HSBC 2009 Annual Report Download - page 65

63
Note 22 on the Financial Statements includes
details of the CGU’s with significant balances of
goodwill, states the key assumptions used to assess
the goodwill in each of those CGUs for impairment,
and provides a discussion of the sensitivity of the
carrying value of goodwill to changes in key
assumptions.
Valuation of financial instruments
HSBC’s accounting policy for determining the
fair value of financial instruments is described in
Note 2d on the Financial Statements.
The best evidence of fair value is a quoted price
in an actively traded market. In the event that the
market for a financial instrument is not active, a
valuation technique is used. The majority of
valuation techniques employ only observable market
data, and so the reliability of the fair value
measurement is high. However, certain financial
instruments are valued on the basis of valuation
techniques that feature one or more significant
market inputs that are unobservable. Valuation
techniques that rely to a greater extent on
unobservable inputs require a higher level of
management judgement to calculate a fair value than
those based wholly on observable inputs.
Valuation techniques used to calculate fair
values include comparisons with similar financial
instruments for which market observable prices
exist, discounted cash flow analysis, option pricing
models and other valuation techniques commonly
used by market participants. Valuation techniques
incorporate assumptions that other market
participants would use in their valuations, including
assumptions about interest rate yield curves,
exchange rates, volatilities, and prepayment and
default rates. When valuing instruments by reference
to comparable instruments, management takes into
account the maturity, structure and rating of the
instrument with which the position held is being
compared.
The main assumptions and estimates which
management considers when applying a model with
valuation techniques are:
• the likelihood and expected timing of future
cash flows on the instrument. These cash flows
are usually governed by the terms of the
instrument, although management judgement
may be required when the ability of the
counterparty to service the instrument in
accordance with the contractual terms is in
doubt. Future cash flows may be sensitive to
changes in market rates;
• selecting an appropriate discount rate for
the instrument. Management bases the
determination of this rate on its assessment of
what a market participant would regard as the
appropriate spread of the rate for the instrument
over the appropriate risk-free rate; and
• judgement to determine what model to use to
calculate fair value in areas where the choice of
valuation model is particularly subjective, for
example, when valuing complex derivative
products.
When applying a model with unobservable
inputs, estimates are made to reflect uncertainties
in fair values resulting from a lack of market data
inputs, for example, as a result of illiquidity in the
market. For these instruments, the fair value
measurement is less reliable. Inputs into valuations
based on unobservable data are inherently uncertain
because there is little or no current market data
available from which to determine the level at which
an arm’s length transaction would occur under
normal business conditions. However, in most cases
there is some market data available on which to base
a determination of fair value, for example historical
data, and the fair values of most financial
instruments will be based on some market
observable inputs even where the unobservable
inputs are significant.
The value of financial assets and liabilities
measured at fair value that use a valuation technique
was US$599 billion (2008: US$876 billion) and
US$447 billion (2008: US$671 billion) or 56 per
cent (2008: 71 per cent) and 75 per cent (2008:
83 per cent) of total financial assets and total
financial liabilities measured at fair value,
respectively.
Disclosures of types and amounts of fair value
adjustments made in determining the fair value of
financial instruments measured at fair value using
valuation techniques is provided on page 168. In
addition, a sensitivity analysis of fair values for
financial instruments with significant unobservable
inputs to reasonably possible alternative assumptions
and a range of assumptions can be found on
page 175. Given the uncertainty and subjective
nature of valuing financial instruments at fair value,
it is possible that the outcomes in the next financial
year could differ from the assumptions used, and this
could result in a material adjustment to the carrying
amount of financial instruments measured at fair
value.