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Earnings Allocation and Fund Transfer Pricing (FTP) System

For all lending activities, which use up cash, some cost of funds has to be defined. The mechanism relies on internal transfer prices. The purpose of the FTP system is to define income at business unit, book and transaction levels for those transactions using up funds, and to make aggregation of such elementary incomes consistent with the overall bank's income. FTP systems are detailed in Section 8.

With the internal reference prices provided by the FTP system, the income allocation consists in calculating the income as the difference between revenues and internal prices. When aggregating allocated incomes, the internal transfers of funds should net to a zero cost. The mechanisms impose that the cost of funds of business units is identical to the revenue of the FTP unit, the central pool of funds. Target profitability imposes mark-ups over these economic prices.

For trading activities, the earnings are defined by the variations of transaction value over a period, and these add up algebraically to total earnings from trading activities. For some portfolios, the revenue is the spread between the yield of securities held and the cost of funds. Any bias in the cost of funds would result in either a subsidy or a penalty for such portfolios. For the banking portfolio, transfer prices apply to loans and to deposit collection. For the market portfolio, those are all market instruments that are "held to maturity" within the trading portfolio[1]. An example is "spread books" held for capturing the spread between the yield of securities, mainly bonds, and the cost of financing these instruments. For loans, transfer prices allow isolating their net interest income, and for setting a cost for warehousing of loans that pile up in the "ramping period" before they are securitized[2].

There are other difficulties for allocating trading profit to proprietary trading and trading for sales to clients because both activities are managed together within trading portfolios. Such allocations are not dealt with in transfer pricing schemes, but through conventions within the trading unit.

  • [1] See Chapter 21 for the classification of assets within the different categories of portfolios defined according to management intention.
  • [2] See the UBS Shareholder Report [75] which describes in detail how internal cost of funds can affect the policies within the trading book. See also [67].
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