HSBC 2006 Annual Report Download - page 165

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Off-balance sheet arrangements
HSBC enters into certain off-balance sheet arrangements with customers in the ordinary course of business, as
described below.
(i) Financial guarantees, letters of credit and similar undertakings
Note 41 on the Financial Statements on page 396 describes various types of guarantees and discloses the
maximum potential future payments under such arrangements. Credit risk associated with all forms of guarantees
is assessed in the same manner as for on-balance sheet credit advances and, where necessary, provisions for
assessed impairment are included in ‘Other provisions’.
(ii) Commitments to lend
Undrawn credit lines are disclosed in Note 41 on the Financial Statements on page 396. The majority by value of
undrawn credit lines arise from ‘open to buy’ lines on personal credit cards, cheques issued to potential
customers offering them a pre-approved loan, advised overdraft limits, and mortgage offers awaiting customer
acceptance. HSBC generally has the right to change or terminate any conditions of a personal customer’s
overdraft, credit card or other credit line upon notification to the customer. In respect of corporate commitments
to lend, in most contracts HSBC’s position will be protected through restrictions on access to funding in the
event of material adverse change.
(iii) Credit derivatives
HSBC uses credit derivatives through its principal dealing operations, acting as a principal counterparty to a
broad range of users, structuring deals to produce risk management products for its customers, or making
markets in certain products. Risk is typically controlled through entering into offsetting credit derivative
contracts with other counterparties.
HSBC manages the credit risk arising on buying and selling credit derivative protection by including the
exposure to any credit risk that arises from such transactions within its overall credit limits structure to the
relevant counterparty. The trading of credit derivatives is restricted to a small number of offices within the major
centres which in management’s view have the control infrastructure and market skills to manage effectively the
credit risk inherent in the products.
Credit derivatives are also used for the management of credit risk in the Group’s loan portfolio. HSBC’s use of
credit derivatives in this manner is not significant, however.The following table presents the notional amounts of
credit derivatives protection bought and sold by HSBC:
At 31 December
2006 2005
US$m US$m
Notional amount of protection bought ..................................................................................... 540,229 249,347
Notional amount of protection sold ......................................................................................... 569,599 262,393
The mismatch between these notional amounts is attributable to HSBC selling protection on large, diversified,
predominantly investment grade portfolios (including the most senior tranches) and then hedging these positions
by buying protection on the more subordinated tranches of the same portfolios. In addition, HSBC uses securities
to hedge certain derivative positions. Consequently, while there is a mismatch in notional amounts of credit
derivatives, the risk positions are largely matched.
(iv) Special purpose and variable interest entities
HSBC predominantly uses special purpose entities (‘SPEs’) or variable interest entities (‘VIEs’) to securitise
loans and advances it has originated where this source of funding is cost effective. Such loans and advances
generally remain on the balance sheet under IFRSs.
HSBC also administers SPEs that have been established for the purpose of providing alternative sources of
financing to HSBC’s customers. Such arrangements also enable HSBC to provide tailored investment
opportunities for investors. These SPEs, commonly referred to as asset-backed or multi-seller conduits, purchase
interests in a diversified pool of receivables from customers or in the market using finance provided by a third