HSBC 2012 Annual Report Download - page 269

267
Overview Operating & Financial Review Corporate Governance Financial Statements Shareholder Information
• VAR measures are calculated to a 99% confidence level and use a one-day holding period scaled to 10 days,
whereas stressed VAR uses a 10-day holding period.
The nature of the VAR models means that an increase in observed market volatility will lead to an increase in VAR
without any changes in the underlying positions.
We routinely validate the accuracy of our VAR models by back-testing the actual daily profit and loss results,
adjusted to remove non-modelled items such as fees and commissions, against the corresponding VAR numbers.
We expect on average to see losses in excess of VAR 1% of the time over a one-year period.
Although a valuable guide to risk, VAR should always be viewed in the context of its limitations. For example:
• the use of historical data as a proxy for estimating future events may not encompass all potential events,
particularly those which are extreme in nature;
• the use of a one-day holding period assumes that all positions can be liquidated or the risks offset in one day.
This may not fully reflect the market risk arising at times of severe illiquidity, when a one-day holding period
may be insufficient to liquidate or hedge all positions fully;
• the use of a 99% confidence level does not take into account losses that might occur beyond this level of
confidence;
• VAR is calculated on the basis of exposures outstanding at the close of business and therefore does not
necessarily reflect intra-day exposures; and
• VAR is unlikely to reflect loss potential on exposures that only arise under significant market moves.
Our VAR model is designed to capture significant basis risks such as CDS vs bond, asset swap spreads and cross-
currency basis. Other basis risks which are not completely covered in VAR, such as the Libor tenor basis, are
complemented by our risk-not-in-VAR calculations and are integrated into our capital framework. Stress testing is
also used as one of the market risk tools for managing basis risks.
Stress testing
(Audited)
In recognition of the limitations of VAR, we augment it with stress testing to evaluate the potential impact on
portfolio values of more extreme, although plausible, events or movements in a set of financial variables.
Stress testing is implemented at the legal entity, regional and the overall Group levels. A standard set of scenarios is
utilised consistently across all regions within the Group. Scenarios are tailored in order to capture the relevant events
or market movements at each level. The risk appetite around potential stress losses for the Group is set and monitored
against referral limits.
The process is governed by the Stress Testing Review Group forum which, in conjunction with regional risk
management, determines the scenarios to be applied at portfolio and consolidated levels, as follows:
• single risk factor stress scenarios that are unlikely to be captured within the VAR models, such as the break of a
currency peg;
• technical scenarios consider the largest move in each risk factor without consideration of any underlying market
correlation;
• hypothetical scenarios consider potential macroeconomic events, for example, the slowdown in mainland China
and the potential effects of a sovereign debt default, including its wider contagion effects; and
• historical scenarios incorporate historical observations of market movements during previous periods of stress
which would not be captured within VAR.
Stress testing results are submitted to the GMB and Risk Management Committee (‘RMC’) meetings in order to
provide senior management with an assessment of the financial effect such events would have.
In addition, the reverse stress test is based upon the premise that there is a fixed loss. The stress test process identifies
which scenarios lead to this loss. The rationale behind the reverse stress test is to understand scenarios which are
beyond normal business settings that could have contagion and systemic implications.
Stressed VAR and stress testing, together with reverse stress testing and the management of gap risk (see page 268),
provide management with insights regarding the ‘tail risk’ beyond VAR. HSBC appetite for tail risk is limited.