HSBC 2009 Annual Report Download - page 257

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within the stress testing scenarios as described on
page 252.
Non-trading portfolios
(Audited)
The principal objective of market risk management
of non-trading portfolios is to optimise net interest
income.
Interest rate risk in non-trading portfolios arises
principally from mismatches between the future
yield on assets and their funding cost, as a result
of interest rate changes. Analysis of this risk is
complicated by having to make assumptions on
embedded optionality within certain product areas
such as the incidence of mortgage prepayments,
and from behavioural assumptions regarding the
economic duration of liabilities which are
contractually repayable on demand such as current
accounts. The prospective change in future net
interest income from non-trading portfolios will be
reflected in the current realisable value of these
positions, should they be sold or closed prior to
maturity.
In order to manage this risk optimally, market
risk in non-trading portfolios is transferred to Global
Markets or to separate books managed under the
supervision of the local ALCO. This transfer is
usually achieved by a series of internal deals between
the business units and these books. When the
behavioural characteristics of a product differ from
its contractual characteristics, the former are
assessed to determine the true underlying interest
rate risk. Local ALCOs are required to regularly
monitor all such behavioural assumptions and
interest rate risk positions to ensure they comply
with interest rate risk limits established by GMB.
In certain cases, the non-linear characteristics of
products cannot be adequately captured by the risk
transfer process. For example, both the flow from
customer deposit accounts to alternative investment
products and the precise prepayment speeds of
mortgages will vary at different interest rate levels,
and where expectations about future moves in interest
rates change. In such circumstances, simulation
modelling is used to identify the impact of varying
scenarios on valuations and net interest income.
Once market risk has been consolidated in
Global Markets or ALCO-managed books, the net
exposure is typically managed through the use of
interest rate swaps within agreed limits. The VAR for
these portfolios is included within the Group VAR
(see ‘Value at risk of the trading and non-trading
portfolios’ above).
Credit spread risk
At 31 December 2009, the sensitivity of equity to
the effect of movements in credit spreads, based on
credit spread VAR, on the Group’s available-for-sale
debt securities was US$535 million (2008:
US$1,013 million). The sensitivity was calculated on
the same basis as applied to the trading portfolio.
Including the gross exposure for the SICs
consolidated within HSBC’s balance sheet at
31 December 2009, the sensitivity increased to
US$549 million. This sensitivity is struck, however,
before taking account of any losses which would be
absorbed by the capital note holders. At
31 December 2009, the capital note holders would
have absorbed the first US$2.2 billion (2008:
US$2.2 billion) of any losses incurred by the SICs
prior to HSBC incurring any equity losses.
The notable decrease in this sensitivity at
31 December 2009, compared with 31 December
2008, was due to the effect of lower volatility in
credit spreads observed during 2009. The overall
credit spread positions within the available-for-sale
portfolios were lower on 31 December 2009
compared with 31 December 2008.
Equity securities classified as available
for sale
Market risk arises on equity securities classified as
available for sale. The fair value of these securities
at 31 December 2009 was US$9.1 billion (2008:
US$7.3 billion) and included private equity holdings
of US$4.0 billion (2008: US$2.5 billion).
Investments in private equity are primarily made
through managed funds that are subject to limits
on the amount of investment. Potential new
commitments are subject to risk appraisal to ensure
that industry and geographical concentrations remain
within acceptable levels for the portfolio as a whole.
Regular reviews are performed to substantiate the
valuation of the investments within the portfolio.
Funds typically invested for short-term cash
management represented US$0.8 billion (2008:
US$0.9 billion). Investments held to facilitate
ongoing business, such as holdings in government-
sponsored enterprises and local stock exchanges,
represented US$1.2 billion (2008: US$1.0 billion).
Other strategic investments represented
US$3.1 billion (2008: US$2.4 billion). The fair value
of the constituents of equity securities classified as
available for sale can fluctuate considerably. A
10 per cent reduction in the value of the available-
for-sale equities at 31 December 2009 would have
reduced equity by US$0.9 billion (2008:
US$0.7 billion). For details of the impairment
incurred on available-for-sale equity securities, see