HSBC 2015 Annual Report Download - page 384

Notes on the Financial Statements (continued)
13 – Fair values of financial instruments carried at fair value
HSBC HOLDINGS PLC
382
Inception profit (Day 1 P&L reserves)
Inception profit adjustments are adopted when the fair value estimated by a valuation model is based on one or more
significant unobservable inputs. The accounting for inception profit adjustments is discussed on page 378.
Credit valuation adjustment/debit valuation adjustment methodology
HSBC calculates a separate CVA and DVA for each HSBC legal entity, and within each entity for each counterparty to which the
entity has exposure. HSBC calculates the CVA by applying the probability of default (‘PD’) of the counterparty, conditional on
the non-default of HSBC, to HSBC’s expected positive exposure to the counterparty and multiplying the result by the loss
expected in the event of default. Conversely, HSBC calculates the DVA by applying the PD of HSBC, conditional on the non-
default of the counterparty, to the expected positive exposure of the counterparty to HSBC and multiplying the result by the
loss expected in the event of default. Both calculations are performed over the life of the potential exposure.
For most products HSBC uses a simulation methodology to calculate the expected positive exposure to a counterparty. This
incorporates a range of potential exposures across the portfolio of transactions with the counterparty over the life of the portfolio.
The simulation methodology includes credit mitigants such as counterparty netting agreements and collateral agreements with the
counterparty.
For certain types of exotic derivatives where the products are not currently supported by the simulation, or for derivative
exposures in smaller trading locations where the simulation tool is not yet available, HSBC adopts alternative methodologies.
The methodologies do not, in general, account for ‘wrong-way risk’. Wrong-way risk arises when the underlying value of the
derivative prior to any CVA is positively correlated to the probability of default by the counterparty. When there is significant
wrong-way risk, a trade-specific approach is applied to reflect the wrong-way risk within the valuation.
With the exception of certain central clearing parties, we include all third-party counterparties in the CVA and DVA calculations
and do not net these adjustments across Group entities. We review and refine the CVA and DVA methodologies on an ongoing
basis.
Fair value valuation bases
Financial instruments measured at fair value using a valuation technique with significant unobservable inputs – Level 3
Assets Liabilities
Available
for sale
Held for
trading
At fair
value1
Deriva-
tives Total
Held for
trading
At fair
value1
Deriva-
tives Total
$m $m $m $m $m $m $m $m $m
Private equity including strategic
investments 3,443 55 453 – 3,951 35 – – 35
Asset-backed securities 1,053 531
–
–
1,584
–
–
–
–
Loans held for securitisation
–
30
–
–
30
–
–
–
–
Structured notes
–
4
–
–
44,250
–
–
4,250
Derivatives with monolines
–
–
–
196 196
–
–
–
–
Other derivatives
–
–
–
2,066 2,066
–
–
1,210 1,210
Other portfolios 231 6,236 21
–
6,488
–
3
–
3
At 31 December 2015 4,727 6,856 474 2,262 14,319 4,285 3 1,210 5,498
Private equity including strategic
investments 3,120 164 432 – 3,716 47 – – 47
Asset-backed securities 1,462 616
–
–
2,078
–
–
–
–
Loans held for securitisation
–
39
–
–
39
–
–
–
–
Structured notes
–
2
–
–
26,092
–
–
6,092
Derivatives with monolines
–
–
–
239 239
–
–
1 1
Other derivatives
–
–
–
2,685 2,685
–
–
1,906 1,906
Other portfolios 406 5,647 294
–
6,347
–
–
–
–
26
At 31 December 2014 4,988 6,468 726 2,924 15,106 6,139
–
1,907 8,046
1 Designated at fair value through profit or loss.
Level 3 instruments are present in both ongoing and legacy businesses. Loans held for securitisation, derivatives with
monolines, certain ‘other derivatives’ and predominantly all Level 3 ABSs are legacy positions. HSBC has the capability to hold
these positions.
Private equity including strategic investments
HSBC’s private equity and strategic investments are generally classified as available for sale and are not traded in active
markets. In the absence of an active market, an investment’s fair value is estimated on the basis of an analysis of the investee’s
financial position and results, risk profile, prospects and other factors, as well as by reference to market valuations for similar
entities quoted in an active market, or the price at which similar companies have changed ownership.