRS 13 requires that instruments that trade in markets with bid-ask spreads (e.g. a
dealer market) be measured at the price within the bid-ask spread that is most
representative of fair value in the circumstances (pricing within the bid-ask spread is
discussed further at 15.3 below). Therefore, an inception loss could be experienced by
the retail counterparty due to a difference in the price within the bid-ask spread that
Fair value measurement 1031
the retail counterparty could hypothetically exit the instrument and the price within the
bid-ask spread that the retail counterparty actually transacted.
The IASB has acknowledged that the fair value of an interest rate swap may differ from
its transaction price because of the bid-ask spread, even when the entry and exit
markets for the swap are identical. [IFRS 13.BC165]. In addition to the bid-ask spread, retail
counterparties may recognise additional losses or expenses at the inception of
derivative contracts. For example, if the transaction price for a complex derivative
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