DERIVATIVE FINANCIAL INSTRUMENTS

12 Months Ended

Dec. 31, 2017

Disclosure of derivative financial instruments [text block] [Abstract]

Disclosure of derivative financial instruments [text block]

NOTE 16: DERIVATIVE FINANCIAL INSTRUMENTS

The fair values and notional amounts of derivative instruments are set out in the following table:

	31 December 2017						31 December 2016
	Contract/ notional amount £m		Fair value assets £m		Fair value liabilities £m		Contract/ notional amount £m		Fair value assets £m		Fair value liabilities £m
Trading and other
Exchange rate contracts:
Spot, forwards and futures		31,716		1,023		789		38,072		1,149		1,383
Currency swaps		223,624		3,157		3,534		288,441		6,903		6,382
Options purchased		8,191		580		–		15,192		808		–
Options written		6,684		–		627		18,342		–		1,016
		270,215		4,760		4,950		360,047		8,860		8,781
Interest rate contracts:
Interest rate swaps		2,264,834		15,791		15,364		2,160,535		19,780		18,862
Forward rate agreements		239,797		5		1		628,962		13		87
Options purchased		32,097		2,329		–		39,509		3,251		–
Options written		32,817		–		2,524		39,847		–		3,400
Futures		35,542		9		7		114,284		6		3
		2,605,087		18,134		17,896		2,983,137		23,050		22,352
Credit derivatives		4,568		77		423		8,098		381		659
Equity and other contracts		25,150		982		1,242		43,218		1,135		1,168
Total derivative assets/liabilities – trading and other		2,905,020		23,953		24,511		3,394,500		33,426		32,960
Hedging
Derivatives designated as fair value hedges:
Currency swaps		1,327		19		38		1,454		19		22
Interest rate swaps		109,670		1,145		407		194,416		1,462		737
		110,997		1,164		445		195,870		1,481		759
Derivatives designated as cash flow hedges:
Interest rate swaps		549,099		597		1,053		384,182		814		1,166
Futures		73,951		–		1		53,115		–		3
Currency swaps		7,310		120		114		8,121		417		36
		630,360		717		1,168		445,418		1,231		1,205
Total derivative assets/liabilities – hedging		741,357		1,881		1,613		641,288		2,712		1,964
Total recognised derivative assets/liabilities		3,646,377		25,834		26,124		4,035,788		36,138		34,924

The notional amount of the contract does not represent the Group’s real exposure to credit risk which is limited to the current cost of replacing contracts with a positive value to the Group should the counterparty default. To reduce credit risk the Group uses a variety of credit enhancement techniques such as netting and collateralisation, where security is provided against the exposure. Further details are provided in note 51 Credit risk.

The Group holds derivatives as part of the following strategies:

– Customer driven, where derivatives are held as part of the provision of risk management products to Group customers;

– To manage and hedge the Group’s interest rate and foreign exchange risk arising from normal banking business. The hedge accounting strategy adopted by the Group is to utilise a combination of fair value and cash flow hedge approaches as described in note 51; and

– Derivatives held in policyholder funds as permitted by the investment strategies of those funds.

The principal derivatives used by the Group are as follows:

– Interest rate related contracts include interest rate swaps, forward rate agreements and options. An interest rate swap is an agreement between two parties to exchange fixed and floating interest payments, based upon interest rates defined in the contract, without the exchange of the underlying principal amounts. Forward rate agreements are contracts for the payment of the difference between a specified rate of interest and a reference rate, applied to a notional principal amount at a specific date in the future. An interest rate option gives the buyer, on payment of a premium, the right, but not the obligation, to fix the rate of interest on a future loan or deposit, for a specified period and commencing on a specified future date.

– Exchange rate related contracts include forward foreign exchange contracts, currency swaps and options. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; the exchange of principal can be notional or actual. A currency option gives the buyer, on payment of a premium, the right, but not the obligation, to sell specified amounts of currency at agreed rates of exchange on or before a specified future date.

– Credit derivatives, principally credit default swaps, are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre-set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place.

– Equity derivatives are also used by the Group as part of its equity-based retail product activity to eliminate the Group’s exposure to fluctuations in various international stock exchange indices. Index-linked equity options are purchased which give the Group the right, but not the obligation, to buy or sell a specified amount of equities, or basket of equities, in the form of published indices on or before a specified future date.

Hedged cash flows

For designated cash flow hedges the following table shows when the Group’s hedged cash flows are expected to occur and when they will affect income.

2017	0-1 years £m		1-2 years £m		2-3 years £m		3-4 years £m		4-5 years £m		5-10 years  £m		10-20 years £m		Over 20 years £m		Total £m
Hedged forecast cash flows expected to occur:
Forecast receivable cash flows	346		515		682		492		395		701		55		46		3,232
Forecast payable cash flows	(475	)	(654	)	(592	)	(552	)	(406	)	(1,150	)	(627	)	(163	)	(4,619	)
Hedged forecast cash flows affect profit or loss:
Forecast receivable cash flows	307		562		648		448		466		684		63		54		3,232
Forecast payable cash flows	(680	)	(640	)	(556	)	(505	)	(377	)	(1,085	)	(612	)	(164	)	(4,619	)

2016	0-1 years £m		1-2 years £m		2-3 years £m		3-4 years £m		4-5 years £m		5-10 years £m		10-20 years £m		Over 20 years £m		Total £m
Hedged forecast cash flows expected to occur:
Forecast receivable cash flows	172		198		415		372		391		1,215		102		45		2,910
Forecast payable cash flows	(565	)	(722	)	(692	)	(599	)	(429	)	(1,541	)	(806	)	(262	)	(5,616	)
Hedged forecast cash flows affect profit or loss:
Forecast receivable cash flows	211		223		418		363		472		1,070		99		54		2,910
Forecast payable cash flows	(777	)	(713	)	(671	)	(521	)	(415	)	(1,477	)	(787	)	(255	)	(5,616	)

There were no transactions for which cash flow hedge accounting had to be ceased in 2016 or 2017 as a result of the highly probable cash flows no longer being expected to occur.