HSBC 2012 Annual Report Download - page 270

HSBC HOLDINGS PLC
Report of the Directors: Operating and Financial Review (continued)
Risk > Appendix – Risk policies and practices > Market risk
268
Trading portfolios
(Audited)
Our control of market risk in the trading portfolios is based on a policy of restricting individual operations to trading
within a list of permissible instruments authorised for each site by Group Risk, of enforcing new product approval
procedures, and of restricting trading in the more complex derivative products only to offices with appropriate levels
of product expertise and robust control systems.
Gap risk
Certain transactions are structured to render the risk to HSBC negligible under a wide range of market conditions or
events, however, there exists a remote possibility that a gap event could lead to loss. A gap event could arise from a
significant change in market price with no accompanying trading opportunity, with the result that the threshold is
breached beyond which the risk profile changes from no risk to full exposure to the underlying structure. Such
movements may occur, for example, when, in reaction to an adverse event or unexpected news announcement, the
market for a specific investment becomes illiquid, making hedging impossible.
Given their characteristics, these transactions make little or no contribution to VAR or to traditional market risk
sensitivity measures. We capture their risks within our stress testing scenarios and monitor gap risk on an ongoing
basis. We regularly consider the probability of gap loss, and fair value adjustments are booked against this risk where
significant.
Gap risk derived from certain transactions in legacy portfolios continued to be managed down during 2012. The
residual exposure is immaterial. We did not incur any material gap loss in 2012.
ABS/MBS exposures
The ABS/MBS exposures within the trading portfolios are managed within sensitivity and VAR limits as described
on page 220, and are included within the stress testing scenarios described above.
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.
Our control of market risk in the non-trading portfolios is based on transferring the risks to the books managed by
Global Markets or the local ALCO. 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.
Credit spread risk for available-for-sale debt instruments
The risk associated with movements in credit spreads is primarily managed through sensitivity limits, stress testing
and VAR. The VAR shows the effect on income from a one-day movement in credit spreads over a two-year period,
calculated to a 99% confidence interval.
Available for sale equity securities
Potential new commitments are subject to risk appraisal to ensure that industry and geographical concentrations
remain within acceptable levels for the portfolio. Regular reviews are performed to substantiate the valuation of the
investments within the portfolio and investments held to facilitate ongoing business, such as holdings in government-
sponsored enterprises and local stock exchanges.
Structural foreign exchange exposures
(Unaudited)
Structural foreign exchange exposures represent net investments in subsidiaries, branches and associates, the