HSBC 2003 Annual Report Download - page 171

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HSBC’s VAR is calculated daily. It is
predominantly calculated on a variance/co-variance
basis, uses historical movements in market rates and
prices, a 99 per cent confidence level and a 10-day
holding period, and takes account of correlations
between different markets and rates within the same
risk type. The movement in market prices is
calculated by reference to market data from the last
two years. Aggregation of VAR from different risk
types is based upon the assumption of independence
between risk types.
HSBC’s VAR should be viewed in the context of
the limitations of the methodology used. For
example:
• the model assumes that changes in risk factors
follow a normal distribution. This may not be
the case in reality, and the probability of extreme
market movements may be underestimated;
• the use of a 10-day holding period assumes that
all positions can be liquidated or hedged in 10
days. This may not fully reflect the market risk
arising at times of severe illiquidity, when a
10-day holding period may be insufficient to
liquidate or hedge all positions fully;
• the use of a 99 per cent confidence level does
not take into account losses that might occur
beyond this level of confidence;
• 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 assumption of independence between risk
types may not be accurate and VAR may not
fully capture market risk where variables exhibit
correlation;
• VAR is calculated at the close of business, with
intra-day exposures not subjected to intra-day
VAR calculations on an HSBC basis; and
• VAR does not necessarily capture all of the
higher order market risks and may underestimate
real market risk exposure.
HSBC recognises these limitations by
augmenting the VAR limits with other position and
sensitivity limit structures, as well as with stress
testing, both on individual portfolios and on a
consolidated basis. HSBC’s stress-testing regime
provides senior management with an assessment of
the impact of extreme events on the market risk
exposures of HSBC.
Trading VAR for HSBC is analysed in Note 40
in the ‘Notes on the Financial Statements’ .
Market-risk related revenues
The average daily revenue earned from market
risk-related activities in 2003, including accrual book
net interest income, funding of dealing positions, and
hedging of mortgage servicing rights, was
US$17.1 million compared with US$14.6 million in
2002. The standard deviation of these daily revenues
was US$12.5 million compared with US$8.9 million
in 2002.
The increase in the standard deviation of daily
revenues and the maximum daily loss and profit over
the corresponding figures for 2002, reflects the
impact of the volatility of the Hong Kong dollar
against the US dollar during the second half of the
year on the long US dollar position which the Group
carries in Hong Kong.
This position arises from the significant surplus
that has arisen in recent years between the increasing
levels of Hong Kong dollar deposits placed with the
Group, and the limited opportunities for the
deployment of those deposits in Hong Kong dollar
assets.
The Group has, accordingly, in recent years,
placed a proportion of these surplus Hong Kong
dollar deposits into highly liquid US dollar assets,
and it is the resultant foreign exchange exposures,
coupled with increased volatility in the US$:HK$
exchange rate that has resulted in the profit and loss
revenues being more widely dispersed than in prior
years.