HSBC 2008 Annual Report Download - page 402

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
Note 18
400
Credit derivatives
HSBC trades credit derivatives through its principal dealing operations and acts as a principal counterparty to a broad
range of users, structuring deals to produce risk management products for its customers, or making markets in certain
products. Risk is typically controlled through entering into offsetting credit derivative contracts with other
counterparties.
HSBC manages the credit risk arising on buying and selling credit derivative protection by including the related
credit exposures within its overall credit limit structure for the relevant counterparty. Trading of credit derivatives is
restricted to a small number of offices within the major centres which have the control infrastructure and market
skills to manage effectively the credit risk inherent in the products.
Credit derivatives are also deployed to a limited extent for the risk management of the Group’s loan portfolios.
The notional contract amount of credit derivatives of US$1,583,337 million (2007: US$1,893,802 million) consisted
of protection bought of US$777,556 million (2007: US$926,794 million) and protection sold of US$805,781 million
(2007: US$967,008 million).
The difference between the notional amounts bought and sold is attributable to HSBC selling protection on large,
diversified, predominantly investment grade portfolios (including the most senior tranches) and then offsetting the
risk on these positions by buying protection on the more subordinated tranches of the same portfolios. In addition,
HSBC uses securities to mitigate risks on certain derivative positions and credit derivative contracts to reduce
counterparty exposures. Consequently, while there is a mismatch in notional amounts of credit derivatives bought and
sold this should not be interpreted as representing the open risk position. The credit derivative business operates
within the market risk management framework described on pages 241 to 251.
Derivatives valued using models with unobservable inputs
The difference between the fair value at initial recognition (the transaction price) and the value that would have been
derived had valuation techniques used for subsequent measurement been applied at initial recognition, less
subsequent releases, is as follows:
2008 2007
US$m US$m
Unamortised balance at 1 January ..................................................................................................... 306 214
Deferral on new transactions ............................................................................................................. 326 384
Recognised in the income statement during the period:
– amortisation ................................................................................................................................ (168) (85)
– subsequent to unobservable inputs becoming observable ......................................................... (118) (83)
– maturity, termination or offsetting derivative ............................................................................ (99) (121)
Exchange differences ......................................................................................................................... (38) 4
Risk hedged ....................................................................................................................................... (5) (7)
Unamortised balance at 31 December1 .............................................................................................. 204 306
1 This amount is yet to be recognised in the consolidated income statement.
Hedging instruments
HSBC uses derivatives (principally interest rate swaps) for hedging purposes in the management of its own asset and
liability portfolios and structural positions. This enables HSBC to optimise the overall cost to the Group of accessing
debt capital markets, and to mitigate the market risk which would otherwise arise from structural imbalances in the
maturity and other profiles of its assets and liabilities.
The accounting treatment of hedge transactions varies according to the nature of the instrument hedged and the type
of hedge transactions. Derivatives may qualify as hedges for accounting purposes if they are fair value hedges, cash
flow hedges, or hedges in net investment of foreign operations. These are described under the relevant headings
below: