Derivative Financial Instruments

In the normal course of business, the derivative instruments we enter into are for trading, market making and risk management purposes. For financial reporting purposes, derivative instruments are designated in one of the following categories: (a) hedging instruments designated as qualifying hedges under derivative and hedge accounting principles, (b) financial instruments held for trading or (c) non-qualifying economic hedges. The derivative instruments held are predominantly swaps, futures, options and forward contracts. All derivatives are stated at fair value. Where we enter into enforceable master netting agreements with counterparties, the master netting agreements permit us to net those derivative asset and liability positions and to offset cash collateral held and posted with the same counterparty.

The following table presents the fair value of derivative contracts by major product type on a gross basis. Gross fair values exclude the effects of both counterparty netting as well as collateral, and therefore are not representative of our exposure. The table below also presents the amounts of counterparty netting and cash collateral that have been offset in the consolidated balance sheet, as well as cash and securities collateral posted and received under enforceable master netting agreements that do not meet the criteria for netting. Derivative assets and liabilities which are not subject to an enforceable master netting agreement, or are subject to a netting agreement where an appropriate legal opinion to determine such agreements are enforceable has not been either sought or obtained, have not been netted in the table below. Where we have received or posted collateral under netting agreements where an appropriate legal opinion to determine such agreements are enforceable has not been either sought or obtained, the related collateral also has not been netted in the table below.



	September 30, 2018				December 31, 2017
	Derivative Assets		Derivative Liabilities		Derivative Assets		Derivative Liabilities
	(in millions)
Derivatives accounted for as fair value hedges⁽¹⁾
OTC-cleared⁽²⁾	$	—	$	—	$	84	$	390
Bilateral OTC⁽²⁾	—		73		—		134
Interest rate contracts	—		73		84		524
Derivatives accounted for as cash flow hedges⁽¹⁾
Foreign exchange contracts - bilateral OTC⁽²⁾	37		—		10		—
OTC-cleared⁽²⁾	—		—		4		86
Bilateral OTC⁽²⁾	4		7		—		22
Interest rate contracts	4		7		4		108
Total derivatives accounted for as hedges	41		80		98		632
Trading derivatives not accounted for as hedges⁽³⁾
Exchange-traded⁽²⁾	3		145		6		59
OTC-cleared⁽²⁾	61		17		11,905		10,526
Bilateral OTC⁽²⁾	9,586		10,098		11,549		12,997
Interest rate contracts	9,650		10,260		23,460		23,582
Exchange-traded⁽²⁾	—		21		4		—
OTC-cleared ⁽²⁾	—		6		—		—
Bilateral OTC⁽²⁾	15,433		14,563		15,746		14,666
Foreign exchange contracts	15,433		14,590		15,750		14,666
Equity contracts - bilateral OTC⁽²⁾	3,124		3,091		2,820		2,806
Exchange-traded⁽²⁾	64		51		52		108
Bilateral OTC⁽²⁾	774		800		502		613
Precious metals contracts	838		851		554		721
OTC-cleared⁽²⁾	230		242		67		75
Bilateral OTC⁽²⁾	709		663		589		485
Credit contracts	939		905		656		560
Other non-qualifying derivatives not accounted for as hedges⁽¹⁾
OTC-cleared⁽²⁾	—		—		519		60
Bilateral OTC⁽²⁾	111		308		170		164
Interest rate contracts	111		308		689		224
Foreign exchange contracts - bilateral OTC⁽²⁾	5		5		—		—
Equity contracts - bilateral OTC⁽²⁾	1,122		286		1,264		145
Precious metals contracts - bilateral OTC⁽²⁾	—		—		—		1
Credit contracts - bilateral OTC⁽²⁾	10		11		—		24
Other contracts - bilateral OTC⁽²⁾⁽⁴⁾	6		51		6		52
Total derivatives	31,279		30,438		45,297		43,413
Less: Gross amounts of receivable / payable subject to enforceable master netting agreements⁽⁵⁾⁽⁷⁾	24,613		24,613		36,394		36,394
Less: Gross amounts of cash collateral received / posted subject to enforceable master netting agreements⁽⁶⁾⁽⁷⁾	3,433		3,517		4,480		3,823
Net amounts of derivative assets / liabilities presented in the balance sheet	3,233		2,308		4,423		3,196
Less: Gross amounts of financial instrument collateral received / posted subject to enforceable master netting agreements but not offset in the consolidated balance sheet	722		462		742		370
Net amounts of derivative assets / liabilities	$	2,511	$	1,846	$	3,681	$	2,826


⁽¹⁾	Derivative assets / liabilities related to cash flow hedges, fair value hedges and derivative instruments held for purposes other than for trading are recorded in other assets / interest, taxes and other liabilities on the consolidated balance sheet.

⁽²⁾

Over-the-counter ("OTC") derivatives include derivatives executed and settled bilaterally with counterparties without the use of an organized exchange or central clearing house. The credit risk associated with bilateral OTC derivatives is managed through obtaining collateral and enforceable master netting agreements. OTC-cleared derivatives are executed bilaterally in the OTC market but then novated to a central clearing counterparty, whereby the central clearing counterparty becomes the counterparty to each of the original counterparties. Exchange traded derivatives are executed directly on an organized exchange. Credit risk is minimized for OTC-cleared derivatives and exchange traded derivatives through daily margining requirements. During the first quarter of 2018, a central clearing counterparty amended its rules for OTC-cleared interest rate derivatives to legally re-characterize daily variation margin payments to be settlement payments as opposed to cash collateral posted. The impact of reflecting the rule change for this central clearing counterparty as of December 31, 2017 would have been a reduction in gross derivative assets and liabilities of approximately $11.5 billion and $10.3 billion, respectively, with corresponding decreases in the related counterparty and cash collateral netting.


⁽³⁾	Trading related derivative assets / liabilities are recorded in trading assets / trading liabilities on the consolidated balance sheet.


⁽⁴⁾	Consists of swap agreements entered into in conjunction with the sales of Visa Inc. ("Visa") Class B common shares ("Class B Shares").


⁽⁵⁾	Represents the netting of derivative receivable and payable balances for the same counterparty under enforceable netting agreements.


⁽⁶⁾	Represents the netting of cash collateral posted and received by counterparty under enforceable netting agreements.


⁽⁷⁾	Netting is performed at a counterparty level in cases where enforceable master netting agreements are in place, regardless of the type of derivative instrument. Therefore, we have not allocated netting to the different types of derivative instruments shown in the table above.

See Note 18, "Guarantee Arrangements, Pledged Assets and Repurchase Agreements," for further information on offsetting related to resale and repurchase agreements and securities borrowing and lending arrangements.

Derivatives Held for Risk Management Purposes Our risk management policy requires us to identify, analyze and manage risks arising from the activities conducted during the normal course of business. We use derivative instruments as an asset and liability management tool to manage our exposures in interest rate, foreign currency and credit risks in existing assets and liabilities, commitments and forecasted transactions. The accounting for changes in fair value of a derivative instrument will depend on whether the derivative has been designated and qualifies for hedge accounting.

We designate derivative instruments to offset the fair value risk and cash flow risk arising from fixed-rate and floating-rate assets and liabilities as well as forecasted transactions. We assess the hedging relationships, both at the inception of the hedge and on an ongoing basis, using a regression approach to determine whether the designated hedging instrument is highly effective in offsetting changes in the fair value or the cash flows attributable to the hedged risk. Accounting principles for qualifying hedges require us to prepare detailed documentation describing the relationship between the hedging instrument and the hedged item, including, but not limited to, the risk management objective, the hedging strategy and the methods to assess and measure the ineffectiveness of the hedging relationship. We discontinue hedge accounting when we determine that the hedge is no longer highly effective, the hedging instrument is terminated, sold or expired, the designated forecasted transaction is not probable of occurring, or when the designation is removed by us.

Fair Value Hedges In the normal course of business, we hold fixed-rate loans and securities and issue fixed-rate senior and subordinated debt obligations. The fair value of fixed-rate (U.S. dollar and non-U.S. dollar denominated) assets and liabilities fluctuates in response to changes in interest rates or foreign currency exchange rates. We utilize interest rate swaps, forward and futures contracts and foreign currency swaps to minimize our exposure to changes in fair value caused by interest rate and foreign currency volatility. The changes in the fair value of the hedged item designated in a qualifying hedge are captured as an adjustment to the carrying amount of the hedged item (basis adjustment). If the hedging relationship is terminated and the hedged item continues to exist, the basis adjustment is amortized over the remaining life of the hedged item.

We recorded basis adjustments for active fair value hedges which decreased the carrying amount of our debt by $179 million and $132 million at September 30, 2018 and December 31, 2017, respectively. During the three and nine months ended September 30, 2018, respectively, we amortized nil and $1 million of basis adjustments related to terminated and/or re-designated fair value hedges of our debt compared with $1 million and $4 million during the three and nine months ended September 30, 2017, respectively. The total accumulated unamortized basis adjustments related to terminated and/or re-designated fair value hedges amounted to a decrease in the carrying amount of our debt of $7 million at September 30, 2018 and an increase of $7 million at December 31, 2017.

We recorded basis adjustments for active fair value hedges of available-for-sale ("AFS") securities which decreased the carrying amount of the securities by $227 million at September 30, 2018 and increased the carrying amount of the securities by $279 million at December 31, 2017.

The following table presents information on gains and losses on derivative instruments designated and qualifying as hedging instruments in fair value hedges and the hedged items in fair value hedges and their locations on the consolidated statement of income:



	Gain (Loss) on Derivative						Gain (Loss) on Hedged Items						Net Ineffective Gain (Loss) Recognized
	Net Interest Income			Other Income (Loss)			Net Interest Income			Other Income (Loss)			Other Income (Loss)
	(in millions)
Three Months Ended September 30, 2018
Interest rate contracts / AFS Securities	$	(9	)	$	147		$	92		$	(142	)	$	5
Interest rate contracts / long-term debt	(18		)	5			(53		)	(5		)	—
Total	$	(27	)	$	152		$	39		$	(147	)	$	5

Three Months Ended September 30, 2017
Interest rate contracts / AFS Securities	$	(28	)	$	2		$	88		$	(2	)	$	—
Interest rate contracts / long-term debt	2			(5		)	(63		)	3			(2		)
Total	$	(26	)	$	(3	)	$	25		$	1		$	(2	)

Nine Months Ended September 30, 2018
Interest rate contracts / AFS Securities	$	(42	)	$	634		$	268		$	(616	)	$	18
Interest rate contracts / long-term debt	(38		)	(62		)	(163		)	60			(2		)
Total	$	(80	)	$	572		$	105		$	(556	)	$	16

Nine Months Ended September 30, 2017
Interest rate contracts / AFS Securities	$	(95	)	$	(59	)	$	268		$	62		$	3
Interest rate contracts / long-term debt	14			14			(197		)	(13		)	1
Total	$	(81	)	$	(45	)	$	71		$	49		$	4

Cash Flow Hedges We own or issue floating rate financial instruments and enter into forecasted transactions that give rise to variability in future cash flows. As a part of our risk management strategy, we use interest rate swaps, currency swaps and futures contracts to mitigate risk associated with variability in the cash flows. Changes in fair value of a derivative instrument associated with the effective portion of a qualifying cash flow hedge are recognized in other comprehensive income (loss). When the cash flows being hedged materialize and are recorded in income or expense, the associated gain or loss from the hedging derivative previously recorded in accumulated other comprehensive loss ("AOCI") is reclassified into earnings in the same accounting period in which the designated forecasted transaction or hedged item affects earnings. If a cash flow hedge of a forecasted transaction is de-designated because it is no longer highly effective, or if the hedge relationship is terminated, the cumulative gain or loss on the hedging derivative to that date will continue to be reported in AOCI unless it is probable that the hedged forecasted transaction will not occur by the end of the originally specified time period as documented at the inception of the hedge, at which time the cumulative gain or loss is released into earnings.

At September 30, 2018 and December 31, 2017, active cash flow hedge relationships extend or mature through July 2036. During the three and nine months ended September 30, 2018, respectively, $6 million and $15 million of losses related to terminated and/or re-designated cash flow hedge relationships were amortized to earnings from AOCI compared with losses of $5 million and $11 million during the three and nine months ended September 30, 2017, respectively. During the next twelve months, we expect to amortize $24 million of remaining losses to earnings resulting from these terminated and/or re-designated cash flow hedges. The interest accrual related to the hedging instruments is recognized in interest income.

The following table presents information on gains and losses on derivative instruments designated and qualifying as hedging instruments in cash flow hedges (including amounts recognized in AOCI from all terminated cash flow hedges) and their locations on the consolidated statement of income:



	Gain (Loss) Recognized in AOCI on Derivative (Effective Portion)						Location of Gain (Loss) Reclassified from AOCI into Income (Effective Portion)	Gain (Loss) Reclassed From AOCI into Income (Effective Portion)						Location of Gain (Loss) Recognized in Income on the Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Gain (Loss) Recognized in Income on the Derivative (Ineffective Portion)
	2018			2017				2018			2017				2018			2017
	(in millions)
Three Months Ended September 30,
Foreign exchange contracts	$	2		$	—		Net interest income	$	—		$	—		Other income (loss)	$	—		$	—
Interest rate contracts	$	21		$	(3	)	Net interest income	$	(6	)	$	(5	)	Other income (loss)	$	(1	)	$	—
Total	$	23		$	(3	)		$	(6	)	$	(5	)		$	(1	)	$	—

Nine Months Ended September 30,
Foreign exchange contracts	$	(4	)	$	—		Net interest income	$	—		$	—		Other income (loss)	$	—		$	—
Interest rate contracts	33			(14		)	Net interest income	(15		)	(11		)	Other income (loss)	(1		)	—
Total	$	29		$	(14	)		$	(15	)	$	(11	)		$	(1	)	$	—

Trading Derivatives and Non-Qualifying Hedging Activities In addition to risk management, we also enter into derivative contracts, including buy- and sell-protection credit derivatives, for the purposes of trading and market making, or repackaging risks to form structured trades to meet clients' risk taking objectives. Additionally, we buy or sell securities and use derivatives to mitigate the market risks arising from our trading activities with our clients that exceed our risk appetite. We also use buy-protection credit derivatives to manage our counterparty credit risk exposure. Where we enter into derivatives for trading purposes, realized and unrealized gains and losses are recognized in trading revenue. Counterparty credit risk associated with OTC derivatives, including risk-mitigating buy-protection credit derivatives, are recognized as an adjustment to the fair value of the derivatives and are recorded in trading revenue.

Our non-qualifying hedging and other activities include:


•	Derivative contracts related to the fixed-rate long-term debt issuances and hybrid instruments, including all structured notes and deposits, for which we have elected fair value option accounting. These derivative contracts are non-qualifying hedges but are considered economic hedges.


•	Credit default swaps which are designated as economic hedges against the credit risks within our loan portfolio. In the event of an impairment loss occurring in a loan that is economically hedged, the impairment loss is recognized as provision for credit losses while the gain on the credit default swap is recorded as other income (loss).

•

Swap agreements entered into in conjunction with the sales of Visa Class B Shares to a third party to retain the litigation risk associated with the Class B Shares sold until the related litigation is settled and the Class B Shares can be converted into Class A common shares ("Class A Shares"). See Note 18, "Guarantee Arrangements, Pledged Assets and Repurchase Agreements," for additional information.

Derivative instruments designated as economic hedges that do not qualify for hedge accounting are recorded at fair value through profit and loss. Realized and unrealized gains and losses on economic hedges are recognized in gain on instruments designated at fair value and related derivatives or other income (loss) while the derivative asset or liability positions are reflected as other assets or other liabilities.

The following table presents information on gains and losses on derivative instruments held for trading purposes and their locations on the consolidated statement of income:



	Location of Gain (Loss) Recognized in Income on Derivatives	Amount of Gain (Loss) Recognized in Income on Derivatives
		Three Months Ended September 30,					Nine Months Ended September 30,
		2018		2017			2018		2017
		(in millions)
Interest rate contracts	Trading revenue	$	65	$	(52	)	$	394	$	(249	)
Foreign exchange contracts	Trading revenue	105		116			33		185
Equity contracts	Trading revenue	11		1			10		—
Precious metals contracts	Trading revenue	44		50			259		161
Credit contracts	Trading revenue	10		(41		)	6		(87		)
Total		$	235	$	74		$	702	$	10

The following table presents information on gains and losses on derivative instruments held for non-qualifying hedging and other activities and their locations on the consolidated statement of income:



	Location of Gain (Loss) Recognized in Income on Derivatives	Amount of Gain (Loss) Recognized in Income on Derivatives
		Three Months Ended September 30,						Nine Months Ended September 30,
		2018			2017			2018			2017
		(in millions)
Interest rate contracts	Gain on instruments designated at fair value and related derivatives	$	(68	)	$	14		$	(284	)	$	89
Foreign exchange contracts	Gain on instruments designated at fair value and related derivatives	(1		)	8			(11		)	11
Equity contracts	Gain on instruments designated at fair value and related derivatives	276			342			104			863
Credit contracts	Other income (loss)	(9		)	(9		)	1			(39		)
Other contracts⁽¹⁾	Other income (loss)	(5		)	(5		)	(19		)	(7		)
Total		$	193		$	350		$	(209	)	$	917


⁽¹⁾	Consists of swap agreements entered into in conjunction with the sales of Visa Class B Shares.

Credit-Risk Related Contingent Features The majority of our derivative contracts contain provisions that require us to maintain a specific credit rating from each of the major credit rating agencies. Sometimes the derivative instrument transactions are a part of broader structured product transactions. If our credit ratings were to fall below the current ratings, the counterparties to our derivative instruments could demand us to post additional collateral. The amount of additional collateral required to be posted will depend on whether we are downgraded by one or more notches. The aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a liability position at September 30, 2018 was $1,073 million, for which we had posted collateral of $666 million. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position at December 31, 2017 was $1,063 million, for which we had posted collateral of $758 million. Substantially all of the collateral posted is in the form of cash or securities available-for-sale. See Note 18, "Guarantee Arrangements, Pledged Assets and Repurchase Agreements," for further details.

The following table presents the amount of additional collateral that we would be required to post (from the current collateral level) related to derivative instruments with credit-risk related contingent features if our long-term ratings were downgraded by one or two notches. A downgrade by a single rating agency that does not result in a rating lower than a preexisting corresponding rating provided by another rating agency will generally not result in additional collateral.



	One-notch downgrade		Two-notch downgrade
	(in millions)
Amount of additional collateral to be posted upon downgrade	$	34	$	53

Notional Value of Derivative Contracts The following table summarizes the notional values of derivative contracts:



	September 30, 2018		December 31, 2017
	(in millions)
Interest rate:
Futures and forwards	$	783,526	$	735,757
Swaps	3,088,381		2,687,273
Options written	102,741		77,144
Options purchased	118,183		93,042
	4,092,831		3,593,216
Foreign exchange:
Swaps, futures and forwards	1,006,804		924,163
Options written	28,800		25,911
Options purchased	29,183		26,617
Spot	49,821		19,401
	1,114,608		996,092
Commodities, equities and precious metals:
Swaps, futures and forwards	49,408		38,709
Options written	31,982		31,631
Options purchased	43,710		43,202
	125,100		113,542
Credit derivatives	101,098		90,290
Other contracts⁽¹⁾	838		644
Total	$	5,434,475	$	4,793,784


⁽¹⁾	Consists of swap agreements entered into in conjunction with the sales of Visa Class B Shares.