HSBC 2014 Annual Report Download - page 74

HSBC BANK PLC
Report of the Directors: Risk (continued)
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consolidated within our balance sheet based on credit
spread VaR. This sensitivity excludes losses which would
have been absorbed by the capital note holders.
The decrease in this sensitivity at 31 December 2014
compared with 31 December 2013 was mainly due to
reducing the overall positions and lower volatilities and
credit spread baselines observed during 2014.
Fixed-rate securities
The principal non-trading risk which is not included in the
VAR reported for Global Banking and Markets arises out
of Fixed Rate Subordinated Notes. The VAR related to
these instruments was £19.4 million at 31 December
2014 (2013: £16.6 million); while the average and
maximum during the year was £17.5 million and
£23.9 million respectively (2013: £24.6 million and
£29.7 million).
Equity securities held as available-for-sale
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 on-going business, such as holdings in
government-sponsored enterprises and local stock
exchanges.
Market risk arises on equity securities held as available-
for-sale. The fair value of these securities at 31
December 2014 was £1,009 million (2013: £1,006
million).
The fair value of the constituents of equity securities
held as available-for-sale can fluctuate considerably. For
details of the impairment incurred on available-for-sale
equity securities see the accounting policies in Note 1(j).
Structural foreign exchange exposures
(Unaudited)
Structural foreign exchange exposures represent net
investments in subsidiaries, branches and associates, the
functional currencies of which are currencies other than
sterling. An entity’s functional currency is that of the
primary economic environment in which the entity
operates.
Exchange differences on structural exposures are
recognised in other comprehensive income.
The group hedges structural foreign currency exposures
only in limited circumstances. The group’s structural
foreign exchange exposures are managed with the
primary objective of ensuring, where practical, that the
group’s consolidated capital ratios and the capital ratios
of individual banking subsidiaries are largely protected
from the effect of changes in exchange rates. This is
usually achieved by ensuring that, for each subsidiary
bank, the ratio of structural exposures in a given
currency to risk-weighted assets denominated in that
currency is broadly equal to the capital ratio of the
subsidiary in question.
The group may also transact hedges where a currency in
which the group have structural exposures is considered
likely to revalue adversely and it is possible in practice to
transact a hedge. Any hedging is undertaken using
forward foreign exchange contracts which are accounted
for under IFRSs as hedges of a net investment in a
foreign operation, or by financing with borrowings in the
same currencies as the functional currencies involved.
For details of structural foreign exchange exposures see
Note 31 ‘Foreign exchange exposures’.
Non-trading interest rate risk
(Unaudited)
Non-trading 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, and the re-pricing behaviour of
managed rate products. These assumptions around
behavioural features are captured in our interest rate
risk behaviouralisation framework, which is described
below.
We aim, through our management of market risk in non-
trading portfolios, to mitigate the effect of prospective
interest rate movements which could reduce future net
interest income, while balancing the cost of such hedging
activities on the current net revenue stream.
Analysis of interest rate risk is complicated by having to
make assumptions on embedded optionality within
certain product areas such as the incidence of mortgage
prepayments.
Interest rate risk behaviouralisation
Unlike liquidity risk which is assessed on the basis of a
very severe stress scenario, non-traded market interest
rate risk is assessed and managed according to ‘business-
as-usual’ conditions. In many cases the contractual
profile of non-traded assets/liabilities arising from
assets/liabilities created outside Markets or BSM does
not reflect the behaviour observed. Behaviouralisation is
therefore used to assess the market interest rate risk of
non-traded assets/liabilities and this assessed market
risk is transferred to BSM, in accordance with the rules
governing the transfer of interest rate risk from the
global businesses to BSM.
Behaviouralisation is applied in three key areas:
• the assessed re-pricing frequency of managed rate
balances;
• the assessed duration of non-interest bearing
balances, typically capital and current accounts; and
• the base case expected prepayment behaviour or
pipeline take-up rate for fixed rate balances with
embedded optionality.
Interest rate behaviouralisation policies have to be
formulated in line with the Group’s behaviouralisation
policies and approved at least annually by local ALCO,
regional ALCM and Group ALCM, in conjunction with
local, regional and Group market risk monitoring teams.
The extent to which balances can be behaviouralised is
driven by: