HSBC 2005 Annual Report Download - page 253

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Hedge accounting
At the inception of a hedging relationship, HSBC documents the relationship between the hedging instruments
and hedged items, its risk management objective and its strategy for undertaking the hedge. HSBC also requires
a documented assessment, both at hedge inception and on an ongoing basis, of whether or not the derivatives that
are used in hedging transactions are highly effective in offsetting the changes attributable to the hedged risks in
the fair values or cash flows of the hedged items. Interest on designated qualifying hedges is included in ‘Net
interest income’.
Fair value hedge
Changes in the fair value of derivatives that are designated and qualify as fair value hedging instruments are
recorded in the income statement, along with changes in the fair value of the assets, liabilities or group thereof,
that are attributable to the hedged risk.
If a hedging relationship no longer meets the criteria for hedge accounting, the cumulative adjustment to the
carrying amount of the hedged item is amortised to the income statement based on a recalculated effective
interest rate over the residual period to maturity, unless the hedged item has been derecognised whereby it is
released to the income statement immediately.
Cash flow hedge
The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow
hedges is recognised in equity within the cash flow hedging reserve. Any gain or loss in fair value relating to an
ineffective portion is recognised immediately in the income statement.
Amounts accumulated in equity are recycled to the income statement in the periods in which the hedged item
will affect profit or loss. However, when the forecast transaction that is hedged results in the recognition of a
non-financial asset or a non-financial liability, the gains and losses previously deferred in equity are transferred
from equity and included in the initial measurement of the cost of the asset or liability.
When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting,
any cumulative gain or loss existing in equity at that time remains in equity until the forecast transaction is
eventually recognised in the income statement. When a forecast transaction is no longer expected to occur, the
cumulative gain or loss that was reported in equity is immediately transferred to the income statement.
Net investment hedge
Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or
loss on the hedging instrument relating to the effective portion of the hedge is recognised in equity; the gain or
loss relating to the ineffective portion is recognised immediately in the income statement. Gains and losses
accumulated in equity are included in the income statement on the disposal of the foreign operation.
Hedge effectiveness testing
To qualify for hedge accounting, HSBC requires that at the inception of the hedge and throughout its life, each
hedge must be expected to be highly effective (prospective effectiveness). Actual effectiveness (retrospective
effectiveness) must also be demonstrated on an ongoing basis.
The documentation of each hedging relationship sets out how the effectiveness of the hedge is assessed. The
method an HSBC entity adopts for assessing hedge effectiveness will depend on its risk management strategy.
For prospective effectiveness, the hedging instrument must be expected to be highly effective in achieving
offsetting changes in fair value or cash flows attributable to the hedged risk during the period for which the
hedge is designated. For actual effectiveness, the changes in fair value or cash flows must offset each other in the
range of 80 per cent to 125 per cent for the hedge to be deemed effective.
Hedge ineffectiveness is recognised in the income statement in ‘Net trading income’.