HSBC 2009 Annual Report Download - page 168

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
Fair values of financial instruments > Carried at fair value
166
US$3.6 billion) and US$1.9 billion to
communications and infrastructure (2008:
US$1.7 billion). During the year, 99 per cent
of the total fair value movement not recognised was
against exposures in these two sectors (2008: 99 per
cent). Subsequent to the end of the year, as part of
portfolio management, US$0.6 billion of the data
processing exposure was sold.
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. The use of assumptions and estimation
in valuing financial instruments is 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 Chief Financial
Officer, Executive Director, Risk and Regulation.
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;
• the elapsed time between the date to which the
market data relates and the balance sheet date;
and
• the manner in which the data was sourced.
Models provide a logical framework for the
capture and processing of necessary valuation inputs.
For fair values determined using a valuation model,
the control framework may include, as applicable,
independent development or validation of (i) the
logic within valuation models; (ii) the inputs to those
models; (iii) any adjustments required outside the
valuation models; and (iv) where possible, model
outputs. Valuation models are subject to a process
of due diligence and calibration before becoming
operational and are calibrated against external
market data on an ongoing basis.
The results of the independent validation
process are reported to, and considered by, Valuation
Committees. Valuation Committees are composed of
valuation experts from several independent support
functions (Product Control, Market Risk
Management, Quantitative Risk and Valuation
Group and Finance) in addition to senior
management. The members of each Valuation
Committee consider the appropriateness and
adequacy of the fair value adjustments and the
effectiveness of valuation models. If necessary,
they may require changes to model calibration or
calibration procedures. The Valuation Committees
are overseen by the Valuation Committee Review
Group, which consists of Heads of Global Banking
and Markets’ Finance and Risk Functions. All
subjective valuation items with a potential impact in
excess of US$5 million are reported to the Valuation
Committee Review Group.