HSBC 2015 Annual Report Download - page 215

HSBC HOLDINGS PLC
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Strategic Report Financial Review Corporate Governance Financial Statements Shareholder Information
The RNIV framework therefore aims to capture and capitalise material market risks that are not adequately covered in the VaR
model. An example of this is Libor-overnight index swap basis risk for minor currencies. In such instances the RNIV framework
uses stress tests to quantify the capital requirement. On average in 2015, the capital requirement derived from these stress
tests represented 2.3% of the total internal model-based market risk requirement.
Risks covered by RNIV represented 19% of market risk RWAs for models with regulatory approval and included those resulting
from underlying risk factors which are not observable on a daily basis across asset classes and products, such as dividend risk
and implied correlation risks.
Risk factors are reviewed on a regular basis and either incorporated directly in the VaR models, where possible, or quantified
through the VaR-based RNIV approach or a stress test approach within the RNIV framework. The severity of the scenarios is
calibrated to be in line with the capital adequacy requirements. The outcome of the VaR-based RNIV is included in the VaR
calculation and back-testing; a stressed VaR RNIV is also computed for the risk factors considered in the VaR-based RNIV
approach.
Level 3 assets
The fair values of Level 3 assets and liabilities in trading portfolios are disclosed on page 382, and represent only a small
proportion of the overall trading portfolio. Market risk arising from Level 3 instruments is managed by various market risk
techniques such as stress testing and notional limits. The table on page 384 shows the movement in Level 3 financial
instruments.
Stress testing
Stress testing is an important procedure that is integrated into our market risk management tool to evaluate the potential
impact on portfolio values of more extreme, although plausible, events or movements in a set of financial variables. In such
scenarios, losses can be much greater than those predicted by VaR modelling.
Stress testing is implemented at legal entity, regional and overall Group levels. A standard set of scenarios is utilised
consistently across all regions within the Group. Scenarios are tailored 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.
Market risk reverse stress tests are undertaken on the premise that there is a fixed loss. The stress testing 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, provide management
with insights regarding the ‘tail risk’ beyond VaR for which HSBC’s appetite is limited.
Trading portfolios
Volcker Rule
In 2013, US regulators finalised the Volcker Rule. Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection
Act and its final implementing rules (collectively referred to as the ‘Volcker Rule’) imposes broad restrictions on HSBC’s ability
to engage in ‘proprietary trading’ or to own, sponsor, or have certain relationships with hedge funds, private equity funds, and
certain other collective investment vehicles (broadly defined as ‘covered funds’). These restrictions are subject to a number of
exemptions or exclusions, including market making, underwriting and risk-mitigating hedging, organising covered funds for
customers and issuers of asset-backed securities, and underwriting or market making in covered fund interests.
The Volcker Rule broadly went into effect on 22 July 2015, with the exception of certain legacy fund activities that are able to
rely on an extension of the conformance date.
HSBC has implemented a programme to comply with the Volcker Rule, including policies and procedures, internal controls,
corporate governance, independent testing, training, and record keeping and, eventually, calculation and reporting of
quantitative metrics for certain trading activities.
HSBC has completed training for all affected front office and control personnel, has conformance plans for those covered funds
to which the extension applies, and believes that it is compliant in all material respects with the Volcker Rule.
Market Risk Stress Testing
Sensitivities Technical Hypothetical Historical
Reverse
Stress
Testing
Impact of a single risk factor
e.g. break of a currency peg
Impact of the largest move
in each risk factor without
consideration of any underlying
market correlation
Impact of potential
macroeconomic events, e.g.
slowdown in mainland China
Scenarios that incorporate
historical observations of
market movements e.g. Black
Monday (in 1987) for equities