As described, a derivatives dealer created a synthetic annuity, and the mark-to-market value is the net present value of the mark-to-market value is the net present value of the annuity that the dealer created. Projected gross income is calculated and then discounted at the mid-market rate. Then the revenue stream is adjusted to reflect future expenses. As a result, the mark-to-market valuations of an OTC derivatives dealer’s books of derivatives positions is universally calculated for all purposes (including tax) on a portfolio-wide basis. The SIA makes it clear that derivatives held by a dealer are unlike physical securities held by a dealer.
“In valuing a dealer’s portfolio of OTC derivatives, the dealer thus focuses not on the derivatives themselves, as if they were inventory form which the dealer will profit through their prompt resale, but rather on the future net income streams expected to be generated through retaining and tending to those derivatives.”
Therefore, the SIA contends that a derivative-by-derivative approach to calculating adjusted mid-market value is inappropriate. The SIA submission also includes an Appendix that provides an overview of commonly accepted adjustments to mid-market values. Categories included are model adjustments, portfolio adjustments, market risk adjustments, credit adjustments, and administrative and other portfolio adjustments.
3.3 Financial statements and business use
As a general matter, the NYSBA agrees with the categories of financial statements listed by the IRS but would expand the listed categories to include financials filed with regulatory agencies of foreign and state governments. The report, therefore, recommends that the regulations include a list of such approved regulatory authorities. Further, as valuations not submitted to approved regulatory authorities are less reliable than those submitted to approved regulatory authorities, taxpayers should be granted a rebuttable (but not a conclusive) presumption that the values reported on other certified financials represent the fair market value for purposes of Sec. 475 if the taxpayer can demonstrate a significant non-tax business purpose that helps to ensure the accuracy of the valuations.
Similarly, the ISDA’s comments seek a broadening of acceptable financial statements and contend that an audited financial statement that is provided to the SEC, to any regulatory body, or to shareholders or creditors should qualify for the safe harbour. According to the ISDA submission, the IRS requirement of significant non-tax business use should be deemed to be fulfilled if the dealer take the profit and loss effects of the mid-market account into consideration when making a determination regarding once of the following:
- managing market and credit risk;
- compensating ket personal; evaluating lines of business; or
- determining which transactions to enter into (hold) and which transactions to avoid (or terminate), and the prices at which transactions are to be entered into or terminated.
The ISDA also argues that when mid-market valuations of non-US entities are incorporated into the financials of a non-US entities are incorporated into the financial of a non-US parent which are not prepared according to GAAP, such valuations should be respected, as well.
The SIA indicates that all reports supplied by its members to federal agencies, as well as to public investors, are prepared in accordance with GAAP, and therefore all employ the same mark-to-market valuations process. The SIA also suggests that in the interest of administrability, the IRS should provide a hierarchy of different types of reports that are considered acceptable for purposes of the safe harbour so that dealers will have a clear understanding of what documentation will be required of them in an audit process.