Use of derivative financial instruments / hedge accounting

6 Use of derivative financial instruments / hedge accounting

Use of derivative financial instruments

Derivative financial instruments are used in both the trading and banking books (in the banking book for hedging purposes as part of asset & liability management and equity securities in financial investments). Transactions are also carried out for the account of clients. Derivative financial instruments are traded only by the two organisational units Trading & Treasury Services and Structured Products Trading. Proprietary and client trading (including on a commission basis) takes place with standardised exchange-traded and OTC instruments on interest rates, currencies, equity securities/indices, precious metals and commodities. Derivative financial instruments can also be used as parts of structured products (e.g. dual currency investments and discount certificates). Structured products within the meaning of Art. 18 para. 1 FINMA AO consist of an underlying instrument and an embedded derivative. In the case of self-issued structured products, the derivative is separated from the underlying instrument and valued and accounted for separately, provided that:

there is no close connection between the economic characteristics and risks of the embedded derivative and the underlying instrument,
the structured product as a whole does not meet the terms and conditions for recognition as a trading transaction or the fair value option is not selected, and
the embedded derivative as a stand-alone instrument meets the definition of a derivative financial instrument.

The bonds (underlying instrument) are recognised at nominal value under ‘Bond issues and central mortgage institution loans’. The derivative component is recognised at fair value in the balance sheet item ‘Positive replacement values of derivative financial instruments’ or ‘Negative replacement values of derivative financial instruments‘.

Income from self-issued structured products is recognised under ‘Result from trading activities and the fair value option’.

Hedge accounting

Hedge accounting is used to hedge interest-rate risk positions in the banking book as part of asset & liability management and against fluctuations in the value of equity securities in financial investments.

Hedging interest-rate risks in the banking book

Derivative financial instruments are used to manage the impact of future interest rate changes. Interest rate risks of interest rate-sensitive positions in the banking book are hedged by interest rate swaps and interest rate futures.

The hedging relationship as well as the objectives and strategy for hedging instruments are documented when the transaction is concluded, while the effectiveness of the hedging is periodically reviewed. For this purpose, assets and liabilities are considered separately. Hedging is classified as ‘effective’ if the present value of the derivative financial instruments changes in the opposite direction to that of the hedged group of underlying transactions. If this is not the case, the hedges are classified as ineffective and the excess portion of the derivative instrument is recognised under ‘Result from trading activities and the fair value option’.

Interest rate swaps are concluded between the trading book and the banking book to hedge interest rate risks. The treatment of these is described in Section ‘Detailed provisions‘ under ‘Positive and negative replacement values of derivative financial instruments‘.

Hedging of fluctuations in the value of equity securities in financial investments

Futures sold or put options purchased on the SMI, SLI or DAX indices on the stock exchange qualify as hedging instruments for equity securities denominated in Swiss francs or euros in financial investments. The ratio of the contract value of the hedging instruments (delta-weighted for options) to the market values of the hedged equities (adjusted by the ratio of book to market values calculated at the time of the hedging trigger as well as by the beta) must be between 50 % and 150 % during the tenor of the hedge. If the ratio moves outside this range, the hedging transaction is considered ineffective and is reclassified as a trading transaction.

Situation on the balance sheet date

As in the previous year, no hedging transactions had to be classified as ineffective on the balance sheet date.