HSBC 2015 Annual Report Download - page 224

Report of the Directors: Risk (continued)
Appendix to Risk – Policies and practices
HSBC HOLDINGS PLC
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How the exposure to market risk is measured
Our insurance manufacturing subsidiaries monitor exposures against mandated limits regularly and report them to Group
Insurance.
In addition, large insurance manufacturing subsidiaries perform a high-level monthly assessment of market risk exposure
against risk appetite. This is submitted to Group Insurance and a global assessment presented to the RBWM Risk Management
Committee. Risk measures include statistics relating to IFRSs, regulatory solvency and economic capital.
Standard measures for quantifying market risks
• for interest rate risk, the sensitivities of the net present values of asset and expected liability cash flows, in total and by currency, to a one
basis point parallel shift in the discount curves used to calculate the net present values;
• for equity price risk, the total market value of equity holdings and the market value of equity holdings by region and country; and
• for foreign exchange risk, the total net short foreign exchange position and the net foreign exchange positions by currency.
The standard measures are relatively straightforward to calculate and aggregate, but they have limitations. The most
significant one is that a parallel shift in yield curves of one basis point does not capture the non-linear relationships between
the values of certain assets and liabilities and interest rates. Non-linearity arises, for example, from investment guarantees and
product features which enable policyholders to surrender their policies. We bear the shortfall if the yields on investments held
to support contracts with guaranteed benefits are less than the investment returns implied by the guaranteed benefits.
We recognise these limitations and augment our standard measures with stress tests which examine the effect of a range
of market rate scenarios on the aggregate annual profits and total equity of our insurance manufacturing subsidiaries, after
taking into consideration tax and accounting treatments where material and relevant. The results of these tests are reported
to Group Insurance and risk committees every quarter.
Similarly economic capital statistics are produced monthly, with a more detailed exercise undertaken on a quarterly basis.
Economic capital measures estimate, on a market consistent economic value basis, the quantum of capital required given the
exposures in the Insurance operation. Total exposures, a breakdown by risk class, and movement analysis are presented to the
Insurance Risk Management Committee on a quarterly basis.
Credit risk
(Audited)
Description of credit risk
Credit risk arises in two main areas for our insurance manufacturers:
(i) risk of default by debt security counterparties after investing premiums to generate a return for policyholders and
shareholders; and
(ii) risk of default by reinsurance counterparties and non-reimbursement for claims made after ceding insurance risk.
How credit risk is managed
Our insurance manufacturing subsidiaries are responsible for the credit risk, quality and performance of their investment
portfolios. Our assessment of the creditworthiness of issuers and counterparties is based primarily upon internationally
recognised credit ratings and other publicly available information.
Investment credit exposures are monitored against limits by our local insurance manufacturing subsidiaries, and are
aggregated and reported to Group Insurance Credit Risk and Group Credit Risk. Stress testing is performed by Group Insurance
on the investment credit exposures using credit spread sensitivities and default probabilities.
We use a number of tools to manage and monitor credit risk. These include a credit report which contains a watch-list of
investments with current credit concerns and is circulated monthly to senior management in Group Insurance and the
individual country CROs to identify investments which may be at risk of future impairment.
Liquidity risk
(Audited)
Description of liquidity risk
It is an inherent characteristic of almost all insurance contracts that there is uncertainty over the amount of claims liabilities
that may arise and the timing of their settlement, and this creates liquidity risk.
There are three aspects to liquidity risk. The first arises in normal market conditions and is referred to as funding liquidity risk;
specifically, the capacity to raise sufficient cash when needed to meet payment obligations. Secondly, market liquidity risk
arises when the size of a particular holding may be so large that a sale cannot be completed around the market price. Finally,
standby liquidity risk refers to the capacity to meet payment terms in abnormal conditions.