HSBC 2010 Annual Report Download - page 181

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Overview Operating & Financial Review Governance Financial Statements Shareholder Information
For consolidated group reporting, the FSA’s
rules permit the use of other regulators’ standardised
approaches where they are considered equivalent.
The use of other regulators’ IRB approaches is
subject to the agreement of the FSA. Under our
Basel II rollout plans, a number of our Group
companies and portfolios are in transition to
advanced IRB approaches. At December 2010,
portfolios in much of Europe, Hong Kong, Rest of
Asia-Pacific and North America were on advanced
IRB approaches. Others remain on the standardised
or foundation approaches under Basel II, pending
definition of local regulations or model approval, or
under exemptions from IRB treatment.
Counterparty credit risk
Counterparty credit risk arises for OTC derivatives
and securities financing transactions. It is calculated
in both the trading and non-trading books and is the
risk that the counterparty to a transaction may
default before completing the satisfactory settlement
of the transaction. Three approaches to calculating
counterparty credit risk and determining exposure
values are defined by Basel II: standardised, mark-
to-market and internal model method. These
exposure values are used to determine capital
requirements under one of the credit risk approaches:
standardised, IRB foundation and IRB advanced.
We use the mark-to-market and internal model
method approaches for counterparty credit risk. Our
longer-term aim is to migrate more positions from
the mark-to-market to the internal model method
approach.
Securitisation
Basel II specifies two methods for calculating credit
risk requirements for securitisation positions in the
non-trading book, being the standardised and IRB
approaches. Both approaches rely on the mapping
of rating agency credit ratings to risk weights,
which range between 7% and 1,250%. Positions
that would otherwise be weighted at 1,250% are
deducted from capital.
Within the IRB approach, we use the Ratings
Based Method for the majority of our non-trading
book securitisation positions, and the Internal
Assessment Approach for unrated liquidity facilities
and programme-wide enhancements for asset-backed
securitisations. We use the IRB approach for the
majority of our non-trading book securitisation
positions, while those in the trading book are treated
like other market risk positions.
Market risk capital requirement
The market risk capital requirement is measured,
with FSA permission, using VAR models, or the
standard rules prescribed by the FSA.
We use both VAR and standard rules
approaches for market risk. Our aim is to migrate
more positions from standard rules to VAR.
Operational risk capital requirement
Basel II includes a capital requirement for
operational risk, again utilising 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.
We have adopted the standardised approach
in determining our operational risk capital
requirements.
Pillar 2 capital requirements
The second pillar of Basel II (Supervisory Review
and Evaluation Process) 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 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 is set as a capital
resources requirement higher than that required
under pillar 1. In 2011, this will be supplemented
by an additional Capital Planning Buffer, set by
the FSA, to cover capital demand should economic
conditions worsen considerably against the current
outlook.
Pillar 3 disclosure requirements
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. Our pillar 3 disclosures for the year
ended 31 December 2010 are published as a separate
document on the Group Investor Relations website.