HSBC 2007 Annual Report Download - page 428

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
Note 33
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33 Fair values of financial instruments
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing
parties in an arm’s length transaction.
Financial instruments measured at fair value on an ongoing basis include trading assets and liabilities, instruments
designated at fair value, derivatives, and financial investments classified as available-for-sale (including treasury and
other eligible bills, debt securities, and equity securities).
Fair value of financial instruments carried at fair value
Control framework
Fair values are subject to a control framework that aims to ensure that they are either determined, or validated, by a
function independent of the risk-taker. To this end, ultimate responsibility for the determination of fair values lies
with Finance, which reports functionally to the Group Finance Director. Finance establishes the accounting policies
and procedures governing valuation, and is responsible for ensuring that these comply with all relevant accounting
standards.
For fair values determined using a valuation model, the control framework may include, as applicable, independent
development or validation of (i) valuation models; (ii) any inputs to those models; and (iii) any adjustments required
outside of the valuation model, and, where possible, independent validation of model outputs.
For fair values determined without a valuation model, independent price determination or validation is utilised. The
results of independent validation processes are reported to senior management, and adjustments to the fair values are
made as appropriate.
Determination of fair value
Fair values are determined according to the following hierarchy:
(a) Quoted market price
Financial instruments with quoted prices for identical instruments in active markets.
(b) Valuation technique using observable inputs
Financial instruments with quoted prices for similar instruments in active markets or quoted prices for identical
or similar instruments in inactive markets and financial instruments valued using models where all significant
inputs are observable.
(c) Valuation technique with significant non-observable inputs
Financial instruments valued using models where one or more significant inputs are not observable.
The best evidence of fair value is a quoted price in an actively traded market. In the event that the market for a
financial instrument is not active, a valuation technique is used. The majority of valuation techniques employ only
observable market data, and so the reliability of the fair value measurement is high. However, certain financial
instruments are valued on the basis of valuation techniques that feature one or more significant market inputs that are
not observable. For these instruments, the fair value derived is more judgemental. ‘Not observable’ in this context
means that there is little or no current market data available from which to determine the level at which an arm’s
length transaction would likely occur, but it generally does not mean that there is absolutely no market data available
upon which to base a determination of fair value (historical data may, for example, be used). Furthermore, the
assessment of hierarchy level is based on the lowest level of input that is significant to the fair value of the financial
instrument. Consequently, the level of uncertainty in the determination of the unobservable inputs will generally give
rise to valuation uncertainty that is less than the fair value itself. To assist in understanding the extent of this
uncertainty, additional information is provided in respect of these instruments in the ‘Effect of changes in significant
non-observable assumptions to reasonably possible alternatives’ section below.
In certain circumstances, HSBC applies the fair value option to its own debt in issue. Where available, the fair value
will be based upon quoted prices in an active market for the specific instrument concerned. Where unavailable, the
fair value will either be based upon quoted prices in an inactive market for the specific instrument concerned, or
estimated by comparison with quoted prices in an active market for similar instruments. The fair value of these
instruments therefore includes the effect of the appropriate credit spread to apply to HSBC’s liabilities. Gains and
losses arising from changes in the credit spread of liabilities issued by HSBC reverse over the contractual life of the