HSBC 2006 Annual Report Download - page 225

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The sensitivities are illustrative only and are
based on simplified scenarios. The table shows
interest rate risk exposures arising in available-for-
sale portfolios and from cash flow hedges which
are marked-to-market through reserves. These
particular exposures form only a part of the
Group’s overall interest rate exposures. The
accounting treatment under IFRSs of the Group’s
remaining interest rate exposures, while
economically largely offsetting the exposures
shown in the above table, does not require
revaluation movements to go to reserves.
Structural foreign exchange exposures
(Unaudited)
Structural foreign exchange exposures represent net
investments in subsidiaries, branches or associated
undertakings, the functional currencies of which
are currencies other than the US dollar.
Exchange differences on structural exposures
are recorded in the consolidated statement of
recognised income and expense. The main
operating (or functional) currencies in which
HSBC’s business is transacted are the US dollar,
the Hong Kong dollar, sterling, the euro, the
Mexican peso, the Brazilian real and the Chinese
renminbi. As the US dollar and currencies linked to
it form the dominant currency bloc in which
HSBC’s operations transact business, HSBC
Holdings prepares its consolidated financial
statements in US dollars. HSBC’s consolidated
balance sheet is, therefore, affected by exchange
differences between the US dollar and all the non-
US dollar functional currencies of underlying
subsidiaries.
HSBC hedges structural foreign exchange
exposures only in limited circumstances. HSBC’s
structural foreign exchange exposures are managed
with the primary objective of ensuring, where
practical, that HSBC’s consolidated capital ratios,
and the capital ratios of individual banking
subsidiaries, are 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.
Selective hedges were in place during 2006.
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. There was no ineffectiveness arising from
these hedges in the year ended 31 December 2006.
There was no material effect from exchange
differences on HSBC’s capital ratios during the
year.
HSBC Holdings
(Audited)
As a financial services holding company, HSBC
Holdings has limited market risk activity. Its
activities predominantly involve maintaining
sufficient capital resources to support the Group’s
diverse activities; allocating these capital resources
across the Group’s businesses; earning dividend
and interest income on its investments in the
Group’s businesses; providing dividend payments
to HSBC Holdings’ equity shareholders and interest
payments to providers of debt capital; and
maintaining a supply of short-term cash resources.
It does not take proprietary trading positions.
The objectives of HSBC Holdings’ market risk
management are to minimise income statement
volatility arising from short-term cash balances and
funding positions; to minimise the market risk
arising from long-term investments and long-term
liabilities; and to protect distributable reserves from
any adverse market risk variables.
Market risk for HSBC Holdings is monitored
by its Structural Positions Review Group.
The main market risks to which HSBC
Holdings is exposed are interest rate risk and
foreign currency risk.
HSBC Holdings is exposed to interest rate risk
on debt capital investments in, and loans to,
subsidiary undertakings; on debt capital issues; and
on short-term cash resources.
Certain loans to subsidiary undertakings of a
capital nature that are not denominated in the
functional currency of either the provider or the
recipient are accounted for as financial assets.
Changes in the carrying amount of these assets due
to exchange differences are taken directly to the
income statement. These loans, and the associated
foreign exchange exposures, are eliminated on a
Group consolidated basis.
Revaluations due to foreign exchange rate
movements affecting loans to subsidiary
undertakings of a capital nature which are
denominated in the functional currency of either
the borrower or the recipient, are taken directly to
reserves. Equity investments in subsidiary
undertakings are accounted for on a cost basis and
are not revalued following movements in exchange
rates.