HSBC 2004 Annual Report Download - page 170

HSBC HOLDINGS PLC
Financial Review (continued)
168
undertaken in Global Markets using risk limits
approved by the Group Management Board. Limits
are set for each portfolio, product and risk type, with
market liquidity being a principal factor in
determining the level of limits set. Traded Markets
Development and Risk, an independent unit within
Corporate, Investment Banking and Markets,
develops the Group’ s market risk management
policies and measurement techniques. Each major
operating entity has an independent Market Risk
Control function which is responsible for measuring
market risk exposures in accordance with the
policies defined by Traded Markets Development
and Risk, and monitoring and reporting these
exposures against the prescribed limits on a daily
basis.
Each operating entity is required to assess the
market risks which arise on each product in its
business and to transfer these risks to either its local
Global Markets unit for management, or to separate
books managed under the auspices of the local Asset
and Liability Management Committee (‘ALCO’ ).
The aim is to ensure that all market risks are
consolidated within operations which have the
necessary skills, tools, management and governance
to professionally manage such risks.
Fair value and price verification control
Where certain financial instruments are carried on
the Group’ s balance sheet at their mark-to-market
values, the mark-to-market valuation and the related
price verification processes are subject to careful
governance across the Group. Financial instruments
which are accounted for on a fair value basis include
assets held in the trading portfolio, obligations
related to securities sold short and derivative
financial instruments (excluding non-trading
derivatives accounted for on an accruals basis).
The determination of mark-to-market values is
therefore a significant element in the reporting of the
Group’s Global Markets activities.
The responsibility for the determination of
accounting policies and procedures governing
valuation and validation ultimately rests with the
Group Finance and the Corporate, Investment
Banking and Markets Finance functions, which
report to the Group Finance Director. All significant
valuation policies, and any changes thereto, must be
approved by senior finance management. HSBC’s
governance of financial reporting requires that
Financial Control departments across the Group are
independent of the risk-taking businesses, with the
Finance functions having ultimate responsibility for
the determination of fair values included in the
financial statements, and for ensuring that the
Group’s policies and relevant accounting standards
are adhered to. Both senior management and the
Group Audit Committee assess the resourcing and
expertise of Finance functions within the Group on a
regular basis to ensure that the Group’s financial
control and price verification processes are properly
staffed to support the required control infrastructure.
Trading
Market risk in trading portfolios is monitored and
controlled at both portfolio and position levels using
a complementary set of techniques, such as value at
risk and present value of a basis point (‘PVBP’ ),
together with stress and sensitivity testing and
concentration limits. These techniques quantify the
impact on capital of defined market movements.
Other controls include restricting individual
operations to trading within a list of permissible
instruments authorised for each site by Traded
Markets Development and Risk, and enforcing
rigorous new product approval procedures. In
particular, trading in the more complex derivative
products is concentrated in offices with appropriate
levels of product expertise and robust control
systems.
Trading value at risk (‘VAR’)
One of the principal tools used by HSBC to monitor
and limit market risk exposure in its trading
portfolios is VAR. VAR is a technique that estimates
the potential losses that could occur on risk positions
as a result of movements in market rates and prices
over a specified time horizon and to a given level of
confidence (for HSBC, 99 per cent). HSBC
calculates VAR daily. During the year, HSBC
refined its basis of calculating VAR from one
predominantly based on variance / co-variance to
one predominantly based on historical simulation.
This latter calculation was introduced because it
better captures the non-linear characteristics of
certain market risk positions. Historical simulation
uses scenarios derived from historical market rates,
and takes account of the relationships between
different markets and rates, for example, interest
rates and foreign exchange rates. Movements in
market prices are calculated by reference to market
data from the last two years.
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