Strategic Shareholder Climate and Risk Financial Financial Barclays PLC 405 report information sustainability report Governance review review statements Annual Report 2022 KPMG LLP’s independent auditor’s report to the members of Barclays PLC (continued) 4.2 Valuation of financial instruments held at fair value Financial Statement Elements FY22 FY21 Our assessment of risk vs FY21 Our results Level 2 assets at fair value* (note 17) £595bn £533bn FY22: 1 Our assessment is that the risk is similar to FY21. Acceptable Level 2 liabilities at fair value* (note 17) £572bn £521bn FY21: Level 3 assets at fair value (note 17) £21bn £16bn Acceptable Level 3 liabilities at fair value (note 17) £7.5bn £6.5bn *The key audit matter identified relates to one derivatives portfolio within these balances, and xVA adjustments made to derivative valuations, both of which we considered to be harder-to-value. Description of the Key Audit Matter Our response to the risk Subjective valuation Our procedures to address the risk included: The fair value of the Group’s financial Risk assessment: We performed granular and detailed risk assessment procedures throughout the instruments is determined through the audit period over the entirety of the balances within the Group’s financial statements (i.e. all of the fair application of valuation techniques which can value financial instruments held by the Group). As part of these risk assessment procedures, we involve the exercise of significant judgement identified which portfolios and the associated valuation inputs have a risk of material misstatement by the Group in relation to the choice of the including those arising from significant judgements over valuation either due to unobservable inputs valuation models, pricing inputs and post- or complex models. model pricing adjustments, including fair value Control testing: We attended management’s valuation committee throughout the year and adjustments (FVAs) and credit and funding observed discussion and challenge over valuation themes including items related to the valuation of adjustments (together referred to as XVAs). certain difficult-to-value financial instruments recorded at fair value. Where significant pricing inputs are We performed end to end process walkthroughs to identify the key systems, applications and controls unobservable, management has limited used in the valuations processes. We tested the design and operating effectiveness of key controls reliable, relevant market data available in relating specifically to these portfolios. determining the fair value and hence estimation uncertainty can be high. These Key aspects of our controls testing involved evaluating the design and implementation and testing the financial instruments are classified as Level 3, operating effectiveness of the key controls over: with management having controls in place • independent price verification (IPV), performed by a control function, of key market pricing inputs, over the boundary between Level 2 and 3 including completeness of positions and valuation inputs subject to the IPV process; positions. Our significant audit risk is therefore primarily over significant Level 3 portfolios. • FVAs, including exit adjustments (to mark the portfolio to bid or offer prices), model shortcoming reserves to address model limitations and XVAs; In addition, there may also be valuation • the validation, completeness, implementation and usage of valuation models. This included complexity associated with Level 2 portfolios, controls over assessment of model limitations and assumptions; and specifically where valuation modelling techniques result in significant limitations or • the assessment of the observability of a product and their unobservable inputs. where there is greater uncertainty around the Our valuations expertise: We involved our own valuations specialists in the following: choice of an appropriate pricing methodology, and consequently more than one valuation • independently re-pricing a selection of fair value financial instruments and challenging methodology could be used for that product management on the valuations where they were outside our tolerance; and across the market. • challenging the appropriateness of significant models and methodologies used in calculating fair values, risk exposures and in calculating FVAs, including comparison to industry practice. We identified two areas of such complexity. Seeking contradictory evidence: For a selection of collateral disputes identified through The first a derivatives portfolio that we management’s control we challenged management’s valuation where significant fair value differences considered to be harder to value Level 2 due to were observable with the market participant on the other side of the trade. We also utilised collateral an element of modelling complexity dispute data to identify fair value financial instruments with significant fair value differences against associated with the product, and the second market counter parties and selected these to independently reprice. the XVA adjustments made to uncollateralised Inspection of movements: We inspected trading revenue arising on level 3 positions to assess and partially collateralised derivative whether material gains or losses generated were in line with the accounting standards. valuations. Historical comparison: We performed a retrospective review by inspecting significant gains and The effect of these matters is that, as part of losses on a selection of new fair value financial instruments, position exits, novations and our risk assessment, we determined that the restructurings throughout the audit period and evaluated whether these data points indicated subjective estimates in fair value elements of fair value not incorporated in the current valuation methodologies. We also inspected measurement of certain portfolios, and movements in unobservable inputs throughout the period to challenge whether any gain or loss harder-to-value Level 2 portfolios have a high generated was appropriate. degree of estimation uncertainty, with a potential range of reasonable outcomes Assessing transparency: For the Level 3 portfolios, we assessed the adequacy of the Group’s greater than our materiality for the financial financial statements disclosures in the context of the relevant accounting standards. statements as a whole, and possibly many times that amount. The financial statements (note 17) disclose the sensitivity estimated by the Group. Disclosure quality For the Level 3 portfolios, the disclosures are key to explaining the valuation techniques, key judgements, assumptions and material inputs.