CFM INDOSUEZ Wealth Management - 2020 Annual Report

68 Embedded derivatives An embedded derivative is the component of a hybrid instrument that qualifies as a derivative. This termapplies only to financial liabilities and non-financial contracts. Embedded derivativesmust be accounted for separately from the host contract if the following three conditions are met: • the hybrid contract is not measured at fair value through profit or loss; • when considered separately from the host contract, the embedded item has the characteristics of a derivative; • the characteristics of the derivative are not closely related to those of the host contract. Determination of the fair value of financial instruments The fair value of financial instruments is determined by maximising the use of observable inputs. It is presented according to the hierarchy defined by IFRS 13. IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, in the main market or the most advantageous market, at the measurement date. Fair value applies to each financial asset or financial liability on an individual basis. By exception, it can be estimated by portfolio, if permitted by the risk management andmonitoring strategy and if it is subject to appropriate documentation. As a result, certain fair value inputs are calculated on a net basis when a group of financial assets and financial liabilities ismanaged on the basis of its net exposure to market or credit risk. The Group believes that the best indication of fair value is the use of quoted prices in an active market. In the absenceof suchquotations, fair value is determined by the application of valuation techniques that maximise the use of relevant observable inputs and minimise the use of unobservable inputs. When a liability is measured at fair value through profit or loss (by default or option), the fair value takes into account the issuer’s own credit risk. Counterparty risk on derivatives The Group includes counterparty risk in the fair value measurement of derivative financial assets (Credit Valuation Adjustment or CVA) and, under a symmetrical approach, non-performance risk for the fair value measurement of derivative liabilities (Debit Valuation Adjustment or DVA or own credit risk). The CVA is used to determine expected losses on the counterparty from the Group’s point of view; the DVA is used to determine expected losses from the Group from the counterparty ’s point of view. The CVA/DVA calculation is based on an estimate of expected losses based on the probability of default and loss given default. Themethodology employedmaximizes the use of observable inputs. It is primarily based on market inputs such as single name CDS or index CDS in the absence of a registered CDS for the counterparty. Under certain circumstances, historical default inputs may be used. Fair value hierarchy The standard classifies fair values i​nto three levels based on the observability of inputs used in the assessment. • Level 1: fair valuesc​ orresponding to (unadjusted) prices in active markets Level 1 includes financial instruments that are directly quoted in activemarkets for identical assets and liabilities that can be accessed by the entity at the measurement date. These include stocks and bonds quoted on an active (such as the Paris Stock Exchange, the London Stock Exchange, the New York Stock Exchange, etc.), units of investment funds listed on an active market and derivatives contracted on an organisedmarket, including futures. A market is considered active if prices are readily and regularly available froma stock exchange, broker, trader, pricing service or regulatory agency and these prices represent actual transactions that regularly occur on the market under normal conditions. For financial assets and liabilities with offsettingmarket risks, theGroupusesmid-prices as abasis for determining the fair value of these positions. For net short positions, bid prices are used and for net long positions, offer prices are used. • Level 2: fair values calculated using directly or indirectly observable data, other than level 1 Thesedata aredirectly observable (i.e. prices) or indirectly observable (derived fromprice data) and generally meet the following conditions: they are non-entity-specific data that are publicly available/accessible and based on a market consensus. The following are present in level 2: • sharesandbondsquotedonamarket that isconsidered inactive, or not quoted in an active market, but for which the fair value is determined using a valuation method commonly used bymarket participants (such as discounted cash flows, the Black &Scholesmodel) and based on observable market data; • instruments traded over-the-counter for which valuation isperformedwithmodels that useobservable market data, i.e. that can be obtained frommultiple sources independent of internal sources and on a regular basis. For example, the fair value of interest rate swaps is generally determined using yield curves based on market interest rates prevailing at the reporting date. When themodels used are based particularly on standard