## Annex 7. Selected Financial Issues (new annex)

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### Overview and definition
- Defines a financial derivative contract as a financial instrument linked to another specific financial instrument or indicator or commodity through which specific financial risks (such as interest rate risk, foreign exchange risk, equity and commodity price risks, credit risk, and so on) can be traded in their own right in financial markets.
- Transactions and positions in financial derivatives are treated separately from the values of any underlying items to which they are linked.
- The risk embodied in a financial derivative can be traded either by trading the contract itself (as with options) or by creating a new contract that countervails the existing contract (offsetability). The outlay required to replace an existing derivative contract represents its value; actual offsetting is not required.
- Many derivatives are settled by payments of net amounts in cash; once a derivative reaches its settlement date, any unpaid overdue amount is reclassified as accounts receivable/payable as its value is fixed and the nature of the claim becomes debt.
- The following are explicitly not financial derivatives (excerpt):
  - Fixed-price contracts for goods and services, unless standardized so that the market risk can be traded in financial markets in its own right.
  - Insurance and standardized guarantees (insurance pools event risk rather than trades risk), though some guarantees other than standardized guarantees may meet the definition of financial derivatives.
  - Contingent assets and liabilities, such as one-off guarantees and letters of credit.
  - Instruments with embedded derivatives are classified according to their primary characteristics; detachable warrants are treated as separate financial derivatives.
  - Timing delays in normal business (including normal settlement periods for spot transactions) do not give rise to financial derivatives.
  - Gold swaps and most central bank swap arrangements are not financial derivatives; however, if a central bank swap arrangement follows pricing and conditions of a regular market priced swap, it should be recorded as a financial derivative.
  - Subscription rights are classified as equity rather than financial derivatives.

### Types of financial derivatives — broad classification
- Two broad types:
  - Option-type contracts: entail two payment streams — a "premium leg" (fixed payments from buyer to seller) and a "contingent leg" (payments from seller to buyer depending on the underlying asset's pricing). The contingent leg usually entails a single payment at maturity; the premium leg in standard put and call options typically is a single payment at inception.
  - Forward-type contracts: entail contingent payments between parties depending on the underlying asset’s pricing.
- Key contrasts:
  - At inception, forward-type contracts usually have no up-front payment and begin with zero value; option-type contracts usually involve a premium representing nonzero value.
  - During the life of a forward-type contract, either party can be creditor or debtor and this may change; for an option-type contract the buyer is always the creditor and the writer is always the debtor except for a credit default swap.
  - At maturity, redemption for a forward-type contract is unconditional; for an option-type contract it is determined by the buyer.

### Option-type contracts (options and warrants)
- An option gives the purchaser the right (but not the obligation) to buy (call) or sell (put) a specified underlying item at a strike price on or before a specified date; the purchaser pays a premium to the writer.
- Exchanges may act as the counterparty to options traded on derivatives exchanges.
- Warrants:
  - Give the owner the right but not the obligation to purchase from the issuer a fixed amount of an underlying asset at an agreed contract price for a specified period or on a specified date.
  - Exercise of warrants can create new securities and dilute existing capital; warrants attached to bonds to allow a lower coupon are not treated as separate financial assets.
  - Covered warrants give the holder the right, but not the obligation, to buy or sell an underlying asset at an agreed contract price for a specified period or date and may cover equities, currencies, commodities.

### Forward-type contracts (forwards, futures, swaps)
- Forward-type contracts are unconditional agreements to exchange a specified quantity of an underlying item at an agreed strike price on a specified date (examples: futures, swaps, forward rate agreements, forward foreign exchange contracts).
- Futures are forward-type contracts traded on organized exchanges with standardized terms, the exchange acting as counterparty and requiring margin.
- At inception, forward-type contracts typically have zero value; market value changes with the underlying price and may be restored to zero by periodic settlement. Asset and liability positions of derivatives may switch except for standard option contracts.
- Swap contracts:
  - Involve counterparties exchanging financial instruments or cash flows based on reference prices of underlying items.
  - Swap types classified as forward-type include foreign exchange swaps, currency swaps, interest rate swaps, and cross-currency interest rate swaps.
  - Obligations of each party under a swap may arise at different times; differing payment schedules are recorded as transactions in the financial derivative contract (e.g., quarterly vs. annual payments).
  - Other arrangements called swaps but not meeting this definition include gold swaps, central bank swap arrangements, and credit default swaps.

### Foreign currency derivatives and off‑balance sheet items
- For currency swaps, foreign exchange swaps, and foreign exchange forwards distinguish between transactions in the derivative contract and transactions in the underlying currencies:
  - At inception, parties’ exchange of underlying instruments is usually classified under other investment.
  - At settlement, differences in values of currencies swapped, measured in the unit of account at the prevailing exchange rate, are allocated to a transaction in a financial derivative, with values swapped recorded in the relevant other item (usually other investment).
- For foreign currency derivatives that could involve exchange of principal, the amount of foreign currency to be delivered at maturity is not recorded on the balance sheet; scheduled payments and receipts of foreign currencies associated with these instruments are to be compiled as described in A7.43.

### Credit derivatives
- Credit derivatives trade credit risk and take the form of both forward-type contracts (total return swaps) and option-type contracts (credit default swaps).
- Under a credit default swap, premiums are paid in return for a cash payment in the event of a default by the debtor of the underlying instrument.
- Credit derivatives are often documented under standard master legal agreements and involve collateral and margining procedures that permit market valuation.

### Margins and collateral
- Margins are payments of cash or deposits of collateral that cover actual or potential obligations incurred; margining reflects market concern over counterparty risk and is standard in derivative markets, especially futures and exchange-traded options.
- Ownership of margin remains with the depositor. Margin payments in cash are classified as deposits (if the debtor’s liabilities are included in broad money), loans, or other accounts receivable/payable.
- When a repayable margin deposit is made in a noncash asset (such as securities), no transaction is recorded because economic ownership does not change.
- In organized exchanges and clearing houses, margins are increased or decreased as a result of settling profits/losses by marking to market (often daily or intraday). Cash changes are recorded as increases/decreases in deposits, loans, or other accounts receivable/payable with a corresponding entry reducing/increasing financial derivative assets or liabilities.
- If margin falls short of the required maintenance margin, an additional margin payment must be made; such payments are not to be recorded in financial derivatives.
- These classification principles also apply to other cash collateral agreements, including margin calls on positions in other financial assets.

### Employee stock options (ESOs) and similar arrangements
- ESOs are options to buy company equity offered to employees as remuneration; they have pricing behavior similar to financial derivatives but differ in nature (granting and vesting arrangements) and purpose (employee motivation rather than risk trading).
- If a stock option granted to employees can be traded on financial markets without restriction, it is classified as a financial derivative.
- Stock options provided to suppliers of goods and services are often recorded under ESOs for convenience; corresponding entries differ (compensation of employees for employee grants; goods and services supplied for supplier grants).
- For transactions associated with the issue of ESOs, see paragraph 8.41.

### Functional category treatment and recording
- Financial transactions, positions, and income in the international accounts use five functional investment categories:
  - direct investment,
  - portfolio investment,
  - financial derivatives (other than reserves) and ESOs,
  - other investment,
  - reserve assets.
- The functional category "financial derivatives and ESOs (other than reserves)" largely coincides with the corresponding financial instrument class; financial derivatives associated with reserve asset management are excluded from this functional category and included in reserve assets.
- The category is identified separately because it relates to risk transfer rather than supply of funds or other resources.
- Unlike other functional categories, no primary income accrues on financial derivatives; amounts accruing under the contract are classified as revaluations and included in other changes in assets and liabilities.
- Recording preferences:
  - Recording financial derivatives separately as both assets and liabilities is encouraged for positions and transactions.
  - Where gross measurement is infeasible (for example when contracts switch between asset and liability positions), net reporting is acceptable by recording net payments as a reduction in liabilities for one party and a decrease in assets for the other.
- Information on financial derivatives (other than reserves) and ESOs is included in Chapters 5–9 of the manual; no investment income arises.

### Valuation and valuation principles for financial derivatives
- Financial derivatives and ESOs are valued at market prices prevailing on balance sheet recording dates.
- If market price data are unavailable, other fair value methods (such as option models or present values) may be used.
- Present value (or market price) is derived from the difference between the agreed-on contract price of an underlying item and the prevailing market price (or the market price expected to prevail), appropriately discounted.
- Option pricing depends on volatility, time to maturity, interest rates, and the difference between strike price and market price.
- Specific valuation rules:
  - Options: counterpart liability attributable, by convention, to the writer and valued at the current cost of buying out the rights of the option holder.
  - Warrants: issuer liability equals current outlay required to buy out the exercise rights of the holder.
  - Credit default swaps: difference between present value of premium payments and estimated present value of potential payments in the event of default.
  - Swap contracts: difference, appropriately discounted, between expected gross receipts and gross payments.
- Gross asset and gross liability data: compiled by summing the values of all individual contracts in asset positions and in liability positions.
- Notional value (notional amount or nominal amount): amount underlying a contract necessary for calculating payments or receipts; may or may not be exchanged and provides information about risk exposure and links to underlying items.

### Position switching and revaluation
- Market value of financial derivatives (except standard option contracts) can switch from asset to liability positions (and vice versa) between reporting dates due to underlying price movements.
- When a switch occurs with no settlement payments:
  - The market value of the gross asset or liability position at the close of the previous accounting period is revalued to zero.
  - The gross liability or asset position is revalued from zero to the market value at the end of the present accounting period.
- Any value change in financial derivatives is classified as revaluations and included in other changes for both assets and liabilities.
- For derivatives that include foreign exchange risk, separating exchange rate and other revaluation may be impractical; valuation change due to exchange rate changes can arise even in the currency of denomination. For complex instruments, a convention that all revaluation effects are due to other price revaluations may be adopted.

### Transactions versus revaluation; measurement guidance
- Cumulation of transactions should never be used to estimate financial derivative positions; transactions relate largely to option-type contracts and settlements, whereas derivative position values emerge largely from revaluation.
- ESOs:
  - Valued consistently with cumulated compensation of employees until the vesting date.
  - Thereafter valued at market prices.
  - Can be measured from market value of equivalent options or according to an options-pricing model, such as Black-Scholes.
  - International accounting standards give guidance; recording in the international accounts normally will follow business accounts.

### Recording events: inception, secondary market, servicing/margins, settlement, and ESOs
- General recording guidance:
  - Financial account entries for derivatives preferably shown separately for assets and liabilities; net settlements acceptable when gross reporting is impractical.
  - Any explicit or implicit service charges should be deducted from the value of the financial derivative; if implicit service charges cannot be distinguished, the entire value is classified as for the financial asset.
- At inception:
  - Forward-type contracts normally have zero value at inception; creation generally does not require recording a transaction in a financial derivative because risk exposures of equal value are usually exchanged. In some cases there may be a nonzero transaction value at issue.
  - Option-type purchaser pays a premium to the seller, which is the acquisition price; if premium is paid after inception, the premium value is recorded at inception and shown as financed by accounts receivable/payable between writer and purchaser.
  - Subsequent price changes are recorded as holding gains or losses (revaluation), not transactions.
- Secondary market transactions:
  - Sales of options in secondary markets are valued at market prices and recorded in the financial account as transactions in financial derivatives.
- Servicing and margins:
  - When a contract requires ongoing servicing and a cash payment is received, there is a decrease (increase) in a financial derivative asset (liability) if the contract is in an asset (liability) position at the time of payment.
  - If compilers cannot implement this approach due to market practice, all cash receipts should be recorded as reductions in financial assets and all cash payments recorded as decreases in liabilities.
  - If margins are adjusted to settle profit or loss as a result of marking to market, margin movements are recorded as increases or decreases in deposits, loans, or other accounts receivable/payable with a corresponding entry reducing financial derivative assets or liabilities.
- At settlement:
  - Cash settlement: record a transaction equal to the cash value of the settlement; receipt typically reduces a financial derivative asset, payment reduces a financial derivative liability.
  - Delivery of underlying item: record two transactions:
    1. The underlying item valued at market price at time of delivery and recorded under the relevant heading.
    2. The derivative transaction valued as the difference, multiplied by the quantity, between market price for the underlying item and the strike price specified in the derivative contract.
  - When multiple contracts are settled at the same time with the same counterparty and some are assets and some liabilities, record asset transactions separately from liabilities wherever possible; net settlements acceptable when gross reporting impractical.
- ESOs specifics:
  - ESO grant date, vesting date, exercise period, and recording:
    - Transactions in ESOs are recorded in the financial account as the corresponding entry to compensation of employees or direct investment.
    - At exercise, the transaction in the ESO is recorded at a value that reflects the difference between the market price of the equity and the price paid by the buyer for the equity.
  - Cancellation of ESOs discussed elsewhere; changes in ESOs at or after vesting date are revaluations (in practice revaluation may be recognized only at exercise date).
  - Special case: employee of a subsidiary issued options for parent-company stock — subsidiary shown as acquiring the option from the parent; if subsidiary pays nothing or an unrealistic value to the parent, a value may be imputed, possibly in direct investment.

### Classification and breakdowns of financial derivatives
- Classification options:
  1) By market risk categories: foreign exchange risk, interest rate risk, equity and commodity price risks and credit risk or risks to other underlying instruments;
  2) By instrument: options, forwards and related instruments (futures), swaps, credit derivatives, marketable ESOs, and other instruments;
  3) By trading venue and clearing status: exchange traded; over-the-counter (OTC) (cleared); OTC (not cleared).
- Market risk categories (definitions preserved):
  - (a) Foreign exchange derivatives: include outright forwards, foreign exchange swaps, currency swaps (including cross-currency interest rate swaps) and currency options; cover all contracts involving exposure to more than one currency.
  - (b) Single currency interest rate derivatives: include forward rate agreements, single-currency interest rate swaps and interest rate options (caps, floors, collars, corridors), excluding contracts involving exchange of currencies.
  - (c) Equity derivatives: returns linked to price of particular equity or index.
  - (d) Commodity derivatives: returns linked to price or price index of a commodity.
  - (e) Credit derivatives: payouts linked to creditworthiness measures; typical instruments include credit default swaps, credit-spread forwards and options, credit event or default swaps and total return swaps.
  - (f) Other derivatives: those not involving exposure to foreign exchange, interest rate, equity, commodity or credit risk (e.g., inflation-indexed derivatives, volatility derivatives, dividend derivatives, weather derivatives, property derivatives, freight derivatives, or client-specific non-standard underlying items).
- Multi-exposure products:
  - Individual derivatives may straddle more than one risk category; simple combinations should be reported separately by components.
  - Products that cannot be broken down into separable components should be reported in only one risk category, determined by the most significant underlying risk component.
  - If doubt about classification of multi-exposure derivatives, allocation should follow BIS order of precedence: commodities, equities, foreign exchange, and single-currency interest rate, credit, and other.

### Currency composition of notional values for foreign exchange-related derivatives
- In balance of payments and IIP, financial derivative contracts are recorded at market value (or fair value when market value not available).
- For foreign exchange-related derivatives (foreign exchange forwards, foreign exchange swaps, currency swaps), notional values provide useful information to assess currency exposures.
- Foreign exchange forwards, foreign exchange swaps, and currency swaps have debt-like characteristics because they may require delivery of the principal amount (i.e., notional value/amount) at maturity; these obligations are not carried on the balance sheet (nor recorded in IIP).
- The currency composition of the notional values of foreign exchange-related derivatives is to be compiled in the Tables I-III in Annex 14, along with the currency composition for debt instruments carried on the balance sheet.
- The tables for notional values of foreign exchange forwards, foreign exchange swaps, and currency swaps are memorandum items and thus required reporting; tables for notional values of foreign exchange related options are supplementary items since delivery of foreign exchange is conditional for options.
- Special properties and risks:
  - In foreign exchange swaps and currency swaps, two parties typically exchange currencies at the spot price and commit to reverse the exchange at a pre-agreed future date and price (the forward rate); once the spot transaction is complete, the position is indistinguishable from an outright forward.
  - These instruments typically require two-way payments at maturity and exchange of principal distinguishes them from other derivatives where relatively small payments reflect rate differences based on a notional amount.
  - Payment obligations from foreign exchange swaps, currency swaps and forwards can be large; contracts are typically short term and markets for these products are subject to squeezes when foreign-currency-funding conditions deteriorate (examples noted: Great Financial Crisis; March 2020 when the Covid-19 pandemic went global).
  - Under standard accounting treatments, payment obligations associated with these products are not recorded on the balance sheet.

### Role of off‑balance‑sheet payment obligations for currency profile and IIP analysis
- Additional information about future payment obligations and receipts from positions carried both on and off the balance sheet forms a more complete view of the currency profile in a country’s IIP position.
- Annex Tables XX capture off-balance sheet payment obligations from foreign exchange derivatives and are designed to be used with Annex Tables YY, which capture the currency breakdown of on-balance sheet positions.
- The combination of these tables provides more complete measures of countries’ and sectors’ external foreign currency positions, which are important in financial stability analysis.

### Post-trade activities: novation and portfolio compression (Box A7.1)
- Post-trade processes introduced or reinforced after the 2008 financial crisis include novation, clearing, portfolio compression, and collateral management; these processes are conducted by specialized infrastructure providers including central clearing counterparties (CCPs). Central clearing is required in the European Union for certain classes of derivatives.
- Recording of novation (rules and example):
  - Novation replaces a bilateral OTC contract between two market participants with two bilateral contracts between each market participant and a CCP.
  - If novation occurs immediately after the initial contract (within reporting time frame), only the novated contracts vis-à-vis the CCP need to be reported.
  - If novation is delayed, both original counterparts should report two offsetting transactions for the reference period(s): (i) terminating the initial contract (extinguishing an asset position) and (ii) creating an asset position vis-à-vis the CCP.
  - If initial parties are not clearing members, each side of the bilateral contract may be replaced by two contracts—one between the initial entity and the clearing member, and another between the clearing member and the CCP—giving rise in total to four transactions/positions.
- Novation Example 1 (numbers preserved exactly):
  - Two entities (A and B), clearing members of a CCP and resident in Country X, sign an OTC contract resulting in assets and liabilities of 100 of A and B, respectively. As both entities are resident in Country X no positions are recorded in balance of payments and IIP statistics.
  - The contract is novated to a CCP resident in Country Y, creating cross-border positions:
    - The original domestic asset and liability positions of A and B disappear.
    - The novation creates a cross-border asset position for A and a cross-border liability position for B.
    - Globally, the novation results in a doubling of positions compared with the situation before novation. The net IIPs of countries X and Y remain unchanged at 0.
  - Tabulated recording before and after novation (as presented) shows domestic assets/liabilities of 100 extinguished and cross-border assets/liabilities of 100 created.

- Recording of portfolio compression (rules and example):
  - Portfolio compression terminates derivatives and replaces them with new derivative(s) whose combined notional value is less than the terminated derivatives.
  - All counterparties involved should report offsetting transactions: (i) terminating the initial contracts and (ii) creating new asset/liability positions. Net positions should remain unchanged, but gross positions and bilateral counterparties may differ.
- Compression Example 2 (numbers preserved exactly):
  - Three entities (residents A and B, and non-resident C) compress positions outstanding at the end of the previous reporting period.
  - Entities A and B have both bilateral domestic positions and cross-border positions with non-resident C.
  - The original deals are “tore up” and replaced with new, lower volume deals that do not change net position of each entity. The termination of all previous deals should also be recorded as financial transactions.
  - Net cross-border position changes in the example:
    - Entity A: from assets of 10 to liabilities 10
    - Entity B: from liabilities of 20 to zero
    - Entity C: asset 10 before and after compression
  - Tabulated recording before and after compression (as presented) shows changes in vis-à-vis non-residents and domestic sectors consistent with the termination and creation of transactions.

### Reverse transactions — definition, major types, and recording
- Reverse transactions: change of legal ownership of securities, gold, or other assets with a commitment to repurchase the same or similar assets at a future date or with open maturity (major types: securities repurchase agreements, gold swaps, securities lending, gold loans).
- Economic treatment:
  - Commitment to reverse means original owner retains risks and rewards of price changes; therefore, no change of economic ownership of the asset and no transaction in that asset is recorded in the IIP if the asset is a financial asset.
- Reverse transactions with or without cash:
  - If cash is supplied (e.g., repo or securities lending with cash collateral), the arrangement gives rise to a loan or deposit. If no cash is supplied (e.g., exchange of one security for another), there is no loan or deposit.
  - Gold swaps for cash are treated as loans with gold as collateral and no change in economic ownership of gold.
- Major types explained:
  - Security repurchase agreements: securities provided for cash with commitment to repurchase same or similar securities at a fixed price; repos, reverse repos, securities lending with cash collateral, and sale-buybacks are treated as collateralized loan/deposit.
  - Gold swaps: exchange of gold for foreign exchange deposits with agreement to reverse at an agreed future date and gold price; recorded as collateralized loan or deposit.
  - Securities lending: temporary exchange of securities, usually for cash or other securities, with obligation to redeliver; legal title typically transfers to borrower while economic rights remain with lender; borrower may on-sell borrowed securities; loan is collateralized.
  - Gold loans: delivery of gold for a time period with obligation to redeliver like quantity; legal ownership transfers to borrower but risks/benefits remain with lender; fees are paid for use of gold.
- Recording guidance (highlights):
  - Supply and receipt of funds under a reverse transaction is treated as a loan or deposit. It is generally a loan but classified as a deposit if it involves liabilities of a deposit-taking corporation or is included in national measures of broad money.
  - Collateral provided under reverse transactions is treated as not having changed economic ownership.
  - Short positions: when a unit sells securities it is not economic owner of, the unit records a negative asset (not a liability); interest accrues negatively on the negative position.
  - Recording of income: the economic owner continues to record dividends and accrual of interest even when legal ownership changes under a reverse transaction; manufactured interest/dividends are recorded to reflect compensation.
  - Fees for securities lending and gold loans are treated as interest with a corresponding entry in other accounts receivable/payable; fees payable to custodians are in principle payable to the owner and then deemed paid to custodian in separate transactions.

### Reserve-asset qualification and availability; recording in reserve management
- Securities or monetary gold transferred under reverse transactions by monetary authorities remain an asset of the original monetary authorities.
- Assets that are not readily available do not qualify as reserve assets.
- If securities provided as collateral under a repurchase agreement are not readily available for meeting a balance of payments financing need for the monetary authorities, they are excluded from reserve assets and reclassified to portfolio investment assets.
- Same treatment applies where securities are available for meeting a balance of payments financing need only if a substitute reserve asset is provided as collateral, because securities and the substitute cannot be readily available simultaneously.
- Monetary gold provided as collateral under a gold swap: if not readily available for a balance of payments financing need, it is excluded from reserve assets and either removed from financial assets (for gold bullion) or reclassified to other investment, currency and deposits, assets (for unallocated gold accounts).
- Recording of liabilities, claims, and collateral:
  - Any loan or deposit liability under reverse transactions is recorded within “other investment”.
  - Convertible foreign currency received is recorded as an increase in currency and deposits in reserve assets, provided it is a liquid claim on a nonresident.
  - If monetary authorities provide funds and receive securities or gold as collateral (reverse repos), the funds provided are recorded as a decrease in currency and deposits in reserve assets.
  - If the claim (e.g., repo asset) is liquid and available upon demand, it is considered part of reserve assets in “other claims” (or “deposits” if classified in national measures of broad money).
  - Securities or gold collateral should not be included in reserve assets of the receiving monetary authorities because the receiving authorities are not the economic owner.
- Supplementary information:
  - Reverse transactions are not separately identified in the standard presentation of balance of payments and IIP; provision of cash is recorded under loans or deposits, but collateral assets are not recorded because there is no change in economic ownership.
  - A supplementary table could be compiled showing loans/deposits and collateralized securities, gold, and other items under reverse transactions to cover movements comprehensively; this information may have high analytical value for economies active in reverse transactions.

### Accrual recording and presentation guidance (schematics)
- Security lending fees are recorded as interest.
- Schematics illustrate accrual recording for:
  - Repo/security lending with cash collateral: loan liability increases (no recording of securities) for one party and loan asset increases (no recording of securities) for the counterparty.
  - Security lending with security collateral: accrued security lending fees recorded as interest and accounts receivable/payable for fees.
  - Security lending without collateral: accrued security lending fees recorded as interest and corresponding accounts receivable/payable movements.
- Tables also illustrate recording of dividends and accrued interests for securities acquired under repo and security lending, including cases of on-selling of securities acquired under repo and security lending; schematics show debit/credit and asset/liability movements across counterparties.

*International Monetary Fund — BPM7 Annex 7 (Annex 7. Selected Financial Issues, IMF BPM7 draft).*

### Annex 7. Selected Financial Issues (new annex)

### Annex 7. Selected Financial Issues (new annex)

### Overview and definition
- The annex defines a financial derivative contract as a financial instrument linked to another specific financial instrument or indicator or commodity through which specific financial risks (such as interest rate risk, foreign exchange risk, equity and commodity price risks, credit risk, and so on) can be traded in their own right in financial markets.
- Transactions and positions in financial derivatives are treated separately from the values of any underlying items to which they are linked.
- The risk embodied in a financial derivative can be traded either by trading the contract itself (as with options) or by creating a new contract that countervails the existing contract (offsetability). The outlay required to replace an existing derivative contract represents its value; actual offsetting is not required.
- Many derivatives are settled by payments of net amounts in cash; once a derivative reaches its settlement date, any unpaid overdue amount is reclassified as accounts receivable/payable as its value is fixed and the nature of the claim becomes debt.
- The following are not financial derivatives (excerpted):
  - Fixed-price contracts for goods and services, unless standardized so that the market risk can be traded in financial markets in its own right (example: an option to purchase an aircraft from the manufacturer is not a financial derivative).
  - Insurance and standardized guarantees (insurance pools event risk rather than trades risk), though some guarantees other than standardized guarantees may meet the definition of financial derivatives (see paragraph 5.68).
  - Contingent assets and liabilities, such as one-off guarantees and letters of credit (see paragraphs 5.10–5.13).
  - Instruments with embedded derivatives are classified according to their primary characteristics; detachable warrants are treated as separate financial derivatives.
  - Timing delays in normal business (including normal settlement periods for spot transactions) do not give rise to financial derivatives.
  - Gold swaps and most central bank swap arrangements are not financial derivatives (see paragraphs 5.55 and 6.102–6.104); however, if a central bank swap arrangement follows pricing and conditions of a regular market priced swap, it should be recorded as a financial derivative.
  - Subscription rights are classified as equity rather than financial derivatives.

### Types of financial derivatives — broad classification
- Two broad types:
  - Option-type contracts: entail two payment streams — a "premium leg" (fixed payments from buyer to seller) and a "contingent leg" (payments from seller to buyer depending on the underlying asset's pricing). The contingent leg usually entails a single payment at maturity; the premium leg in standard put and call options typically is a single payment at inception.
  - Forward-type contracts: entail contingent payments between parties depending on the underlying asset’s pricing.
- Key contrasts between option-type and forward-type contracts:
  - At inception, forward-type contracts usually have no up-front payment and begin with zero value; option-type contracts usually involve a premium representing nonzero value.
  - During the life of a forward-type contract, either party can be creditor or debtor and this may change; for an option-type contract the buyer is always the creditor and the writer is always the debtor except for a credit default swap.
  - At maturity, redemption for a forward-type contract is unconditional; for an option-type contract it is determined by the buyer.

### Option-type contracts (options and warrants)
- An option gives the purchaser the right (but not the obligation) to buy (call) or sell (put) a specified underlying item at a strike price on or before a specified date; the purchaser pays a premium to the writer.
- Exchanges may act as the counterparty to options traded on derivatives exchanges.
- Warrants:
  - Give the owner the right but not the obligation to purchase from the issuer a fixed amount of an underlying asset at an agreed contract price for a specified period or on a specified date.
  - Exercise of warrants can create new securities and dilute existing capital; warrants attached to bonds to allow a lower coupon are not treated as separate financial assets (see 5.83(d)).
  - Covered warrants give the holder the right, but not the obligation, to buy or sell an underlying asset at an agreed contract price for a specified period or date and may cover a variety of items (equities, currencies, commodities).

### Forward-type contracts (forwards, futures, swaps)
- A forward-type contract is an unconditional agreement by two counterparties to exchange a specified quantity of an underlying item at an agreed strike price on a specified date. Examples include futures, swaps, forward rate agreements, and forward foreign exchange contracts.
- Futures are forward-type contracts traded on organized exchanges with standardized terms, the exchange acting as counterparty and requiring margin.
- At inception of a forward-type contract, risk exposures of equal market value are exchanged, so the contract typically has zero value; market value changes with the underlying price and may be restored to zero by periodic settlement. Asset and liability positions of derivatives may switch except for standard option contracts.
- Swap contracts:
  - Involve counterparties exchanging financial instruments or cash flows based on reference prices of underlying items.
  - Swap types classified as forward-type include foreign exchange swaps, currency swaps, interest rate swaps, and cross-currency interest rate swaps.
  - Obligations of each party under a swap may arise at different times; differing payment schedules are recorded as transactions in the financial derivative contract (e.g., quarterly vs. annual payments).
  - Other arrangements called swaps but not meeting this definition include gold swaps (see paragraphs 5.55 and 7.58), central bank swap arrangements (see paragraphs 6.102–6.104), and credit default swaps (see paragraph 5.93).

### Foreign currency derivatives and off‑balance sheet items
- For foreign currency derivatives (currency swaps, foreign exchange swaps, foreign exchange forwards) distinguish between transactions in the derivative contract and transactions in the underlying currencies.
  - At inception, parties’ exchange of underlying instruments is usually classified under other investment.
  - At settlement, differences in values of currencies swapped, measured in the unit of account at the prevailing exchange rate, are allocated to a transaction in a financial derivative, with values swapped recorded in the relevant other item (usually other investment).
- For foreign currency derivatives that could involve exchange of principal, the amount of foreign currency to be delivered at maturity is not recorded on the balance sheet; scheduled payments and receipts of foreign currencies associated with these instruments are to be compiled as described in A7.43.

### Credit derivatives
- Credit derivatives are financial derivatives whose primary purpose is to trade credit risk (loan and security default risk) and take the form of both forward-type contracts (total return swaps) and option-type contracts (credit default swaps).
- Under a credit default swap, premiums are paid in return for a cash payment in the event of a default by the debtor of the underlying instrument.
- Credit derivatives are often documented under standard master legal agreements and involve collateral and margining procedures that permit market valuation.

### Margins and collateral
- Margins are payments of cash or deposits of collateral that cover actual or potential obligations incurred; margining reflects market concern over counterparty risk and is standard in derivative markets, especially futures and exchange-traded options.
- Ownership of margin remains with the depositor. Margin payments in cash are classified as deposits (if the debtor’s liabilities are included in broad money), loans, or other accounts receivable/payable.
- When a repayable margin deposit is made in a noncash asset (such as securities), no transaction is recorded because economic ownership does not change.
- In organized exchanges and clearing houses, margins are increased or decreased as a result of settling profits/losses by marking to market (often daily or intraday). Cash changes are recorded as increases/decreases in deposits, loans, or other accounts receivable/payable with a corresponding entry reducing/increasing financial derivative assets or liabilities.
- If margin falls short of the required maintenance margin, an additional margin payment must be made; such payments are not to be recorded in financial derivatives.
- These classification principles also apply to other cash collateral agreements, including margin calls on positions in other financial assets.

### Employee stock options (ESOs) and similar arrangements
- ESOs are options to buy company equity offered to employees as remuneration; they have pricing behavior similar to financial derivatives but differ in nature (granting and vesting arrangements) and purpose (employee motivation rather than risk trading).
- If a stock option granted to employees can be traded on financial markets without restriction, it is classified as a financial derivative.
- Stock options provided to suppliers of goods and services are often recorded under ESOs for convenience because of similarity in nature and motivation; the corresponding entry differs (compensation of employees for employee grants; goods and services supplied for supplier grants).
- For transactions associated with the issue of ESOs, see paragraph 8.41.

### Functional category treatment and recording
- Financial transactions, positions, and income in the international accounts use five functional investment categories:
  - direct investment,
  - portfolio investment,
  - financial derivatives (other than reserves) and ESOs,
  - other investment,
  - reserve assets.
- The functional category "financial derivatives and ESOs (other than reserves)" largely coincides with the corresponding financial instrument class; financial derivatives associated with reserve asset management are excluded from this functional category and included in reserve assets (see paragraph 6.91).
- The category is identified separately because it relates to risk transfer rather than supply of funds or other resources.
- Unlike other functional categories, no primary income accrues on financial derivatives; amounts accruing under the contract are classified as revaluations and included in other changes in assets and liabilities.
- Recording financial derivatives separately as both assets and liabilities is encouraged for positions and transactions; where gross measurement is infeasible (for example when contracts switch between asset and liability positions), net reporting is acceptable by recording net payments as a reduction in liabilities for one party and a decrease in assets for the other.
- Information on financial derivatives (other than reserves) and ESOs is included in Chapters 5–9 of the manual (conceptual framework, functional category, positions, financial account transactions, and revaluations); no investment income arises (see paragraph 11.95).

### Valuation
- Financial derivatives and ESOs are valued at market prices prevailing on balance sheet recording dates.
- If market price data are unavailable, other fair value methods (such as option models or present values) may be used.
- Compilers are generally constrained to use the parties’ own accounts.
- When payments are made before a derivative contract expires (such as payments in interest swaps), the change in the value of the contract is recorded as transactions.

*Annex 7. Selected Financial Issues (new annex), IMF BPM7 draft.*

### 7.27 A key characteristic of many derivative contracts is that the counterparties make commitments to transact, in

### 7.27 A key characteristic of many derivative contracts is that the counterparties make commitments to transact, in

### Valuation principles for financial derivatives
- The present value (or market price) of a financial derivative is derived from the difference between the agreed-on contract price of an underlying item and the prevailing market price (or the market price expected to prevail), appropriately discounted, for that item.
- Option pricing depends on: the potential price volatility of the underlying instrument, the time to maturity, interest rates, and the difference between the strike price and the market price of the underlying item.
- The counterpart liability:
  - For options: attributable, by convention, to the writer of the option and valued at the current cost of buying out the rights of the option holder.
  - For warrants: the counterpart liability of the issuer is the current outlay required to buy out the exercise rights of the holder.
- Credit default swap valuation: difference between the present value of the series of premium payments and the estimated present value of the potential payments in the event of default.
- Swap contract valuation: derived from the difference, appropriately discounted, between expected gross receipts and gross payments.
- Gross asset and gross liability data: compiled by summing, respectively, the values of all individual contracts in asset positions and the values of all individual contracts in liability positions.
- Notional value (notional amount or nominal amount): the amount underlying a financial derivative contract necessary for calculating payments or receipts on the contract; may or may not be exchanged and provides information about risk exposure and links to underlying items.

### Position switching and revaluation
- The market value of financial derivatives (except for standard option contracts) can switch from an asset position to a liability position (and vice versa) between reporting dates due to movements in the price of underlying item(s).
- When a switch occurs with no settlement payments:
  - The market value of the gross asset or liability position at the close of the previous accounting period is revalued to zero.
  - The gross liability or asset position is revalued from zero to the market value at the end of the present accounting period.
- Any value change in financial derivatives is classified as revaluations and included in other changes for both assets and liabilities.
- For financial derivatives that include foreign exchange risk, steps for separating exchange rate and other revaluation may not be applicable; valuation change due to exchange rate changes can arise even in the currency of denomination.
- For complex instruments (e.g., cross-currency swaps that are also interest rate swaps), it may not be practical to separate exchange rate revaluations from other revaluation; a convention that all revaluation effects are due to other price revaluations may be adopted.

### Transactions versus revaluation; measurement guidance
- Cumulation of transactions should never be used to estimate financial derivative positions; transactions relate largely to option-type contracts and to settlements, whereas derivative position values emerge largely from revaluation.
- Employee stock options (ESOs):
  - Valued consistently with cumulated compensation of employees until the vesting date (see paragraphs 11.20–11.21).
  - Thereafter valued at market prices (see paragraph 9.30).
  - ESOs can be measured from a market value of equivalent options or according to an options-pricing model, such as Black-Scholes.
  - International accounting standards give guidance; recording in the international accounts normally will follow business accounts.

### Recording events: inception, secondary market, servicing/margins, settlement, and ESOs
- General: Financial account entries for derivatives preferably shown separately for assets and liabilities; net settlements acceptable when gross reporting is impractical. Any explicit or implicit service charges should be deducted from the value of the financial derivative; if implicit service charges cannot be distinguished, the entire value is classified as for the financial asset.
- At inception:
  - Forward-type contracts normally have zero value at inception; creation generally does not require recording a transaction in a financial derivative because risk exposures of equal value are usually exchanged. In some cases there may be a nonzero transaction value at issue.
  - Option-type purchaser pays a premium to the seller, which is the acquisition price; if premium is paid after inception, the premium value is recorded at inception and shown as financed by accounts receivable/payable between writer and purchaser.
  - Subsequent price changes are recorded as holding gains or losses (revaluation), not transactions.
- Secondary market transactions:
  - Sales of options in secondary markets are valued at market prices and recorded in the financial account as transactions in financial derivatives.
- Servicing and margins:
  - When a contract requires ongoing servicing and a cash payment is received, there is a decrease (increase) in a financial derivative asset (liability) if the contract is in an asset (liability) position at the time of payment.
  - If compilers cannot implement this approach due to market practice, all cash receipts should be recorded as reductions in financial assets and all cash payments recorded as decreases in liabilities.
  - If margins are adjusted to settle profit or loss as a result of marking to market, margin movements are recorded as increases or decreases in deposits, loans, or other accounts receivable/payable with a corresponding entry reducing financial derivative assets or liabilities.
- At settlement:
  - Cash settlement: record a transaction equal to the cash value of the settlement; receipt typically reduces a financial derivative asset, payment reduces a financial derivative liability.
  - Delivery of underlying item: record two transactions:
    1. The underlying item valued at market price at time of delivery and recorded under the relevant heading.
    2. The derivative transaction valued as the difference, multiplied by the quantity, between market price for the underlying item and the strike price specified in the derivative contract.
  - When multiple contracts are settled at the same time with the same counterparty and some are assets and some liabilities, record asset transactions separately from liabilities wherever possible; net settlements acceptable when gross reporting impractical.
- ESOs specifics:
  - ESO grant date, vesting date, exercise period, and recording:
    - Transactions in ESOs are recorded in the financial account as the corresponding entry to compensation of employees (see paragraph 11.20) or direct investment (paragraph 11.21).
    - At exercise, the transaction in the ESO is recorded at a value that reflects the difference between the market price of the equity and the price paid by the buyer for the equity (see paragraph 8.40(a) and (b)).
  - Cancellation of ESOs discussed in paragraph 9.12.
  - Changes in ESOs at or after vesting date are revaluations (see paragraphs 3.59, 7.39, and 11.20); in practice revaluation may be recognized only at exercise date.
  - Special case: employee of a subsidiary issued options for parent-company stock — subsidiary shown as acquiring the option from the parent; if subsidiary pays nothing or an unrealistic value to the parent, a value may be imputed, possibly in direct investment (see paragraph 11.101 on transfer pricing).

### Classification and breakdowns of financial derivatives
- Further classification options:
  1) By market risk categories: foreign exchange risk, interest rate risk, equity and commodity price risks and credit risk or risks to other underlying instruments;
  2) By instrument: options, forwards and related instruments (i.e., futures), swaps, credit derivatives, marketable ESOs, and other instruments;
  3) By trading venue and clearing status: exchange traded; over-the-counter (OTC) (cleared); OTC (not cleared).
- Market risk category characteristics:
  - (a) Foreign exchange derivatives: involve exchange of currencies in the forward market; include outright forwards, foreign exchange swaps, currency swaps (including cross-currency interest rate swaps) and currency options; cover all contracts involving exposure to more than one currency.
  - (b) Single currency interest rate derivatives: restricted to deals where all legs are exposed to only one currency’s interest rate; include forward rate agreements, single-currency interest rate swaps and interest rate options (caps, floors, collars, corridors), but exclude contracts involving exchange of currencies.
  - (c) Equity derivatives: returns linked to the price of a particular equity or to an index of equity prices.
  - (d) Commodity derivatives: returns linked to the price or price index of a commodity such as a precious metal, petroleum, lumber or agricultural products.
  - (e) Credit derivatives: payouts linked primarily to some measure of the creditworthiness of a reference asset; payouts can be triggered by default, rating downgrade, or a stipulated change in credit spread. Typical instruments: credit default swaps, credit-spread forwards and options, credit event or default swaps and total return swaps.
  - (f) Other derivatives: those not involving exposure to foreign exchange, interest rate, equity, commodity or credit risk (e.g., inflation-indexed derivatives, volatility derivatives, dividend derivatives, weather derivatives, property derivatives, freight derivatives, or client-specific non-standard underlying items).
- Multi-exposure products:
  - Individual derivatives may straddle more than one risk category; simple combinations should be reported separately by components.
  - Products that cannot be broken down into separable components should be reported in only one risk category, determined by the most significant underlying risk component.
  - If doubt about classification of multi-exposure derivatives, allocation should follow BIS order of precedence: commodities, equities, foreign exchange, and single-currency interest rate, credit, and other.

### Currency composition of notional values for foreign exchange-related derivatives
- In balance of payments and IIP, financial derivative contracts are recorded at market value (or fair value when market value not available).
- For foreign exchange-related derivatives (foreign exchange forwards, foreign exchange swaps, currency swaps), notional values provide useful information to assess currency exposures of the economy.
- Foreign exchange forwards, foreign exchange swaps, and currency swaps have debt-like characteristics because they may require delivery of the principal amount (i.e., notional value/amount) at maturity; these obligations are not carried on the balance sheet (nor recorded in IIP).
- The currency composition of the notional values of foreign exchange-related derivatives is to be compiled in the Tables I-III in Annex 14, along with the currency composition for debt instruments carried on the balance sheet (see paragraph 7.37).
- The tables for notional values of foreign exchange forwards, foreign exchange swaps, and currency swaps are memorandum items and thus required reporting; tables for notional values of foreign exchange related options are supplementary items since delivery of foreign exchange is conditional for options.
- Special properties and risks:
  - In foreign exchange swaps and currency swaps, two parties typically exchange currencies at the spot price and commit to reverse the exchange at a pre-agreed future date and price (the forward rate); once the spot transaction is complete, the position is indistinguishable from an outright forward.
  - These instruments typically require two-way payments at maturity and exchange of principal distinguishes them from other derivatives (e.g., interest rate swaps) where relatively small payments reflect rate differences based on a notional amount.
  - Payment obligations from foreign exchange swaps, currency swaps and forwards can be large; contracts are typically short term and markets for these products are subject to squeezes when foreign-currency-funding conditions deteriorate (as occurred during the Great Financial Crisis and in March 2020 when the Covid-19 pandemic went global).
  - Under standard accounting treatments, payment obligations associated with these products are not recorded on the balance sheet.

*International Monetary Fund — BPM7 Annex 7*

### 7.45 Additional information about the payment obligations from foreign exchange derivatives helps users of the IIP

### 7.45 Additional information about the payment obligations from foreign exchange derivatives helps users of the IIP

### Role of off‑balance‑sheet payment obligations for currency profile and IIP analysis
- The annex states that additional information about future payment obligations and receipts from positions carried both on and off the balance sheet forms a more complete view of the currency profile in a country’s IIP position.
- Annex Tables XX capture off-balance sheet payment obligations from foreign exchange derivatives and are designed to be used in conjunction with Annex Tables YY, which capture the currency breakdown of on-balance sheet positions.
- The combination of these tables provides more complete measures of countries’ and sectors’ external foreign currency positions, which are important in financial stability analysis.

### Post-trade activities in financial derivatives (Box A7.1) — legislative and market context
- The 2008 financial crisis triggered legislative actions (for example, EMIR in the European Union and the Dodd Frank Act in the United States) that changed derivatives market practices by introducing stricter clearing and reporting obligations and post-trade processes such as novation, clearing, portfolio compression, and collateral management.
- Post-trade processes are conducted by specialized financial infrastructure providers including central clearing counterparties (CCPs).
- Central clearing is required in the European Union for certain classes of financial derivatives.
- The box provides methodological guidance for recording novation and portfolio compression as financial transactions.

### Recording of novation (Box A7.1, paragraphs 2 and Example 1)
- Definition and recording rule:
  - Novation replaces a bilateral OTC contract between two market participants with two bilateral contracts between each market participant and a CCP.
  - If novation occurs immediately after the initial contract (within reporting time frame), only the novated contracts vis-à-vis the CCP need to be reported.
  - If novation is delayed, both original counterparts should report two offsetting transactions for the reference period(s): (i) terminating the initial contract (extinguishing an asset position in financial derivatives) and (ii) creating an asset position in financial derivatives of equal market value vis-à-vis the CCP.
  - If initial parties are not clearing members, each side of the bilateral contract may be replaced by two contracts—one between the initial entity and the clearing member, and another between the clearing member and the CCP—giving rise in total to four transactions/positions.
  - The country(ies) of residence of the initial entities, the clearing member, and the CCP determine whether a novated contract is recorded in cross-border statistics and how it is treated in national accounts.
- Example 1 (numbers preserved exactly as presented):
  - Two entities (A and B), clearing members of a CCP and resident in Country X, sign an OTC contract resulting in assets and liabilities of 100 of A and B, respectively. As both entities are resident in Country X no positions are recorded in balance of payments and IIP statistics.
  - The contract is novated to a CCP resident in Country Y, creating cross-border positions:
    - The original domestic asset and liability positions of A and B disappear.
    - The novation creates a cross-border asset position for A and a cross-border liability position for B.
    - Globally, the novation results in a doubling of positions compared with the situation before novation. The net IIPs of countries X and Y remain unchanged at 0.
  - Table 1 (recording before and after novation as shown):
    - Resident in country: Entity A — X; Entity B — X; CCP — Y
    - 1. Before novation
      - Vis-à-vis non-residents (IIP): Assets Liabilities
      - Vis-à-vis domestic sectors: Assets 100; Liabilities 100
    - 2. After novation
      - Vis-à-vis non-residents (IIP): Assets 100 100; Liabilities 100 100
      - Vis-à-vis domestic sectors: Assets 0; Liabilities 0

### Recording of portfolio compression (Box A7.1, paragraphs 3–4 and Example 2)
- Definition and recording rule:
  - Portfolio compression is a bilateral or multilateral process in which counterparties wholly or partially terminate derivatives submitted for inclusion and replace them with new derivative(s) whose combined notional value is less than the combined notional value of the terminated derivatives.
  - All counterparties involved should report offsetting transactions: (i) transactions terminating the initial contracts (extinguishing asset/liability positions) and (ii) transactions creating new asset/liability positions.
  - While net positions of involved parties should remain unchanged, post-compression gross positions can differ considerably and bilateral counterparts of the new transactions may differ from the original ones; comprehensive recording of both termination and creation transactions is required.
- Example 2 (numbers preserved exactly as presented):
  - Three entities (residents A and B, and non-resident C) compress positions outstanding at the end of the previous reporting period.
  - For the purpose of the example, there are no obstacles for entities to involve in multilateral compression. Entities A and B have both bilateral domestic positions and cross-border positions with non-resident entity C.
  - The original deals are “tore up” and replaced with new, lower volume deals that do not change net position of each entity. The termination of all previous deals should also be recorded as financial transactions.
  - Net cross-border position changes in the example:
    - Entity A: from assets of 10 to liabilities 10
    - Entity B: from liabilities of 20 to zero
    - Entity C: asset 10 before and after compression
  - Table 2 (recording of positions arising from compression as shown):
    - Resident in country: Entity A — X; Entity B — X; Entity C — Y
    - 1. Before compression
      - Vis-à-vis non-residents (IIP): Assets 10 20; Liabilities 20 10
      - Vis-à-vis domestic sectors: Assets 30; Liabilities 30
      - Net assets position -2010 10
    - 2. After compression
      - Vis-à-vis non-residents (IIP): Assets 10; Liabilities 10
      - Vis-à-vis domestic sectors: Assets 10; Liabilities 10

### Reverse transactions — definition, major types, and recording
- Definition (A7.46):
  - Reverse transactions involve a change of legal ownership of securities, gold, or other assets with a commitment to repurchase the same or similar assets either on a specified date or with open maturity.
  - Major types: securities repurchase agreements, gold swaps, securities lending, and gold loans.
  - The commitment to reverse the change in legal ownership at a future fixed price means the original owner retains the risks and rewards of price changes; accordingly, there is considered to be no change of economic ownership of the asset and no transaction in that asset is recorded in the IIP if the asset is a financial asset.
- Reverse transactions with or without cash (A7.47):
  - If cash is supplied (e.g., repo or securities lending with cash collateral), the arrangement gives rise to a loan or deposit. The classification of cash supplied is discussed in paragraphs 5.52–5.54 (Editors: BPM6 para 5.52).
  - Gold swaps for cash are treated as loans with gold as collateral and no change in economic ownership of gold.
- Major types (A7.48–A7.51):
  - Security repurchase agreements (A7.48):
    - Provision of securities in exchange for cash with commitment to repurchase same or similar securities at a fixed price; repos, reverse repos, securities lending with cash collateral, and sale-buybacks are economically equivalent and involve collateralized loan/deposit treatment.
  - Gold swaps (A7.49):
    - Exchange of gold for foreign exchange deposits with agreement to reverse at an agreed future date and gold price; analogous to repurchase agreements and recorded as collateralized loan or deposit.
  - Securities lending (A7.50):
    - Temporary exchange of securities, usually for cash or other securities, with obligation to redeliver like quantity later; legal title typically transfers to borrower while economic rights remain with lender; borrower may on-sell borrowed securities; loan is collateralized.
  - Gold loans (A7.51):
    - Delivery of gold for a time period with obligation to redeliver like quantity; legal ownership transfers to borrower but risks/benefits remain with lender; fees are paid for use of gold.
- Recording of reverse transactions (A7.52–A7.59):
  - Recording of a loan or deposit (A7.52):
    - Supply and receipt of funds under a reverse transaction is treated as a loan or deposit. It is generally a loan but classified as a deposit if it involves liabilities of a deposit-taking corporation or is included in national measures of broad money.
    - If no cash is supplied (e.g., exchange of one security for another), there is no loan or deposit.
    - Margin calls in cash under a reverse transaction are classified as loans or deposits.
  - Collateral treatment (A7.53–A7.54):
    - Securities or gold provided as collateral under reverse transactions are treated as not having changed economic ownership because the cash receiver remains subject to price risks/rewards.
    - Custodian data sources may pose problems in attributing securities ownership because custodians may not know whether securities are under repurchase agreements.
  - Short/negative positions (A7.55–A7.56):
    - Short positions occur when an institutional unit sells securities for which it is not the economic owner; the party with the short position records a negative value for the holding of the asset (shown as a negative asset, not a liability).
    - Interest accrues negatively on the negative position (i.e., the negative position becomes larger). Recording negative positions overcomes double counting and helps present consistent debtor-creditor relationships globally.
  - Recording of income (A7.57–A7.58):
    - The economic owner continues to record dividends and accrual of interest even when legal ownership changes under a reverse transaction.
    - When reverse transaction covers dividend/coupon payment periods, the security taker typically compensates the security lender via “manufactured interest” or “manufactured dividends.”
    - Manufactured interest and dividends are recorded as positive credit/receipt for the security lender and negative credit/receipt for the security borrower; recording of negative credit for the borrower reflects the negative position in the security and offsets double-recording of positive credit.
  - Fees for securities lending and gold loans (A7.59):
    - Fees for securities lending without cash collateral and gold loans are payments for putting a financial instrument at the disposal of another unit and accrue to the security owner; they are treated as interest with a corresponding entry in other accounts receivable/payable.
    - Fees payable to custodians in the first instance are, in principle, payable to the owner and then deemed paid to the custodian in a separate transaction; amounts accruing to custodians are included under custodial services (Editors: references to BPM6 and BIS materials noted).

*BPM7 Annex 7, International Monetary Fund*

### 7.60 Monetary  authorities  may  also be engaged in reverse transactions as part of their  reserve  asset  management

### 7.60 Monetary authorities may also be engaged in reverse transactions as part of their reserve asset management

### Reserve-asset qualification and availability (paras 7.60–7.61)
- Securities or monetary gold transferred under reverse transactions by the monetary authorities remain an asset of the original monetary authorities (para 7.60).
- Assets that are not readily available do not qualify as reserve assets (para 7.60).
- If securities provided as collateral under a repurchase agreement are not readily available for meeting a balance of payments financing need for the monetary authorities, they are excluded from reserve assets and reclassified to portfolio investment assets (para 7.61).
- The same treatment applies where securities are available for meeting a balance of payments financing need only if a substitute reserve asset is provided as collateral, because the securities and the substitute reserve asset cannot be readily available simultaneously (para 7.61).
- Monetary gold provided as collateral under a gold swap is treated similarly: if not readily available for a balance of payments financing need, it is excluded from reserve assets and either removed from financial assets (for gold bullion) or reclassified to other investment, currency and deposits, assets (for unallocated gold accounts) (para 7.61).

### Recording of liabilities, claims, and collateral in reverse transactions (para 7.62)
- Any loan or deposit liability under reverse transactions is recorded within “other investment” (para 7.62).
- Convertible foreign currency received is recorded as an increase in currency and deposits in reserve assets, provided it is a liquid claim on a nonresident (para 7.62).
- If monetary authorities provide funds and receive securities or gold as collateral (e.g., reverse repos), the funds provided to the counterparty are recorded as a decrease in currency and deposits in reserve assets (para 7.62).
- If the claim (e.g., repo asset) is liquid and available upon demand to the monetary authorities, it is considered part of reserve assets in “other claims” (or “deposits” if classified in national measures of broad money) (para 7.62).
- Securities or gold collateral should not be included in reserve assets of the receiving monetary authorities because the receiving monetary authorities are not the economic owner of the asset (para 7.62).

### Supplementary information and analytical disclosure (para 7.63)
- Reverse transactions are not separately identified in the standard presentation of balance of payments and IIP; provision of cash is recorded under loans or deposits, but assets used as collateral (e.g., securities) are not recorded because there is no change in their economic ownership (para 7.63).
- To identify reverse-transaction items, a supplementary table could be compiled showing loans/deposits and collateralized securities, gold, and other items (i.e., commodities) under reverse transactions, covering movements comprehensively regardless of changes in economic ownership (para 7.63).
- This supplementary information may have high analytical value, particularly for economies that are actively involved in reverse transactions (para 7.63).

### Accrual recording and presentation guidance (tables and notes)
- Security lending fees, when involved, should be recorded separately and are recorded as interest (reference to BPM6 §11.68 noted in table footnote).
- The material presents accrual-recording schematics showing:
  - Repo/security lending with cash collateral: loan liability increases (no recording of securities) for one party and loan asset increases (no recording of securities) for the counterparty.
  - Security lending with security collateral: various entries including accrued security lending fees recorded as interest and accounts receivable/payable for fees.
  - Security lending without collateral: accrued security lending fees recorded as interest and corresponding accounts receivable/payable movements.
- Tables illustrate recording of (1) dividends and (2) accrued interests for securities acquired under repo and security lending, including cases of on-selling of securities acquired under repo and security lending; the schematics show debit/credit and asset/liability movements across Country/sector A, B, C, D (annotated examples in the tables).

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_Source: https://www.imf.org/-/media/files/data/statistics/bmp7/draft-chapters/bpm7-annex7.pdf_