HSBC 2009 Annual Report Download - page 427

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second category includes derivatives managed in conjunction with financial instruments designated at fair value.
These activities are described more fully below.
HSBC’s derivative activities give rise to significant open positions in portfolios of derivatives. These positions are
managed constantly to ensure that they remain within acceptable risk levels, with matching deals being utilised to
achieve this where necessary. When entering into derivative transactions, HSBC employs the same credit risk
management procedures to assess and approve potential credit exposures that are used for traditional lending.
Trading derivatives
Most of HSBC’s derivative transactions relate to sales and trading activities. Sales activities include the structuring
and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or
expected risks. Trading activities in derivatives are entered into principally for the purpose of generating profits from
short-term fluctuations in price or margin. Positions may be traded actively or be held over a period of time to benefit
from expected changes in exchange rates, interest rates, equity prices or other market parameters. Trading includes
market-making, positioning and arbitrage activities. Market-making entails quoting bid and offer prices to other
market participants for the purpose of generating revenues based on spread and volume; positioning means managing
market risk positions in the expectation of benefiting from favourable movements in prices, rates or indices; arbitrage
involves identifying and profiting from price differentials between markets and products.
As mentioned above, other derivatives classified as held for trading include non-qualifying hedging derivatives,
ineffective hedging derivatives and the components of hedging derivatives that are excluded from assessing hedge
effectiveness. Non-qualifying hedging derivatives are entered into for risk management purposes but do not meet the
criteria for hedge accounting. These include derivatives managed in conjunction with financial instruments
designated at fair value.
Gains and losses from changes in the fair value of derivatives, including the contractual interest, that do not qualify
for hedge accounting are reported in ‘Net trading income’, except for derivatives managed in conjunction with
financial instruments designated at fair value, where gains and losses are reported in ‘Net income from financial
instruments designated at fair value’, together with the gains and losses on the hedged items. Where the derivatives
are managed with debt securities in issue, the contractual interest is shown in ‘interest expense’ together with the
interest payable on the issued debt. Substantially all of HSBC Holdings’ derivatives entered into with HSBC
undertakings are managed in conjunction with financial liabilities designated at fair value.
The notional contract amounts of derivatives held for trading purposes indicate the nominal value of transactions
outstanding at the balance sheet date; they do not represent amounts at risk.
Notional contract amounts of derivatives held for trading purposes by product type
HSBC HSBC Holdings
2009 2008 2009 2008
US$m US$m US$m US$m
Foreign exchange ...................................................................... 2,883,201 3,045,017 17,150 14,312
Interest rate ............................................................................... 13,874,355 12,435,965 6,804 7,804
Equity ........................................................................................ 217,828 221,053 – –
Credit ........................................................................................ 1,237,055 1,583,337 – –
Commodity and other ............................................................... 53,720 63,103 – –
18,266,159 17,348,475 23,954 22,116
Credit derivatives
HSBC trades credit derivatives through its principal dealing operations and acts as a principal counterparty to a broad
range of users, structuring deals to produce risk management products for its customers, or making markets in certain
products. Risk is typically controlled through entering into offsetting credit derivative contracts with other
counterparties.
HSBC manages the credit risk arising on buying and selling credit derivative protection by including the related
credit exposures within its overall credit limit structure for the relevant counterparty. Trading of credit derivatives is
restricted to a small number of offices within the major centres which have the control infrastructure and market
skills to manage effectively the credit risk inherent in the products.