Published online by Cambridge University Press: 15 September 2022
Sometimes, financial institutions and other similar reporting entities manage a group of financial assets and financial liabilities (a portfolio) on the basis of the net exposure to market risks or to credit risk (of a particular counterparty). This means a portfolio that includes financial assets and financial liabilities with risks that offset one another, which is done intentionally (rather than arbitrarily or incidentally).
As a rule, fair value is measured at the level of the relevant unit of account. Normally the unit of account of financial instruments is an individual instrument (for more details, see Chapter 3, Section 3). The offset (netting) of mutual exposures within the portfolio (e.g., offsetting a mutual credit risk) is an entity-specific characteristic rather than a separate characteristic of each of the portfolio's instruments. Therefore, it cannot be taken into account in the measurement of fair value in an ordinary situation. This means that if a portfolio has a shared characteristic that causes a certain risk to be mitigated or diversified, such as a master netting agreement (for more information, see Chapter 10, Section 5.3), this characteristic will generally not be taken into consideration in a fair value measurement of its components. Furthermore, even if from the perspective of a market participant it made sense to transfer the financial assets along with the financial liabilities, the Standards reject the joint valuation premise when it comes to financial instruments (for more information, see Chapter 9, Section 3), and therefore, such an assumption should not be made.
In other words, according to the ordinary principles established by the Standards, each of the exposures within the portfolio should be estimated separately (on a gross basis). Indeed, this accounting treatment may be different from the reporting entity's internal risk management and may even require the reporting entity to maintain a dual system: one for risk management purposes (based on net exposures) and another to estimate the risk for financial statement purposes.