LONDON, Jan 14 (IFR) - JP Morgan has recorded a US$1.5bn
loss as a result of implementing a framework for funding
valuation adjustments (FVA) in its derivatives and structured
notes portfolios, in a further sign of the growing prominence of
the controversial measure among the dealer community.
Banks have been working behind the scenes for several years
on developing their own frameworks for calculating FVA - a
measure used to account for the cost of bank funding in
uncollateralised derivatives positions - in order to accurately
price and value transactions.
Marianne Lake, JP Morgan's CFO, noted on a call with
analysts today that there has been no broad consensus so far on
whether funding should be incorporated into valuation estimates
for derivatives. However, she said the firm believes market
practices have noticeably evolved over the course of 2013.
"We've now accumulated compelling evidence both from
transactions as well as industry pricing services that dealers
are pricing funding into uncollateralised derivatives with a
degree of consistency. This supports incorporating an FVA
framework this quarter," said Lake.
The bank indicated the sizeable quarterly loss would be a
one-off event as it incorporated the FVA framework into the
valuation of its portfolios. From now on, FVA will be factored
into derivatives valuations at the inception of a trade. This
should significantly reduce JP Morgan's sensitivity to funding
spreads going forward, Lake said.
JP Morgan described FVA as a spread over Libor, which had
the effect of "present valuing" - in other words, marking to
market - a contract's funding costs rather than accruing these
costs over the lifetime of the derivative. FVA is only applied
to uncollateralised transactions; collateralised derivatives
effectively fund themselves using the collateral backing the
The FVA will vary depending on the size and tenor of the
transaction, as well as the bank's own cost of funding. By way
of example, Lake said if a bank held derivatives receivables net
of cash and securities collateral of approximately US$50
billion, applying an average duration of approximately five
years and a spread of approximately 50 basis points, that would
account for about a billion dollars plus or minus the
As a result of adopting the new framework, JP Morgan expects
the volatility of profits and losses associated with FVA and
debit valuation adjustments (DVA) - another measurement that
overlaps with FVA - to be lower going forward.
FVA has sparked a lively debate in the derivatives world.
Noted academic John Hull has argued that FVA should not be
included in valuing derivatives as it moves away from
risk-neutral pricing, while banks counter that it represents a
real cost of doing business, and a substantial one at that. RBS,
one of a handful of firms that has started making public
disclosures, mentioned an FVA of £475m in its 2012 annual
Other industry professionals have criticised the lack of
transparency around factoring FVA into derivatives valuations,
and have called for the creation of a simplified market
(For more from IFR Magazine, go to www.ifre.com)