HSBC 2014 Annual Report Download - page 143

HSBC BANK PLC
Notes on the Financial Statements (continued)
141
counterparty, to the expected positive exposure of the counterparty to the group and multiplying by the loss expected in
the event of default. Both calculations are performed over the life of the potential exposure.
For most products, the group uses a simulation methodology to calculate the expected positive exposure to a
counterparty. This incorporates the range of potential exposures across the portfolio of transactions with the
counterparty over the life of the portfolio. The simulation methodology includes credit mitigants such as counterparty
netting agreements and collateral agreements with the counterparty. A standard loss given default assumption of 60% is
generally adopted for developed market exposures, and 75% for emerging market exposures. Alternative loss given
default assumptions may be adopted where both the nature of the exposure and the available data support this.
For certain types of exotic derivatives where the products are not currently supported by the simulation, or for derivative
exposures in smaller trading locations where the simulation tool is not yet available, the group adopts alternative
methodologies. These may involve mapping to the results for similar products from the simulation tool or where the
mapping approach is not appropriate, using a simplified methodology which generally follows the same principles as the
simulation methodology. The calculation is applied at a trade level, with more limited recognition of credit mitigants such
as netting or collateral agreements than used in the simulation methodology.
The methodologies do not, in general, account for ‘wrong-way risk’. Wrong-way risk arises where the underlying value of
the derivative prior to any CVA is positively correlated to the probability of default of the counterparty. When there is
significant wrong-way risk, a trade-specific approach is applied to reflect the wrong-way risk within the valuation.
With the exception of certain central clearing parties, the group includes all third party counterparties in the CVA and DVA
calculations and does not net these calculations across group entities. The group reviews and refines the CVA and DVA
methodologies on an ongoing basis.
Valuation of uncollateralised derivatives
Historically, the group has valued uncollateralised derivatives by discounting expected future cash flows at a benchmark
interest rate, typically Libor or its equivalent. In line with evolving industry practice, the group changed this approach in the
second half of 2014. The group now views the OIS curve as the base discounting curve for all derivatives, both collateralised
and uncollateralised, and has adopted a ‘funding fair value adjustment’ to reflect the funding of uncollateralised derivative
exposure at rates other than OIS. As at 31 December 2014, the funding fair value adjustment was £152 million. The impact of
adopting the funding fair value adjustment was a one-off reduction in trading revenues of £152 million. This is an area in
which a full industry consensus has not yet emerged. The group will continue to monitor industry evolution and refine the
calculation methodology as necessary.
Fair value valuation bases
Financial instruments measured at fair value using a valuation technique with significant unobservable inputs – Level 3
The group
Assets
Liabilities
Available-
for-sale
Held for
trading
At fair
value
Derivatives
Held for
trading
At fair
value
Derivatives
£m
£m
£m
£m
£m
£m
£m
Private equity investments
595
96
–
–
28
–
–
Asset-backed securities
934
275
–
–
–
–
–
Structured notes
–
–
–
–
1,265
–
–
Derivatives
–
–
–
1,614
–
–
1,221
Other portfolios
17
1,782
5
–
–
5
–
At 31 December 2014
1,546
2,153
5
1,614
1,293
5
1,221
Private equity investments
642
56
–
–
–
–
–
Asset-backed securities
1,011
264
–
–
–
–
–
Structured notes
–
–
–
–
1,361
–
–
Derivatives
–
–
–
1,072
–
–
1,297
Other portfolios
–
1,242
–
–
–
–
–
At 31 December 2013
1,653
1,562
–
1,072
1,361
–
1,297