Contents Introduction Management report Appendices Corporate governance Consolidated Financial Statements Company Financial Statements
Key audit matter
Valuation of financial instruments
Refer to note 2 'Accounting policies' and note 4.9 'Fair value of
financial assets and liabilities'.
The financial instruments that are measured at fair value which are
significant to the financial statements are:
Derivatives (EUR 25.5 billion of derivative assets and EUR 28.1
billion of derivative liabilities are level 2 and level 3 financial
instruments at 31 December 2017);
Financial assets available for sale (EUR 4.0 billion of financial
assets available for sale are level 2 or level 3 financial
instruments at 31 December 2017; and
Financial liabilities designated at fair value (EUR 13.8 billion of
financial liabilities designated at fair value are level 2 or level 3
financial instruments at 31 December 2017).
For financial instruments in active markets and for which
observable market prices or other market information is available,
there is a high degree of objectivity involved in determining
the fair value (level 1 financial instruments). However, when
observable market prices or other market information is not
available the fair value is subject to significant judgement. The fair
value of such financial instruments (level 2 and level 3 financial
instruments) is determined using valuation techniques (such
as discounted cash flow models and option valuation models)
in which judgements made by management and the use of
assumptions and estimates such as market prices, credit spreads,
yield curves, correlations and volatilities are important factors.
At 31 December 2017, this related in particular to derivatives,
financial assets available for sale and financial liabilities
designated at fair value (in each case if they are classified as level 2
and/or level 3 financial instruments).
The main assumptions and estimates used by management in this
respect relate to:
The credit valuation adjustment (CVA) and debit valuation
adjustment (DVA) used in the valuation of derivatives;
The credit spreads applied in the valuation of financial assets
available for sale; and
The credit yield curves used in the valuation of financial
liabilities designated at fair value.
Given the level of judgement and complexity involved in
determining the fair value of these financial instruments, we
determined this to be a key audit matter in our audit. Due to the
size of the portfolio's, some deviation could have a significant
impact on result and equity.
Litigation, regulatory and client care
Refer to note 2.21 'Provisions', note 4.10 'Legal and arbitration
proceedings' and note 25 'Provisions'.
Given the continued regulatory focus on the financial services
industry, there is a risk that claims and/or regulatory investigations
emerge that could impact the financial statements.
There is an industry risk that emerging compliance or litigation
areas have not been identified and or addressed by management
for financial statement purposes. This includes the consideration
whether there is a need for the recognition of a provision or a
contingent liability disclosure on the future outcome of legal or
regulatory processes.
The recognition and measurement of provisions and the
disclosure of contingent liabilities requires considerable
management judgement.
In 2016 the Bank decided to adopt the Uniform Recovery
Framework for SME Interest Rate Derivatives. As at 31 December
2017 the SME provision amounted to EUR 450 million.
Given the inherent uncertainty and the judgemental nature of
contingent liabilities and provisions we determined the provisions
and disclosures on contingent liabilities to be of particular
importance to our audit.
How our audit addressed the matter
Our audit work included, amongst others, understanding, the design and operating
effectiveness of the controls at the Bank that cover the valuation process for financial
instruments such as:
The governance over valuation models, including the validation and approval process of such
models and subsequent changes thereto;
Controls that cover the collateral valuation and dispute process for collateralised derivatives;
Controls over the completeness and accuracy of data inputs used in the valuation of financial
instruments; and
The Bank's independent price verification process where the reasonableness of models and
outputs is assessed.
Based on these audit procedures, we determined that we could place reliance on these controls
for the purpose of our audit.
For derivatives, financial assets available for sale and financial liabilities designated at fair
value, with assistance of our internal valuation specialists, we tested the appropriateness of the
methodologies, models and inputs applied in the valuation of such financial instruments. The
purpose of these procedures was to determine that the methodologies, models and inputs used
by the Bank are fit-for-purpose and in line with best practices applied in the market.
Furthermore, we reconciled the most significant inputs to independent sources and external
available market data, where possible. Where assumptions and estimates were made by
management on key valuation inputs, we assessed and evaluated these by comparing them
to available market data. In particular, we performed the following procedures on the main
assumptions and estimates used by management:
We assessed the credit valuation adjustment (CVA) and debit valuation adjustment (DVA)
used in the valuation of derivatives, by comparing assumptions and inputs to market data;
We, assisted by our internal valuation specialists, performed an independent valuation of a
sample of financial assets available for sale using benchmark data to assess the credit spreads
applied in the valuation; and
Assessing the data points used by management in determining the credit yield curves used
in the valuation of financial liabilities designated at fair value by comparing these data points
against available market data. Furthermore we evaluated the interpolation for data points for
which limited market data is available.
We, assisted by our valuation specialists, performed an independent valuation of a sample of
derivative positions. In some cases our independent valuation resulted in different values as
compared to those calculated by management. We have assessed that those differences fell
within the range of reasonable outcomes, in the context of the inherent uncertainties and use of
models and assumptions.
We understood, evaluated and tested the design and operating effectiveness of controls of the
Bank to identify litigation and regulatory exposures within the group. We determined that we
could place reliance on these controls for the purpose of our audit.
We met with different members of the Managing Board on a regular basis to understand the
emerging and potential exposures that they identified. We challenged management's view on
these exposures based upon our knowledge and experience of emerging industry trends and
the regulatory environment.
We inquired with internal legal counsel to understand the risk position of new and existing
regulatory matters.
To identify potential regulatory investigations that could lead to the need for potential new
provisions we read the Bank's relevant correspondence with the Autoriteit Financiële Markten
("AFM"), De Nederlandsche Bank ("DNB") and European Central Bank ("ECB"). We met on a
trilateral and bilateral basis with the DNB and ECB during the year.
We read the minutes of the Managing Board and the Supervisory Board meetings and attended
all Risk- and Audit committee meetings throughout the year. We held regular bilateral meetings
with the Chairs of the Supervisory Board, Audit committee and Risk committee.
We obtained legal letters from the external lawyers to validate the identified exposures in
particular for the SME interest rate derivatives, Libor/Euribor and Bank Secrecy Act/Anti-Money
Laundering framework for Rabobank, N.A. (RNA). We assessed customer complaints received
and the analysis prepared by management of these complaints. We used this analysis to
understand whether there were indicators of more systematic exposures being present for
which provisions or disclosures should be made in the financial statements. These procedures
did not result in the identification of any new provisions or systematic exposures.
The majority of our detailed audit work was on the significant provision for SME interest
rate derivatives. We assessed the reasonableness of assumptions and interpretations of the
SME framework by management in relation to their calculations by performing back testing
procedures on the offer letters send to customers before 31 December 2017 and comparing the
results of the individual compensation offers to the original estimates of management. On the
basis of our carried out audit procedures we assessed the remaining recognized provision for
SME interest rate derivatives, and based on the information currently available to the Bank, to
be reasonable. We focused on disclosures regarding SME interest rate derivatives, Libor/Euribor
and Bank Secrecy Act/Anti-Money Laundering framework for Rabobank, N.A. (RNA).
We have assessed that the disclosures were sufficiently clear in highlighting the uncertainties
and exposures that exist.
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