HSBC 2010 Annual Report Download - page 311

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Overview Operating & Financial Review Governance Financial Statements Shareholder Information
For all financial instruments where fair values are determined by reference to externally quoted prices or observable
pricing inputs to models, independent price determination or validation is utilised. In inactive markets, direct
observation of a traded price may not be possible. In these circumstances, HSBC will source alternative market
information to validate the financial instrument’s fair value, with greater weight given to information that is
considered to be more relevant and reliable. The factors that are considered in this regard are, inter alia:
• the extent to which prices may be expected to represent genuine traded or tradeable prices;
• the degree of similarity between financial instruments;
• the degree of consistency between different sources;
• the process followed by the pricing provider to derive the data;
• the elapsed time between the date to which the market data relates and the balance sheet date; and
• the manner in which the data was sourced.
For fair values determined using a valuation model, the control framework may include, as applicable, independent
development or validation of (i) the logic within valuation models; (ii) the inputs to those models; (iii) any
adjustments required outside the valuation models; and (iv) where possible, model outputs. Valuation models are
subject to a process of due diligence and calibration before becoming operational and are calibrated against external
market data on an ongoing basis.
The fair value governance structure is as follows:
Finance
Responsible for determining
fair value:
•Establishing accounting
policies for fair value
•Establishing procedures
governing valuation
•Ensuring compliance with
all relevant accounting
standards
Group Finance Director
Valuation Committees
Consist of valuation experts
from several independent
support functions
(product control, market
risk management, quantitative
risk and valuation group
and finance), in addition
to senior management
Valuation Committee
Review Group
Chaired by Global Head of
Product Control,
Global Markets
Consists of heads of
Global Banking and
Markets, finance
and risk functions
Provides
results
Overseen by
and report
all valuations
considered
to have
material
subjectivity
Finance
Responsible for determining
fair value:
•Establishing accounting
policies for fair value
•Establishing procedures
governing valuation
•Ensuring compliance with
all relevant accounting
standards
Group Finance Director
Valuation Committees
Consist of valuation experts
from several independent
support functions
(product control, market
risk management, quantitative
risk and valuation group
and finance), in addition
to senior management
Valuation Committee
Review Group
Chaired by Global Head of
Product Control,
Global Markets
Consists of heads of
Global Banking and
Markets, finance
and risk functions
Provides
results
Overseen by
and report
all valuations
considered
to have
material
subjectivity
Determination of fair value
Fair values are determined according to the following hierarchy:
• Level 1 – quoted market price: financial instruments with quoted prices for identical instruments in active
markets.
• Level 2 – valuation technique using observable inputs: financial instruments with quoted prices for similar
instruments in active markets or quoted prices for identical or similar instruments in inactive markets and
financial instruments valued using models where all significant inputs are observable.
• Level 3 – valuation technique with significant unobservable inputs: financial instruments valued using valuation
techniques where one or more significant inputs are unobservable.
The best evidence of fair value is a quoted price in an actively traded market. The fair values of financial instruments
that are quoted in active markets are based on bid prices for assets held and offer prices for liabilities issued. Where a
financial instrument has a quoted price in an active market and it is part of a portfolio, the fair value of the portfolio is
calculated as the product of the number of units and quoted price and no block discounts are applied. In the event that
the market for a financial instrument is not active, a valuation technique is used.
The judgement as to whether a market is active may include, but is not restricted to, the consideration of factors such
as the magnitude and frequency of trading activity, the availability of prices and the size of bid/offer spreads. The
bid/offer spread represents the difference in prices at which a market participant would be willing to buy compared
with the price at which they would be willing to sell. In inactive markets, obtaining assurance that the transaction
price provides evidence of fair value or determining the adjustments to transaction prices that are necessary to
measure the fair value of the instrument requires additional work during the valuation process.