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Rothschild & Co | Annual Report 2017
3 Derivative instruments and hedge accounting
DERIVATIVES
Derivatives are entered into for trading or risk management purposes. Derivatives used for risk management are recognised as hedging instruments when
they qualify as such under IAS 39.
Derivatives are initially recognised at fair value and are subsequently measured at fair value with changes in fair value recognised in the income statement.
If there is a designated hedging relationship between a hedging instrument and a hedged item, the recognition of the profit or loss on the hedging instrument
and the hedged instrument must comply with the conditions of IAS 39, depending on the hedging relationship.
HEDGE ACCOUNTING
The Group may apply hedge accounting when transactions meet the criteria set out in IAS 39. At the inception of the hedge, the Group assesses whether
the hedging derivatives meet the effectiveness criteria of IAS 39 in offsetting changes in the fair value or cash flows of the hedged items. The Group then
documents the relationship between the hedging instrument and the hedged item. It also records its risk management objectives, its strategy for undertaking
the hedge transaction and the methods used to assess the effectiveness of the hedging relationship.
After inception, effectiveness is tested on an ongoing basis. Hedge accounting is discontinued when it is determined that a derivative has ceased to be
highly effective, or when the derivative or the hedged item is derecognised, or when the forecast transaction is no longer expected to occur.
FAIR VALUE HEDGE ACCOUNTING
Changes in value of fair value hedge derivatives are recorded in the income statement, together with fair value changes to the underlying hedged item in
respect of the risk being hedged.
If the hedge no longer meets the criteria for hedge accounting, the difference between the carrying value of the hedged item on termination of the hedging
relationship and the value at which it would have been carried had the hedge never existed is amortised to the income statement over the residual period
to maturity based on a recalculated effective interest rate. Where the hedged item is an available-for-sale equity security, the adjustment remains in equity
until the disposal of the equity security.
NET INVESTMENT HEDGE IN FOREIGN OPERATIONS
Hedges of net investments in foreign operations are accounted for in a way similar to cash flow hedges. Any gain or loss on the hedging instrument relating
to the effective portion of the hedge is recognised in equity; the gain or loss relating to the ineffective portion is recognised immediately in the income
statement. Gains and losses accumulated in equity are transferred to the income statement when the foreign operation is disposed of.
4 Net gains or losses on financial instruments at fair value through profit or loss
The net gains or losses on financial instruments at fair value through profit or loss result from changes in the fair value of the financial assets held for
trading and financial assets designated as being at fair value through profit or loss.
5 Income from fees and commissions
The Group earns fee and commission income from services provided to clients. Fee income from advisory and other services can be divided into two broad
categories: fees earned from services that are provided over a period of time, which are recognised over the period in which the service is provided; and
fees that are earned on completion of a significant act or on the occurrence of an event, such as the completion of a transaction, which are recognised
when the act is completed or the event occurs.
The Group recognises revenue from providing services when the following criteria are met: there is persuasive evidence of an arrangement with a client;
the agreed-upon services have been provided; the amount of fees has been determined; and collection is probable.
Fees and commissions that are an integral part of a loan, and loan commitment fees for loans that are likely to be drawn down, are deferred (together with
related direct costs) and recognised over the life of the loan as an adjustment to the effective interest rate.
Portfolio and other management fees are recognised based on the applicable service contracts. Asset management fees related to investment funds are
recognised over the period the service is provided. The same principle is applied to the recognition of income from wealth management, financial planning
and custody services that are continuously provided over an extended period of time.
6 Interest income and expense
Interest receivable and payable represents all interest arising out of banking activities, including lending and deposit-taking business, interest on related
hedging transactions and interest on debt securities. Interest on all financial instruments, excluding those classified as held for trading or designated at
fair value through profit or loss, is recognised in the income statement using the effective interest rate method.
Where negative interest arises from financial assets, the negative interest income is disclosed within interest expense.
The effective interest rate is the rate that exactly discounts the estimated future cash flows of a financial instrument to its net carrying amount. It is used
to calculate the amortised cost of a financial asset or a financial liability and to allocate the interest over the relevant period (usually the expected life of the
instrument). When calculating the effective interest rate, the Group considers all contractual terms of the financial instrument (for example, prepayment
options) but does not consider future credit losses. The calculation includes any premiums or discounts, as well as all fees and transaction costs that are
an integral part of the loan.
Notes to the consolidated financial statements