BNP tags €10bn of equity derivatives as hard-to-value

Over 12% of BNP Paribas’s €80 billion ($94.3 billion) of equity derivatives exposures were classified as mark-to-model as of end-June, as skittish markets and blurry forward curves complicated valuations.

Equity derivatives tagged as Level 3 – an accounting category reserved for complex, illiquid exposures –  totalled €10.2 billion in Q2, up 28% from end-December. Of these, €3.2 billion had positive fair values and €7 billion negative fair values. 

Equity derivatives classified as Level 1, meaning they were valued using market prices, increased 78% to €26.3 billion over the first half of the year. Level 2 equity derivatives, valued using other observable inputs, increased 13% to €43.5 billion.


Overall, the net fair value of BNP’s equity derivatives portfolio was -€8.8 billion, compared to -€10.4 billion at end-December. Total exposures increased 31% over this period.

BNP’s other derivatives portfolios had fewer assets or liabilities designated as Level 3. Just 1% of interest rate derivatives exposures were classified as such, and 7% of credit derivatives.

The French bank’s equity derivatives book has been a source of pain through the coronavirus crisis. Equity and prime services revenues totalled €290 million for Q2, down 53% year-on-year, but an improvement on the €87 million loss recorded in Q1.

Across its fair valued asset portfolio as a whole, BNP Paribas said Level 3 instruments made up less than 2% of the €574.8 billion total. Level 3 instruments made up 4% of fair value liabilities.

The bank transferred €2.2 billion of fair value assets into Level 3 over the first half, and €4.9 billion of liabilities.

What is it?

Financial assets are typically valued at either fair value or amortised cost in banks’ accounts. Fair value assets are priced at their estimated potential market price.

Those calculated in reference to actual quoted prices are designated Level 1, those to other observable inputs Level 2, and those to unobservable inputs Level 3.

At BNP Paribas, Level 3 equity derivatives are those that are long-dated forward or volatility products or exposures where there is a limited market for optional products. They also include equity-hybrid correlation products

Level 3 valuation inputs for these include data points from the extrapolation of forward curves and volatility surfaces, or alternatively, those based on proxy or historical analysis.

Why it matters

BNP Paribas incurred a painful €184 million hit in Q1 when a portfolio of derivatives linked to stock dividends blew up, as companies held back pre-announced dividends when the extent of the coronavirus-induced recession became clear.

These extraordinary decisions, coupled with ongoing uncertainty as to equity markets’ resilience in the face of the ongoing pandemic, make valuing complex derivatives and structured products challenging – explaining the migration of a large chunk of BNP’s portfolio into the mark-to-model pen.

These positions are a source of valuation uncertainty. The bank said negative changes to the assumptions used to value these could take up to €230 million out of income.

That’s a sizeable potential liability, which perhaps goes some way towards explaining why Jean-Laurent Bonnafé, the firm’s chief executive officer, said the bank would be managing the equity derivatives portfolio “conservatively” going forwards.

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