HSBC 2004 Annual Report Download - page 347

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assessment of hedge effectiveness is demonstrated on a prospective basis utilising both statistical regression
analysis and the cumulative dollar offset method. In order to satisfy the retrospective assessment of effectiveness
for SFAS 133, the cumulative dollar offset method is utilised and ineffectiveness is recognised in the income
statement on a monthly basis. The time value component of the derivative contracts is excluded from the
assessment of hedge effectiveness.
Ineffectiveness of cash flow hedging activities recognised in US GAAP reported net income was a loss of
US$1 million (2003: gain of US$4 million; 2002: gain of US$13 million). The adjustment to US GAAP reported
equity of such hedges at 31 December 2004 was to increase equity by US$133 million (2003: US$409 million).
Trading derivatives
All other UK GAAP hedging derivatives have been marked to market for US GAAP purposes with the gain or
loss recognised in net income for the period. This has given rise to the increase in US reported net income of
US$210 million (2003: US$613 million; 2002: US$221 million). The principal impact of applying SFAS 133 is
to reduce other assets by US$5,487 million (2003: US$6,545 million) and reduce other liabilities by
US$5,754 million (2003: US$7,491 million). Under UK GAAP, internal derivatives used to hedge banking book
transactions may be accruals accounted but, under US GAAP, all derivatives are held at fair value.
(i) Foreign exchange gains on available-for-sale securities
Within individual legal entities HSBC holds securities in a number of different currencies which are classified as
available-for-sale. For example, within the private bank in Switzerland, which has the US dollar as its reporting
currency, the Group holds euro-denominated bonds which are funded in euros and Swiss franc securities funded
in Swiss francs. No foreign exchange exposure arises from this because, although the value of the assets in US
dollar terms changes according to the exchange rate, there is an identical offsetting change in the US dollar value
of the related funding. Under UK GAAP both the assets and the liabilities are translated at closing exchange
rates and the differences between historical book value and current value are reflected in foreign exchange
dealing profits. This reflects the economic substance of holding currency assets financed by currency liabilities.
However, under US accounting rules, SFAS 115 and Emerging Issues Task Force (‘EITF’ ) Abstract 96-15
‘Accounting for the Effects of Changes in Foreign Currency Exchange Rates on Foreign-Currency-Denominated
Available-for-Sale Debt Securities’ the change in value of the investments classified as available-for-sale is
taken directly to reserves whereas the offsetting change in US dollar terms of the borrowing is taken to earnings.
This leads to an accounting result which, although in compliance with US GAAP, does not necessarily reflect
either the underlying risk position or the economics of the transactions. It is also a situation that will reverse on
maturity of the asset or earlier sale. A similar difference arises where foreign currency exposure on foreign
currency assets is covered using forward contracts, but where HSBC does not manage these hedges to conform
with the detailed US hedge designation requirements of SFAS 133.
The result of this is that for 2004, US GAAP profits were increased by US$1,069 million (2003: decreased by
US$2,283 million; 2002: decreased by US$2,197 million) compared to UK GAAP profits. There is no difference
in shareholders’ equity between UK GAAP and US GAAP as a result of this reconciling item.
The adjustment for 2004 largely reflects the reversal of adjustments in prior periods on the maturity or disposal
of securities. This was offset by the impact of a weakening of the US dollar against the principal currencies in
which HSBC held ‘available for sale’ securities, which also gave rise to the adjustments in prior periods.
(j) Investment securities
Under UK GAAP, debt securities and equity shares intended to be held on a continuing basis are classified as
investment securities and are included in the balance sheet at cost less provision for any permanent diminution in
value. Other participating interests are accounted for on the same basis. Where dated investment securities have
been purchased at a premium or discount, these premiums and discounts are amortised through the profit and
loss account over the period from the date of purchase to the date of maturity and included in ‘interest income’ .
These securities are included in the balance sheet at cost adjusted for the amortisation of premium and discounts
arising on acquisition. Any gain or loss on realisation of these securities is recognised in the profit and loss
account as it arises and included in ‘Gains on disposal of investments’ .
Other debt securities and equity shares are included in the balance sheet at market value. Changes in the market