HSBC 2006 Annual Report Download - page 313

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Net investment hedge
Hedges of net investments in foreign operations are accounted for in a similar way to cash flow hedges. A gain
or loss on the effective portion of the hedging instrument is recognised in equity; a gain or loss on 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), and demonstrate actual effectiveness
(retrospective effectiveness) 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 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 to be achieved, the changes in fair value or cash flows must offset each other
in the range of 80 per cent to 125 per cent.
Hedge ineffectiveness is recognised in the income statement in ‘Net trading income’.
Derivatives that do not qualify for hedge accounting
All gains and losses from changes in the fair values of derivatives that do not qualify for hedge accounting are
recognised immediately in the income statement. These gains and losses are reported in ‘Net trading income’,
except where derivatives are managed in conjunction with financial instruments designated at fair value (other
than derivatives managed in conjunction with debt securities issued by the Group), in which case gains and
losses are reported in ‘Net income from financial instruments designated at fair value’. The interest on
derivatives managed in conjunction with debt securities issued by the Group which are designated at fair value is
recognised in ‘Interest expense’. All other gains and losses on these derivatives are reported in ‘Net income from
financial instruments designated at fair value’.
(l) Derecognition of financial assets and liabilities
Financial assets are derecognised when the right to receive cash flows from the assets has expired; or when
HSBC has transferred its contractual right to receive the cash flows of the financial assets, and either
– substantially all the risks and rewards of ownership have been transferred; or
– substantially all the risks and rewards have neither been retained nor transferred but control is not retained.
Financial liabilities are derecognised when they are extinguished, that is when the obligation is discharged,
cancelled or expires.
(m) Offsetting financial assets and financial liabilities
Financial assets and financial liabilities are offset and the net amount reported in the balance sheet when there is
a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or
realise the asset and settle the liability simultaneously.
(n) Subsidiaries, associates and joint ventures
HSBC Holdings’ investments in subsidiaries are stated at cost less any impairment losses. Reversals of
impairment losses are recognised in the income statement if there has been a change in the estimates used to
determine the recoverable amount of the investment.
Investments in associates and interests in joint ventures are recognised using the equity method, initially stated at
cost, including attributable goodwill, and are adjusted thereafter for the post-acquisition change in HSBC’s share
of net assets.