The International Valuation Standards Council (IVSC) has launched a project aimed at bringing greater consistency and understanding of the techniques used for valuing financial derivatives.

The valuations placed on the portfolios of derivative instruments held by financial institutions have been the subject of extensive scrutiny by financial regulators following the 2008 financial crisis. It is therefore the IVSC’s objective to provide greater transparency around the valuation process in order to assist management, investors and other stakeholders in understanding the valuations.

The project is being led by Ana Castañeda a member of the IVSC Standards Board and CEO of Intermoney Valora Consulting in Madrid. Ms Castañeda commented:

“There are many academic texts available on the mathematical models used for valuing derivative instruments, all of which involve complex maths. The IVSC’s role is not to endorse or explain these methods in detail but to produce a high level overview of the principles on which they are based, the key inputs and the sensitivity of different types of models to those inputs.”

The IVSC’s Technical Director, Chris Thorne added:

“Our role as a standard setter is primarily investor protection. Investors and others who rely on valuations do not need to understand how the highly technical methods used for valuing complex financial products work, but they do need to have sufficient understanding of the fundamental criteria on which they are based so that they are not taken by surprise when there is a change in those criteria.”

The IVSC Standards Board has formed an expert working group comprising of representatives of some of the major banks including UBS, Deutsche Bank and HSBC, independent consultants and buy side investors to advise it on the project.

An exposure draft for public comment is anticipated in the autumn of 2012.

Additional Information on the project

Banks and other financial institutions are required to value their interest in derivative instruments in their financial statements under the IFRSs and also in the calculation of their solvency ratios, for example under Basel III (Banks) or Solvency II (Insurers). Many investment funds hold instruments and are required to regularly report the value of their holdings to investors.

Because most derivative instruments are not traded on public exchanges where a current price can be readily observed many financial regulators have expressed concern at the lack of transparency in the way in which financial institutions calculate the reported values. This lack of transparency means that the conditions on which the valuations depend are not readily understood by senior management or investors which increases the risk associated with any decisions based on those values.

The types of derivative instrument that will be addressed by the project are equity derivatives, fixed income derivatives, credit derivatives, foreign exchange derivatives, commodity derivatives and hybrid derivatives. The intention is to examine the factors that influence the value of these instruments and how these are reflected in the models most commonly used for valuing them.

Membership of the Expert Working Group

The following are members of the Expert Working Group:

Ana Castañeda, Intermoney Valora Consulting
Paul Hawkes, UBS
Laurence Levine, McGladrey
Mark Wilson, Deutsche Bank
Chiu-Wang (Leo) Chan, US Securities and Exchange Commission
Lucas Duplá García-Pardo, CECA (Spanish Confederation of Savings Banks)
Cindy Ma, Houlihan Lokey
Laurent-Olivier Valigny, HSBC
Stuart Sarter, Legal & General Investment Management Limited

For further information on the IVSC please contact:
Marianne Tissier, Executive Director, IVSC
Tel: +44 (0)20 7374 5585