HSBC 2015 Annual Report Download - page 247

HSBC HOLDINGS PLC
245
Strategic Report Financial Review Corporate Governance Financial Statements Shareholder Information
to rated counterparties. Other counterparties are grouped into broad categories and standardised risk weightings are applied
to these categories. The next level, the internal ratings-based (‘IRB’) foundation approach, allows banks to calculate their credit
risk capital requirements on the basis of their internal assessment of a counterparty’s probability of default (‘PD’), but the
estimates of exposure at default (‘EAD’) and loss given default (‘LGD’) are subject to standard supervisory parameters. Finally,
the IRB advanced approach allows banks to use their own internal assessment in both determining PD and quantifying EAD and
LGD.
The capital resources requirement, which is intended to cover unexpected losses, is derived from a formula specified in the
regulatory rules which incorporates PD, LGD, EAD and other variables such as maturity and correlation. Expected losses are
calculated by multiplying PD by EAD and LGD. Expected losses are deducted from capital to the extent that they exceed total
accounting impairment allowances. For credit risk we have adopted the IRB advanced approach for the majority of our
portfolios, with the remainder on either IRB foundation or standardised approaches.
At the end of 2015, a number of portfolios in Europe, Asia and North America were on the advanced IRB approach as well as
our sovereigns, banks and large corporate exposures globally. Others remain on the standardised or foundation approach
pending definition of local regulations or model approval, or under exemptions from IRB treatment. In some instances,
regulators have allowed us to transition from advanced to standardised approaches for a limited number of portfolios.
• Counterparty credit risk
Counterparty credit risk (‘CCR’) arises for derivatives and securities financing transactions. It is calculated for both the
trading and non-trading books and is the risk that the counterparty to a transaction may default before completing the
satisfactory settlement of the transaction. Three approaches to calculating CCR and determining exposure values are
defined by CRD IV: mark-to-market, standardised and internal model method. These exposure values are used to determine
capital requirements under one of the credit risk approaches: standardised, IRB foundation and IRB advanced.
We use the mark-to-market and internal model method approaches for CCR.
In addition, CRD IV introduced a regulatory capital charge to cover CVA risk, the risk of adverse movements in the credit
valuation adjustments taken for expected credit losses on derivative transactions. Where we have both specific risk VaR
approval and internal model method approval for a product, the CVA VaR approach has been used to calculate the CVA
capital charge. Where we do not hold both approvals, the standardised approach has been applied. Certain counterparty
exposures are exempt from CVA, such as non-financial counterparties and sovereigns.
• Securitisation
Securitisation positions are held in both the trading and non-trading books. For non-trading book securitisation positions,
CRD IV specifies two methods for calculating credit risk requirements, the standardised and the IRB approaches. Both rely
on the mapping of rating agency credit ratings to risk weights, which range from 7% to 1,250%.
Within the IRB approach, we use the ratings-based method for the majority of our non-trading book securitisation
positions, and the internal assessment approach for exposures arising from asset-backed commercial paper programmes,
mainly related to liquidity facilities and programme wide credit enhancement.
The majority of securitisation positions in the trading book are risk weighted for capital purposes as though they are held in
the non-trading book under the standardised or IRB approaches.
Market risk capital requirement
The market risk capital requirement is measured using internal market risk models where approved by the PRA, or the
standard rules of CRD IV. Our internal market risk models are VaR, stressed VaR and Incremental Risk. Since the sale of our
correlation portfolio in September 2014, there has been no market risk capital requirement associated with the
comprehensive risk measure.
Operational risk capital requirement
CRD IV includes a capital requirement for operational risk, again utilising three levels of sophistication. The capital required
under the basic indicator approach is a simple percentage of gross revenues, whereas under the standardised approach the
calculation is applied to the same measure with varying percentages by business line. Both these approaches use an average of
the last three financial years’ revenues. Finally, the advanced measurement approach uses banks’ own statistical analysis and
modelling of operational risk data to determine capital requirements. We have adopted the standardised approach
in determining our operational risk capital requirements.
Pillar 2 capital requirements
We conduct an annual internal capital adequacy assessment process (‘ICAAP’) to determine a forward looking assessment of
our capital requirements given our business strategy, risk profile, risk appetite and capital plan. This process incorporates the
Group’s risk management processes and governance framework. As a part of our ICAAP, we carry out internal stress testing of
our base capital plan where both the PRA released stress scenario and concurrent scenario in the context of our business and