HSBC 2009 Annual Report Download - page 278

HSBC HOLDINGS PLC
Report of the Directors: Risk (continued)
Insurance operations > Financial risks > Market risk / Credit risk
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includes an individual responsible for market and
liquidity risk.
As described above, the product approval
process includes an identification and assessment of
the risk embedded in new products, for example,
those including options and guarantees within the
contract. When such product features are identified,
the product proposal is reviewed by Group Insurance
Head Office to ensure that the key risks are
identified and appropriate risk management
procedures are in place. Management reviews certain
exposures more frequently when markets
demonstrate increased volatility to ensure that any
matters arising are dealt with in a timely fashion.
Each insurance manufacturing subsidiary is
required to have a market risk mandate which
specifies the investment instruments in which it is
permitted to invest and the maximum quantum of
market risk which it is permitted to retain. It is the
responsibility of the subsidiary’s ALCO and the
Market and Liquidity Risk Committee (sub-
committee to the Group Insurance Risk Committee)
to ensure that each mandate is consistent with local
regulations. All mandates are reviewed and agreed
annually by Group Insurance Head Office, and
aggregate limits are approved by the Risk
Management Meeting of GMB. All market risk
mandates include management action loss limits
designed to control risk.
How the exposures to risks are measured
(Audited)
HSBC’s insurance manufacturing subsidiaries
monitor exposures against mandated limits regularly
and report these quarterly to Group Insurance Head
Office. Exposures are aggregated and reported to
senior risk management forums in the Group,
including the Group Insurance Market and Liquidity
Risk Committee, Group Insurance Risk Committee
and the Group Stress Test Review Group.
The standard measures used to quantify the
market risks are as follows:
• for interest rate risk, the sensitivities of the net
present values of asset and expected liability
cash flows, in total and by currency, to a one
basis point parallel shift in the discount curves
used to calculate the net present values;
• for equity price risk, the total market value of
equity holdings and the market value of equity
holdings by region and country; and
• for foreign exchange risk, the total net short
foreign exchange position and the net foreign
exchange positions by currency.
Although these measures are relatively
straightforward to calculate and aggregate, there
are limitations with them. The most significant
limitation is that a parallel shift in yield curves of
one basis point does not capture the non-linear
relationships between the values of certain assets and
liabilities and interest rates. Non-linearity arises, for
example, from investment return guarantees and
certain product features such as the ability of
policyholders to surrender their policies. If the
yields on investments held to support contracts
with guarantees are less than the investment returns
implied by the guarantees, shortfalls will be to the
account of HSBC.
HSBC recognises these limitations and
augments its standard measures with stress tests
which examine the effect of a range of market rate
scenarios on the aggregate annual profits and total
equity of the insurance manufacturing subsidiaries.
HSBC’s insurance manufacturing subsidiaries report
the results of their stress tests every quarter to Group
Insurance Head Office, where the reports are
consolidated and reviewed by the Group Insurance
Market and Liquidity Risk Meeting and the Group
Stress Test Review Group.
HSBC’s insurance manufacturing subsidiaries
identify the assets and liabilities in their financial
statements whose values are sensitive to each
category of market risk and revalue them at various
market rates. The outcome of the exercise is
expressed in terms of the effect on profit for the year
and total equity under the stress-tested assumptions,
after taking into consideration tax and accounting
treatments where material and relevant.