HSBC 2008 Annual Report Download - page 244

HSBC HOLDINGS PLC
Report of the Directors: Risk (continued)
Market risk > Impact of market turmoil > VAR
242
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 one-day holding period assumes that
all positions can be liquidated or the risk offset
in one day. This may not fully reflect the market
risk arising at times of severe illiquidity, when a
one-day holding period may be insufficient to
liquidate or hedge all positions fully;
• the use of a 99 per cent confidence level, by
definition, does not take into account losses that
might occur beyond this level of confidence;
• VAR is calculated on the basis of exposures
outstanding at the close of business and
therefore does not necessarily reflect intra-day
exposures; and
• VAR is unlikely to reflect loss potential on
exposures that only arise under significant
market moves.
Stress testing
In recognition of the limitations of VAR, HSBC
augments it with stress testing to evaluate the
potential impact on portfolio values of more
extreme, although plausible, events or movements in
a set of financial variables.
Stress testing is performed at a portfolio level,
as well as on the consolidated positions of the
Group, and covers the following scenarios:
• sensitivity scenarios, which consider the impact
of market moves to any single risk factor or a
set of factors. For example the impact resulting
from a break of a currency peg that is unlikely
to be captured within the VAR models;
• technical scenarios, which consider the largest
move in each risk factor, without consideration
of any underlying market correlation;
• hypothetical scenarios, which consider potential
macro economic events; and
• historical scenarios, which incorporate historical
observations of market moves during previous
periods of stress which would not be captured
within VAR.
Stress testing is governed by the ‘Stress Testing
Review Group’ forum that coordinates the Group
stress testing scenarios in conjunction with the
regional risk managers. Consideration is given to the
actual market risk exposures, along with market
events in determining the stress scenarios.
Stress testing results are reported to senior
management and provide them with an assessment
of the financial impact such events would have on
the profit of HSBC. The daily losses experienced
during 2008 were within the stress loss scenarios
reported to senior management.
The following table provides an overview of the
reporting of risks within this section:
Portfolio
Trading Non-trading
Risk type
Foreign exchange ............... VAR VAR1
Interest rate ......................... VAR VAR2
Commodity ........................ VAR N/A
Equity ................................. VAR Sensitivity
Credit spread ...................... Sensitivity Sensitivity3
1 The structural foreign exchange risk is monitored using
sensitivity analysis. See page 429.
2 The interest rate risk on the fixed-rate securities issued by
HSBC Holdings is not included in the Group VAR. The
management of this risk is described on page 249.
3 Credit spread VAR is reported for the credit derivatives
transacted by Global Banking. See page 244.
The impact of market turmoil on market risk
(Audited)
The years preceding the current market turmoil were
characterised by historically low levels of volatility,
with ample market liquidity. This period was
associated with falling levels of VAR as the level of
observed market volatility is a key determinant in the
VAR calculation. As a consequence HSBC reduced
the overall VAR limit to reflect the lower level of
volatility, and associated VAR.
The tightening of both credit and liquidity
within the wholesale markets observed during the
latter half of 2007 led to an increase in market
volatility, most noticeably in the credit spreads of
financial institutions and ABSs/MBSs.
Credit spread volatility continued to increase
during the first half of 2008, and as the effect of the
market turmoil on the wider economy became more
apparent, there was a larger increase in the volatility
in other risk types, such as interest rates. Coupled
with positions taken in anticipation of rate
reductions, the increase in volatility led to an
increase in the total VAR in early 2008.
Volatility across all asset classes continued to
increase in the second half of 2008, as central banks
coordinated a series of rate cuts, in an attempt to
stimulate demand within the global economy.
Although the increase in volatility led to a further