HSBC 2007 Annual Report Download - page 402

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
Note 18
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management purposes but which for various reasons do not meet the qualifying criteria for hedge accounting. The
second category includes derivatives managed in conjunction with financial instruments designated at fair value.
These activities are described more fully below.
HSBC’s derivative activities give rise to significant open positions in portfolios of derivatives. These positions are
managed constantly to ensure that they remain within acceptable risk levels, with matching deals being utilised to
achieve this where necessary. When entering into derivative transactions, HSBC employs the same credit risk
management procedures to assess and approve potential credit exposures that are used for traditional lending.
Derivative assets with a carrying amount of US$123,041 million or 65.5 per cent of the total carrying amount (2006:
US$67,628 million; 65.2 per cent) are held with banking counterparties, and US$46,789 million or 24.9 per cent of
the total carrying amount (2006: US$26,811 million; 25.9 per cent) with other financial institutions. The remainder
are held with government and other counterparties.
Trading derivatives
Most of HSBC’s derivative transactions relate to sales and trading activities. Sales activities include the structuring
and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or
expected risks. Trading activities in derivatives are entered into principally for the purpose of generating profits from
short-term fluctuations in price or margin. Positions may be traded actively or be held over a period of time to benefit
from expected changes in exchange rates, interest rates, equity prices or other market parameters. Trading includes
market-making, positioning and arbitrage activities. Market-making entails quoting bid and offer prices to other
market participants for the purpose of generating revenues based on spread and volume; positioning means managing
market risk positions in the expectation of benefiting from favourable movements in prices, rates or indices; arbitrage
involves identifying and profiting from price differentials between markets and products.
As mentioned above, other derivatives classified as held for trading include non-qualifying hedging derivatives,
ineffective hedging derivatives and the components of hedging derivatives that are excluded from assessing hedge
effectiveness. Non-qualifying hedging derivatives are entered into for risk management purposes but do not meet the
criteria for hedge accounting. These include derivatives managed in conjunction with financial instruments
designated at fair value.
Gains and losses from changes in the fair value of derivatives that do not qualify for hedge accounting are reported in
‘Net trading income’, except for derivatives managed in conjunction with financial instruments designated at fair
value, where gains and losses are reported in ‘Net income from financial instruments designated at fair value’,
together with the gains and losses on the hedged items. Changes in the fair values of trading derivatives are inclusive
of contractual interest. Changes in the fair value of derivatives managed in conjunction with financial instruments
designated at fair value are included in ‘Net income from financial instruments designated at fair value’ inclusive of
contractual interest unless the derivatives are managed with debt securities in issue, in which case the contractual
interest is shown in interest payable with the interest payable on the issued debt. Substantially all of HSBC Holdings’
derivatives entered into with HSBC undertakings are managed in conjunction with financial liabilities designated at
fair value.
Notional contract amounts of derivatives held for trading purposes by product type
HSBC HSBC Holdings
2007 2006 2007 2006
US$m US$m US$m US$m
Foreign exchange .......................................................... 3,243,738 2,182,005 12,790 9,869
Interest rate ................................................................... 10,672,971 9,843,601 7,804 5,304
Equities ......................................................................... 286,927 207,016 – –
Credit derivatives .......................................................... 1,893,802 1,109,828 – –
Commodity and other ................................................... 33,188 30,532 – –
16,130,626 13,372,982 20,594 15,173
Credit derivatives
HSBC trades credit derivatives through its principal dealing operations and acts as a principal counterparty to a broad
range of users, structuring deals to produce risk management products for its customers, or making markets in certain