HSBC 2008 Annual Report Download - page 164

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
Footnotes / Fair values of financial instruments / Carried at fair value
162
Footnotes to ‘Nature and extent of HSBC’s exposures’
1 Mortgage-backed securities (‘MBSs’), asset-backed securities (‘ABSs’) and collateralised debt obligations (‘CDOs’).
2 High grade assets rated AA or AAA.
3 Unrealised gains and losses on the net principal exposure (see footnote 9) recognised in the income statement as a result of changes in
the fair value of the asset, adjusted for the cumulative amount of transfers to realised gains and losses as a result of the disposal of
assets.
4 Realised gains and losses on the net principal exposure (see footnote 9) recognised in the income statement as a result of the disposal of
assets.
5 Fair value gains and losses on the net principal exposure (see footnote 9) recognised in equity as a result of the changes in the fair
value of available-for-sale assets, adjusted for transfers from the available-for-sale reserve to the income statement as a result of
impairment, and adjusted for transfers to realised gains and losses following the disposal of assets.
6 Impairment losses recognised in the income statement in respect of the net principal exposure (see footnote 9) of available-for-sale and
held-to-maturity assets.
7 The gross principal is the redemption amount on maturity or, in the case of an amortising instrument, the sum of the future redemption
amounts through the residual life of the security.
8 A CDS is a credit default swap. CDS gross protection is the gross principal of the underlying instrument that is protected by CDSs.
9 Net principal exposure is the gross principal amount of assets that are not protected by CDSs. It includes assets that benefit from
monoline protection, except where this protection is purchased with a CDS.
10 Carrying amount of the net principal exposure.
11 During 2008, the Group reclassified holdings of HELoCs to US sub-prime residential mortgage-related assets from Other US
residential mortgage-related assets, and restated the amounts of certain direct lending exposures presented in the ABS tables to show
the gross carrying amount of assets on the consolidated balance sheet rather than the net exposure, consistent with other direct lending
exposures. 2007 amounts have been restated accordingly, resulting in an increase of US$6.3 billion in the reported balance of US
sub-prime mortgage-related assets as at 31 December 2007.
12 Net exposure after legal netting and any other relevant credit mitigation prior to deduction of the credit risk adjustment.
13 Cumulative fair value adjustment recorded against OTC derivative counterparty exposures to reflect the creditworthiness of the
counterparty.
14 Funded exposure represents the loan amount advanced to the customer, less any fair value write-downs, net of fees held on deposit.
15 Unfunded exposures represent the contractually committed loan facility amount not yet drawn down by the customer, less any fair value
write-downs, net of fees held on deposit.
Fair values of financial instruments
(Audited)
The classification of financial instruments is
determined in accordance with the accounting
policies set out in Note 2 on the Financial
Statements, and the use of assumptions and
estimation in respect of valuation of financial
instruments as described on page 63. The following
is a description of HSBC’s methods of determining
fair value and its related control framework, and a
quantification of its exposure to financial
instruments measured at fair value.
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 values of financial instruments carried
at fair value
Control framework
Fair values are subject to a control framework
designed 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 they comply with all relevant
accounting standards.
For all financial instruments where fair values
are determined by reference to externally quoted
prices or observable pricing inputs to models,
independent price determination or validation is
utilised. In inactive markets, direct observation
of a traded price may not be possible. In these
circumstances, HSBC will source alternative market
information to validate the financial instrument’s fair
value, with greater weight given to information that
is considered to be more relevant and reliable. The
factors that are considered in this regard are, inter
alia:
• the extent to which prices may be expected to
represent genuine traded or tradeable prices;
• the degree of similarity between financial
instruments;
• the degree of consistency between different
sources;
• the process followed by the pricing provider to
derive the data;