HSBC 2006 Annual Report Download - page 218

HSBC HOLDINGS PLC
Report of the Directors: The Management of Risk (continued)
Market risk > Value at risk
216
Market risk management
(Audited)
The objective of HSBC’s market risk management is
to manage and control market risk exposures in order
to optimise return on risk while maintaining a market
profile consistent with the Group’s status as a
premier provider of financial products and services.
Market risk is the risk that movements in market
risk factors, including foreign exchange rates and
commodity prices, interest rates, credit spreads and
equity prices will reduce HSBC’s income or the
value of its portfolios. Credit risk is discussed
separately in the Credit risk section on page 171.
HSBC separates exposures to market risk into
either trading or non-trading portfolios. Trading
portfolios include those positions arising from
market-making, proprietary position-taking and
other marked-to-market positions so designated. The
contribution of the marked-to-market positions so
designated but not held with trading intent is
disclosed separately.
Non-trading portfolios primarily arise from the
interest rate management of HSBC’s retail and
commercial banking assets and liabilities.
The management of market risk is principally
undertaken in Global Markets using risk limits
approved by the Group Management Board. Limits
are set for portfolios, products and risk types, with
market liquidity being a principal factor in
determining the level of limits set. Traded Credit and
Market Risk, an independent unit within Corporate,
Investment Banking and Markets, develops the
Group’s market risk management policies and
measurement techniques. Each major operating
entity has an independent market risk control
function which is responsible for measuring market
risk exposures in accordance with the policies
defined by Traded Credit and Market Risk, and
monitoring and reporting these exposures against the
prescribed limits on a daily basis.
Each operating entity is required to assess the
market risks which arise on each product in its
business and to transfer these risks to either its local
Global Markets unit for management, or to separate
books managed under the supervision of the local
Asset and Liability Management Committee
(‘ALCO’). The aim is to ensure that all market risks
are consolidated within operations which have the
necessary skills, tools, management and governance
to manage such risks professionally.
Value at risk (‘VAR’)
(Audited)
One of the principal tools used by HSBC to monitor
and limit market risk exposure is VAR. VAR is a
technique that estimates the potential losses that
could occur on risk positions as a result of
movements in market rates and prices over a
specified time horizon and to a given level of
confidence.
The VAR models used by HSBC are
predominantly based on historical simulation. The
historical simulation models derive plausible future
scenarios from historical market rate time series,
taking account of inter-relationships between
different markets and rates, for example, between
interest rates and foreign exchange rates. The models
also incorporate the impact of option features in the
underlying exposures.
The historical simulation models used by HSBC
incorporate the following features:
• potential market movements are calculated with
reference to data from the last two years;
• historical market rates and prices are calculated
with reference to foreign exchange rates and
commodity prices, interest rates, equity prices
and the associated volatilities;
• VAR is calculated to a 99 per cent confidence
level; and
• VAR is calculated for a one-day holding period.
HSBC routinely validates the accuracy of its
VAR models by backtesting the actual daily profit
and loss results, adjusted to remove non-modelled
items such as fees and commissions, against the
corresponding VAR numbers. Statistically, HSBC
would expect to see losses in excess of VAR only
one per cent of the time over a one-year period. The
actual number of excesses over this period can
therefore be used to gauge how well the models are
performing.
Although a valuable guide to risk, VAR should
always be viewed in the context of its limitations.
For example:
• the use of historical data as a proxy for
estimating future events may not encompass all
potential events, particularly those which are
extreme in nature;
• the use of a 1-day holding period assumes that
all positions can be liquidated or hedged in one
day. This may not fully reflect the market risk