HSBC 2006 Annual Report Download - page 411

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Impact
• Prior to 2006, HSBC’s North American subsidiaries followed the ‘shortcut method’ of hedge effectiveness
testing for certain transactions in their US GAAP reporting. Alternative hedge effectiveness testing
methodologies were sought under IFRSs for these hedging relationships.
• Apart from certain subsidiaries in North America, HSBC has chosen not to adopt hedge accounting for US
GAAP purposes as this would require a designated hedged item inconsistent with the approach adopted under
IFRSs. Qualifying IAS 39 hedging derivatives have been measured at fair value with the gain or loss recognised
in net income for US GAAP purposes.
Designation of financial assets and liabilities at fair value through profit and loss
IFRSs
• Under IAS 39, a financial instrument, other than one held for trading, is classified in this category if it meets the
criteria set out below, and is so designated by management. An entity may designate financial instruments at fair
value where the designation:
− eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise
from measuring financial assets or financial liabilities or recognising the gains and losses on them on
different bases; or
− applies to a group of financial assets, financial liabilities or a combination of both that is managed and its
performance evaluated on a fair value basis, in accordance with a documented risk management or
investment strategy, and where information about that group of financial instruments is provided internally
on that basis to management; or
− relates to financial instruments containing one or more embedded derivatives that significantly modify the
cash flows resulting from those financial instruments.
• Financial assets and financial liabilities so designated are recognised initially at fair value, with transaction costs
taken directly to the income statement, and are subsequently remeasured at fair value. The designation, once
made, is irrevocable in respect of the financial instruments to which it relates. Financial assets and financial
liabilities are recognised when HSBC enters into the contractual provisions of the arrangements with
counterparties, which is generally on trade date.
• Gains and losses from changes in the fair value of such assets and liabilities are recognised in the income
statement as they arise, together with related interest income and expense and dividends, within ‘Net income
from financial instruments designated at fair value’, except for interest on own debt issued by HSBC, and related
derivatives, which is reported in ‘Interest expense’.
US GAAP
• Generally, for financial assets to be measured at fair value with gains and losses recognised immediately in the
income statement, they must meet the definition of trading securities in SFAS 115 ‘Accounting for Certain
Investments in Debt and Equity Securities’ (‘SFAS 115’). Financial liabilities are usually reported at amortised
cost under US GAAP.
• Since 1 January 2006, HSBC has accounted for hybrid financial instruments under the provisions of SFAS 155
‘Hybrid Financial Instruments’. Hybrid financial instruments used that contain an embedded derivative that
would otherwise require bifurcation are, where so designated through an irrevocable election, initially and
subsequently measured at fair value, with changes in fair value recognised through income.
Impact
• HSBC has principally used the fair value designation option in the following cases:
− for certain fixed rate long-term debt issues whose interest rate characteristic has been changed to floating
through interest rate swaps as part of a documented interest rate management strategy. In 2006,
approximately US$56 billion (2005: US$51 billion) of the Group’s debt issues have been accounted for
using this option. The movement in fair value of these debt issues includes the effect of changes in own
credit spread and any ineffectiveness in the economic relationship between the related swaps and own debt.
Such ineffectiveness arises from the different credit characteristics of the swap and own debt coupled with