HSBC 2015 Annual Report Download - page 217

HSBC HOLDINGS PLC
215
Strategic Report Financial Review Corporate Governance Financial Statements Shareholder Information
Equity securities classified as available for sale
Potential new commitments are subject to risk appraisal to ensure that industry and geographical concentrations remain
within acceptable levels for the portfolio. Regular reviews are performed to substantiate the valuation of the investments
within the portfolio and investments held to facilitate ongoing business, such as holdings in government-sponsored enterprises
and local stock exchanges.
Structural foreign exchange exposures
Structural foreign exchange exposures represent net investments in subsidiaries, branches and associates, the functional
currencies of which are currencies other than the US dollar. An entity’s functional currency is that of the primary economic
environment in which the entity operates.
Exchange differences on structural exposures are recognised in ‘Other comprehensive income’. We use the US dollar as our
presentation currency in our consolidated financial statements because the US dollar and currencies linked to it form the
major currency bloc in which we transact and fund our business. Our consolidated balance sheet is, therefore, affected by
exchange differences between the US dollar and all the non-US dollar functional currencies of underlying subsidiaries.
We hedge structural foreign exchange exposures only in limited circumstances. Our structural foreign exchange exposures are
managed with the primary objective of ensuring, where practical, that our consolidated capital ratios and the capital ratios
of individual banking subsidiaries are largely 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 RWAs denominated in that
currency is broadly equal to the capital ratio of the subsidiary in question.
We may also transact hedges where a currency in which we have structural exposures is considered likely to revalue adversely,
and it is possible in practice to transact a hedge. Any 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. We evaluate residual structural foreign exchange exposures using an
expected shortfall method.
Non-trading interest rate risk
Non-trading book interest rate risk arises principally from mismatches between the future yield on assets and their funding
cost, as a result of interest rate changes. Analysis of this risk is complicated by making assumptions on embedded optionality
within certain product areas such as the incidence of mortgage prepayments, and from behavioural assumptions regarding the
economic duration of liabilities which are contractually repayable on demand such as current accounts, and the re-pricing
behaviour of managed rate products. These assumptions around behavioural features are captured in our interest rate risk
behaviouralisation framework, which is described below.
We aim, through our management of market risk in non-trading portfolios, to mitigate the effect of prospective interest rate
movements which could reduce future net interest income, while balancing the cost of such hedging activities on the current
net revenue stream.
Our funds transfer pricing policies give rise to a two stage funds transfer pricing approach. For details see page 207.
Interest rate risk behaviouralisation
Unlike liquidity risk, which is assessed on the basis of a very severe stress scenario, non-trading interest rate risk is
assessed and managed according to ‘business-as-usual’ conditions. In many cases the contractual profile of non-trading
assets/liabilities arising from assets/liabilities created outside Markets or BSM does not reflect the behaviour observed.
Behaviouralisation is therefore used to assess the market interest rate risk of non-trading assets/liabilities and this assessed
market risk is transferred to BSM, in accordance with the rules governing the transfer of interest rate risk from the global
businesses to BSM.
Behaviouralisation is applied in three key areas:
• the assessed re-pricing frequency of managed rate balances;
• the assessed duration of non-interest bearing balances, typically capital and current accounts; and
• the base case expected prepayment behaviour or pipeline take-up rate for fixed-rate balances with embedded optionality.
Interest rate behaviouralisation policies have to be formulated in line with the Group’s behaviouralisation policies and
approved at least annually by local ALCOs and regional ALCMs, in conjunction with local, regional and Group market risk
monitoring teams.
The extent to which balances can be behaviouralised is driven by:
• the amount of the current balance that can be assessed as ‘stable’ under business-as-usual conditions; and
• for managed rate balances, the historical market interest rate re-pricing behaviour observed; or