Definition: Financial derivatives

Category: ECB terminology

Financial derivatives are financial instruments that are linked to a specific financial instrument, indicator or commodity, and through which specific financial risks can be traded in financial markets in their own right. Transactions in financial derivatives are treated as separate transactions rather than as integral parts of the value of underlying transactions to which they may be linked.

Transactions and positions in options, futures, swaps, forward foreign exchange contracts, credit derivatives and embedded derivatives are recorded in the balance of payments, international reserves and international investment position. For practical reasons, embedded derivatives are not distinguished from the underlying instrument to which they are linked.

Net flows associated with interest-rate derivatives are recorded as financial derivatives, not as investment income, in line with recent international agreement. The classification of specific instruments of credit derivatives should be decided on a case-by-case basis.

Initial margin payments are regarded as changes in deposits and should be recorded, if identifiable, under "other investment". The treatment of variation margin payments depends on the form of the variation margin: options-style variation margins are regarded, in principle, as changes in deposits and should be recorded, if identifiable, under "other investment". Futures-style variation margin payments are regarded, in principle, as transactions in derivatives and should be recorded under "financial derivatives".

In the case of options, the full premium (i.e. the purchase/sale price of the options and the implied service charge) is recorded.

The valuation of financial derivatives should be conducted on a marked-to-market basis.

The recording of transactions in financial derivatives takes place when the euro-area creditors and debtors enter the claim or liability in their books. Owing to practical problems involved in separating the asset and liability flows for some derivative instruments, all financial derivatives transactions in the euro-area balance of payments are recorded net. Financial derivative asset and liability positions in the international investment position statistics are recorded on a gross basis, with the exception of those financial derivatives falling into the category of reserve assets, which are recorded on a net basis.
European Union, Recommendation of the European Central Bank of 16 July 2004 on the statistical reporting requirements of the European Central Bank in the field of balance of payments and international investment position statistics, and the international reserves template (ECB/2004/16)