14 Fair Value measurement

Measurement guidelines

The fair value represents a market-based measurement and not an entity-specific valuation. It is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date on the principal market or the most advantageous market.

As far as possible, the fair value is determined on the basis of the quoted market prices in active markets accessible to the company on the measurement date. An active, accessible market is one in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis. The fair value is determined using significant and observable inputs. These are basically available in the case of quoted assets or liabilities. If a market for financial or non-financial assets or liabilities is inactive, or if no observable inputs, or insufficient observable inputs, are available, the LLB Group must employ techniques or processes (valuation methods or models) to determine the fair value. The valuation techniques contain assumptions including estimates to enable an exit price on the measurement date from the perspective of the market participant to be determined. However, such assumptions and estimates contain uncertainties, which at a later date can lead to substantial changes in the fair value of financial and non-financial assets and liabilities. In the case of financial and non-financial assets and liabilities, for which a valuation technique involving non-observable market data are used to determine the fair value, these are measured at the transaction price. This fair value can differ from the fair value determined on the basis of valuation techniques.

All financial and non-financial assets and liabilities measured at fair value are categorised into one of the following three fair value hierarchies:

Level 1

The fair value of listed securities and derivatives contained in the trading portfolio and financial investments is determined on the basis of market price quotes on an active market.

Level 2

If no market price quotes are available, the fair value is determined by means of valuation methods or models, which are based on assumptions made on the basis of observable market prices and other market quotes.

Level 3

For the remaining financial instruments neither market price quotes nor valuation models or models based on market prices are available. Our own valuation methods or models with our own inputs are employed to measure the fair value of these instruments.

Valuation methods

Valuation methods and techniques are employed to determine the fair value of financial and non-financial assets and liabilities for which no observable market prices on an active market are available. These include, in particular, illiquid financial investments and financial liabilities from insurance contracts. If available, the LLB Group uses market-based assumptions and inputs as the basis for valuation techniques. If such information is not available, assumptions and inputs from comparable assets and liabilities are employed. In the case of complex and very illiquid financial and non-financial assets and liabilities, the fair value is determined using a combination of observable transaction prices and market information.

The LLB Group employs standardised and accepted valuation techniques to determine the fair value of financial and non-financial assets and liabilities, which are not actively traded or listed. In general, the LLB Group uses the following methods and techniques as well as the following inputs:

Measurement of fair values by active markets or valuation techniques

The following table shows the classification of fair value hierarchies of financial and non-financial assets and liabilities of the LLB Group. All assets and liabilities are measured at fair value on a recurring basis in the financial statement. As per 30 June 2016, the LLB Group had no assets or liabilities which were measured at fair value on a non-recurring basis in the balance sheet. In the first half of 2016 there were no significant transfers between Level 1 and Level 2 financial instruments.

Measurement of assets and liabilities classified as Level 3

For the recurring measurement of the fair value of financial and non-financial assets and liabilities for which significant non-observable inputs have been used and which are classified as Level 3, the effects on the income statement as per 30 June 2016 are immaterial and therefore they are not shown. The measurement and valuation had no influence on other comprehensive income for the first half of 2016.

The measurement process to determine the fair value of recurring and non-recurring Level 3 assets and liabilities, especially the significant non-observable inputs as shown in the previous table are explained in the following. The interrelationships between observable and non-observable inputs are not explained in the following because such interrelationships have no significant influence on the measurement of fair value.

Investment property

Investment property is periodically valued by external experts or is valued on the basis of relative values in a market comparison. If no corresponding values for comparable properties are available, on which to base a reliable calculation of the fair value, assumptions are made. These assumptions contain assessments and considerations of such circumstances as the location and condition of the property, as well as the expected costs and revenues with it. Properties are always revalued whenever on the basis of events or changed circumstances the fair value no longer reflects the market price, so that changes in the calculation of the fair value can be promptly determined and recognised in the accounts. Changes in the inputs, on which the measurement of the fair value is based, can lead to significant changes in it. It cannot be quantified to what extent changes influence the fair value and the sensitivity of fair value, because the valuation of a property is based on an individual measurement, which is influenced by various assumptions. Consequently, a significant change in the fair value can occur, which is not quantifiable. Investment properties do not diverge to highest and best use.

Structured products (OTC market)

Among its financial investments, the LLB Group has structured products with capital protection until final maturity, whose market value is estimated by the LLB Group with the aid of valuation models.

Structured products with capital protection until final maturity are periodically valued on the basis of an internal cash value model. On the basis of their characteristics up to maturity, the products correspond to zero coupon bonds. To calculate the discount interest rate in the cash value model, assumptions are made regarding the interest rate components, which are estimated periodically on the basis – among other criteria – of the market data of other bond issuers. Since no public market exists, assumptions are made regarding the redemption fees of issuers. These assumptions are periodically reviewed on the basis of data from various market participants and information from issuers regarding internal liquidity management.

Changes on the bond markets, for example due to monetary policy measures or the creditworthiness and internal liquidity of issuers, could lead, in the event of redemption during the life of the instrument, to changes in the valuation, especially in the bid / ask spread.