HSBC 2006 Annual Report Download - page 427

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hedges for US GAAP purposes. In addition, there were US$9 million of gains on such derivatives that did not
qualify for hedge accounting under US GAAP and amortisation of hedge valuation adjustments for de-
designated hedge relationships.
On electing to report under the fair value option under IAS 39, unamortised purchase accounting adjustments on
HSBC Finance Corporation's own debt were eliminated through retained earnings upon transition to IAS 39 on
1 January 2005. As a result, a US$27 million benefit (2005: US$298 million benefit) to US GAAP net income
was not recognised under IFRSs.
Cash flow hedges
HSBC’s US operating subsidiaries designate under SFAS 133 certain derivative financial instruments, including
interest rate swaps and cross-currency contracts, as qualifying cash flow hedges of the forecast repricing of
certain deposit liabilities and issues of debt. A number of variable rate commercial loans were also subject to
cash flow hedges up until 2004.
In order to qualify initially, hedge effectiveness is assessed and demonstrated on a prospective basis utilising
both statistical regression analysis and the cumulative dollar offset method. The latter is used in order to satisfy
the retrospective assessment of effectiveness for SFAS 133, and subsequent 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.
Since 1 January 2005, such hedging arrangements have been recognised as cash flow hedges for IFRSs purposes.
US GAAP net income for 2006 was lower than that under IFRSs by US$20 million (2005: US$6 million),
relating to differences in amortisation of other comprehensive income for de-designated hedge relationships
under US GAAP and IFRS and unrecorded ineffectiveness on shortcut cash flow hedges during 2005 for
US GAAP purposes.
Trading derivatives
From 1 January 2005, certain hedging relationships outside North America were elected and qualified as fair
value hedges, were designated under the fair value option, or were elected and qualified as cash flow hedges
under IAS 39, but were not elected as hedges under SFAS 133. The mark to market for these derivatives has
been reported directly in net income for US GAAP purposes.
For fair value hedges recognised under IFRSs, no corresponding, offsetting fair value movement of the hedged
item with respect to the hedged risk has been recorded for US GAAP purposes. For hedging relationships
designated as at fair value for IFRSs purposes, no fair value movement in respect of own debt is recorded under
US GAAP.
The effect of this was to increase US GAAP net income by US$214 million (2005: US$1,266 million reduction),
net of elimination of a loss under IFRS of US$41 million (2005: US$76 million loss) of own credit spread,
outside North America.
Fair value option
HSBC has also applied the fair value option under IFRSs to groups of financial assets and liabilities which are
managed and evaluated on a fair value basis, and to financial instruments containing embedded derivatives (see
Note 3). In addition, movements in the fair value of certain liabilities which meet the definition of ‘held for
trading’ under IAS 39 are taken through net income. US GAAP does not include a fair value election and does
not generally permit liabilities to be reported at fair value.
From 1 January 2006, with HSBC’s adoption of SFAS 155, the Group’s hybrid debt issues that contain an
embedded derivative that would otherwise require bifurcation, are accounted for in a consistent manner under
both IFRSs and US GAAP, where such instruments are designated to be measured at fair value. The elimination
of all other fair value option accounting increased US GAAP net income for 2006 by US$193 million (2005:
US$733 million reduction prior to the adoption of SFAS 155).