HSBC 2008 Annual Report Download - page 279

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reporting, leaving a small residue of exposures on
the standardised approach.
Market risk is derived from fluctuations on
trading book assets arising from changes in values,
income, interest and foreign exchange rates and is
measured using VAR models with FSA permission
or the standard rules prescribed by the FSA.
Counterparty credit risk in the trading book and the
non-trading book is the risk that the counterparty to a
transaction may default before completing the
satisfactory settlement of the transaction. Three
counterparty credit risk calculation approaches are
defined by Basel II to determine exposure values,
being the standardised, mark to market and the
internal model method. These exposure values are
then used to determine capital requirements using
one of the credit risk approaches, standardised, IRB
foundation and IRB advanced. Across the Group,
HSBC uses both VAR and standard rules approaches
for market risk and the mark to market and internal
model method approaches for counterparty credit
risk. It is the longer-term aim of HSBC to migrate
more positions from standard rules to VAR for
market risk and from mark to market to internal
model method for counterparty credit risk.
Basel II also introduces capital requirements for
operational risk and, again, contains three levels of
sophistication. The capital required under the basic
indicator approach is a simple percentage of gross
revenues, whereas under the standardised approach it
is one of three different percentages of gross
revenues allocated to each of eight defined business
lines. Both these approaches use an average of the
last three financial years’ revenues. Finally, the
advanced measurement approach uses banks’ own
statistical analysis and modelling of operational risk
data to determine capital requirements. HSBC has
adopted the standardised approach to the
determination of Group operational risk capital
requirements.
The second pillar of Basel II (Supervisory
Review and Evaluation Process – ‘SREP’) involves
both firms and regulators taking a view on whether a
firm should hold additional capital against risks not
covered in pillar 1. Part of the pillar 2 process is the
Internal Capital Adequacy Assessment Process
(‘ICAAP’) which is the firm’s self assessment of the
levels of capital that it needs to hold. The pillar 2
process culminates in the FSA providing firms with
Individual Capital Guidance (‘ICG’). The ICG
replaces the trigger ratio and is set as a capital
resources requirement higher than that required
under pillar 1.
Pillar 3 of Basel II is related to market discipline
and aims to make firms more transparent by
requiring them to publish specific, prescribed details
of their risks, capital and risk management under the
Basel II framework. On 10 November 2008, HSBC
published summary qualitative pillar 3 disclosures
(‘Interim Pillar 3 Disclosures 2008’) for 30 June
2008 on the investor relations section of its website,
www.hsbc.com. HSBC expects to publish the first
full set of pillar 3 disclosures for 31 December 2008,
including quantitative tables, during the first half of
2009.
During 2007, HSBC was supervised under
Basel I. Under Basel I, banking operations are
categorised as either trading book or banking book
and risk-weighted assets are determined accordingly.
Banking book risk-weighted assets are measured by
means of a hierarchy of risk weightings classified
according to the nature of each asset and
counterparty, taking into account any eligible
collateral or guarantees. Banking book off-balance
sheet items giving rise to credit, foreign exchange or
interest rate risk are assigned weights appropriate to
the category of the counterparty, taking into account
any eligible collateral or guarantees. Trading book
risk-weighted assets are determined by taking into
account market-related risks such as foreign
exchange, interest rate and equity position risks, and
counterparty risk.