Fair Value Option

6 Months Ended

Jun. 30, 2017

We have elected the fair value option ("FVO") for certain issuances of our fixed rate debt in order to align our accounting treatment with that of HSBC under International Financial Accounting Standards ("IFRSs"). Electing FVO accounting for the same issuances of fixed rate debt under U.S. GAAP and IFRSs, allows us to simplify the accounting model applied to these fixed rate debt issuances. The following table summarizes fixed rate debt issuances accounted for under FVO:



	June 30, 2017		December 31, 2016
	(in millions)
Fixed rate debt accounted for under FVO reported in:
Long-term debt	$	250	$	1,317
Due to affiliates	487		485
Total fixed rate debt accounted for under FVO	$	737	$	1,802

Unpaid principal balance of fixed rate debt accounted for under FVO⁽¹⁾	$	665	$	1,712


⁽¹⁾	Balance includes a foreign currency translation adjustment relating to our foreign denominated FVO debt which decreased the debt balance by $11 million at June 30, 2017 and decreased the debt balance by $310 million at December 31, 2016.

We determine the fair value of the fixed rate debt accounted for under FVO through the use of a third party pricing service. Such fair value represents the full market price (including credit and interest rate impacts) based on observable market data for the same or similar debt instruments. See Note 11, "Fair Value Measurements," for a description of the methods and significant assumptions used to estimate the fair value of our fixed rate debt accounted for under FVO.

The following table summarizes the components of the gain on debt designated at fair value and related derivatives reflected in the consolidated statement of income (loss) for the three and six months ended June 30, 2017 and 2016:



	Three Months Ended June 30,						Six Months Ended June 30,
	2017			2016			2017			2016
	(in millions)
Mark-to-market on debt designated at fair value⁽¹⁾:
Interest rate component	$	8		$	12		$	26		$	18
Credit risk component⁽²⁾	—			8			—			19
Total mark-to-market on debt designated at fair value	8			20			26			37
Mark-to-market on the related derivatives⁽¹⁾⁽³⁾	(11		)	(15		)	(26		)	(24		)
Net realized gains on the related derivatives⁽¹⁾	7			11			16			27
Gain on debt designated at fair value and related derivatives	$	4		$	16		$	16		$	40


⁽¹⁾	The derivatives associated with debt designated at fair value are economic hedges but do not qualify for hedge accounting. See Note 6, "Derivative Financial Instruments," for additional discussion of these non-qualifying hedges.

⁽²⁾

As discussed below and more fully in Note 13, "New Accounting Pronouncements," beginning January 1, 2017, the fair value movement on fair value option debt attributable to our credit spreads is recorded in common equity as a component of other comprehensive income (loss). For the three and six months ended June 30, 2017, the fair value movement on fair value option debt attributable to our credit spreads was a gain of less than $1 million and loss of $8 million, respectively.

⁽³⁾

Mark-to-market on debt designated at fair value and related derivatives excludes market value changes due to fluctuations in foreign currency exchange rates. Foreign currency translation gains (losses) recorded in derivative related income (expense) associated with debt designated at fair value was a loss of $51 million and a gain of $20 million for the three months ended June 30, 2017 and 2016, respectively, and a loss of $72 million and a loss of $46 million for the six months ended June 30, 2017 and 2016, respectively. Offsetting gains (losses) recorded in derivative related income (expense) associated with the related derivatives was a gain of $51 million and a loss of $20 million for the three months ended June 30, 2017 and 2016, respectively and a gain of $72 million and a gain of $46 million for the six months ended June 30, 2017 and 2016, respectively.

Prior to January 1, 2017, changes in the fair value of fair value option debt and the value of the related derivatives, including changes in fair value related to interest rates, credit and other risks as well as any realized gains or losses on those derivatives, were reported in gain on debt designated at fair value and related derivatives in the consolidated statement of income (loss). As discussed more fully in Note 13, "New Accounting Pronouncements," beginning January 1, 2017, the fair value movement on fair value debt attributable to our credit spreads is recorded in common equity as a component of other comprehensive income.

Differences arise between the movement in the fair value of the debt and the fair value of the related derivative due to the different credit characteristics and differences in the calculation of fair value for debt and derivatives. The size and direction of the accounting consequences of such changes can be volatile from period to period but do not alter the cash flows intended as part of our interest rate management strategy. On a cumulative basis, we have recorded fair value option adjustments which increased the value of our long-term debt and due to affiliates balances in total by $72 million and $90 million at June 30, 2017 and December 31, 2016, respectively.

- Definition

The entire disclosure for a company's election to apply the fair value option for measurement and reporting of eligible financial assets and liabilities (as defined), as well as certain other eligible items (as defined) included in the statement of financial position, whether such option is elected for a single eligible item or a group of similar eligible items and is in addition to other disclosures concerning fair value which the company may be required to provide. Such disclosure might be expected to include: (1) for items included in the statement of financial position: (a) the reasons for electing a fair value option for each eligible item or group of similar eligible items; (b) if the fair value option is elected for some but not all eligible items within a group of similar eligible items: (i) a description of those similar items and the reasons for partial election and (ii) information of how the group of similar items relates to individual balance sheet line items; (c) for each line item in the statement of financial position that includes an item or items for which the fair value option has been elected: (i) information of how each line item in the statement of financial position relates to major categories of assets and liabilities presented in accordance with other fair value disclosures and (ii) the aggregate carrying amount of ineligible items included in each line item in the balance sheet, if any; (d) the difference between the aggregate fair value and the aggregate unpaid principal balance (assuming contractual principal amounts and fair value option elected) of: (i) loans and long-term receivables (other than securities otherwise reported at fair value) and (ii) long-term debt instruments; (e) for loans held as assets for which the fair value option has been elected: (i) the aggregate fair value of loans that are 90 days or more past due, (ii) if the policy is to recognize interest income separately from other changes in fair value, the aggregate fair value of loans in nonaccrual status, and (iii) the difference between the aggregate fair value and the aggregate unpaid principal balance for loans that are 90 days or more past due, in nonaccrual status, or both; (f) for investments that would have been accounted for under the equity method if the entity had not chosen to apply the fair value option, the information required for such investments, if material either individually or in the aggregate; (2) for items included in the income statement: (a) the amounts of gains and losses from fair value changes included in earnings and in which line in the income statement those gains and losses are reported whether or not combined with gains and losses from items required to be accounted for at fair value; (b) a description of how interest and dividends are measured and where they are reported in the income statement; (c) for loans and other receivables held as assets: (i) the estimated amount of gains or losses included in earnings attributable to changes in instrument-specific credit risk and (ii) how the gains or losses attributable to changes in instrument-specific credit risk were determined; (d) for liabilities with fair values that have been significantly affected during the reporting period by changes in the instrument-specific credit risk: (i) the estimated amount of gains and losses from fair value changes included in earnings that are attributable to changes in the instrument-specific credit risk, (ii) qualitative information about the reasons for those changes, and (iii) how the gains and losses attributable to changes in instrument-specific credit risk were determined; and (3) certain other disclosures as required or determined to be provided.

+ References + Details