HSBC 2011 Annual Report Download - page 364

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
20 – Derivatives
362
The 33% increase in the fair value of derivative assets during 2011 was driven by increased interest rate derivative
fair values as yield curves declined in major currencies during the second half of the year, reflecting the deteriorating
economic outlook. This drove both the increase in gross fair values and the increase in the netting adjustment.
Fair values of derivatives by product contract type held by HSBC Holdings with subsidiaries
At 31 December 2011 At 31 December 2010
Trading Trading Trading Trading
assets liabilities assets liabilities
US$m US$m US$m US$m
Foreign exchange .......................................................................... 1,546 1,067 1,407 827
Interest rate ................................................................................... 2,022 – 920 –
3,568 1,067 2,327 827
Derivatives are financial instruments that derive their value from the price of underlying items such as equities,
bonds, interest rates, foreign exchange, credit spreads, commodities and equity or other indices. Derivatives enable
users to increase, reduce or alter exposure to credit or market risks. HSBC makes markets in derivatives for its
customers and uses derivatives to manage its exposure to credit and market risks.
Derivatives are carried at fair value and shown in the balance sheet as separate totals of assets and liabilities. A
description of how the fair value of derivatives is derived is set out on page 352. Derivative assets and liabilities on
different transactions are only set off if the transactions are with the same counterparty, a legal right of set-off exists
and the cash flows are intended to be settled on a net basis.
Use of derivatives
HSBC transacts derivatives for three primary purposes: to create risk management solutions for clients, to manage the
portfolio risks arising from client business and to manage and hedge HSBC’s own risks. Derivatives (except for
derivatives which are designated as effective hedging instruments as defined in IAS 39) are held for trading. The held
for trading classification includes two types of derivatives: those used in sales and trading activities, and those used
for risk management purposes but which for various reasons do not meet the qualifying criteria for hedge accounting.
The second category includes derivatives managed in conjunction with financial instruments designated at fair value.
These activities are described more fully below.
HSBC’s derivative activities give rise to significant open positions in portfolios of derivatives. These positions are
managed constantly to ensure that they remain within acceptable risk levels, with matching deals being utilised to
achieve this where necessary. When entering into derivative transactions, HSBC employs the same credit risk
management framework to assess and approve potential credit exposures that are used for traditional lending.
Trading derivatives
Most of HSBC’s derivative transactions relate to sales and trading activities. Sales activities include the structuring
and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or
expected risks. Trading activities in derivatives are entered into principally for the purpose of generating profits from
short-term fluctuations in price or margin. Positions may be traded actively or be held over a period of time to benefit
from expected changes in exchange rates, interest rates, equity prices or other market parameters. Trading includes
market-making, positioning and arbitrage activities. Market-making entails quoting bid and offer prices to other
market participants for the purpose of generating revenues based on spread and volume; positioning means managing
market risk positions in the expectation of benefiting from favourable movements in prices, rates or indices; arbitrage
involves identifying and profiting from price differentials between markets and products.
As mentioned above, other derivatives classified as held for trading include non-qualifying hedging derivatives,
ineffective hedging derivatives and the components of hedging derivatives that are excluded from assessing hedge
effectiveness. Non-qualifying hedging derivatives are entered into for risk management purposes but do not meet the
criteria for hedge accounting. These include derivatives managed in conjunction with financial instruments
designated at fair value.
Gains and losses from changes in the fair value of derivatives, including the contractual interest, that do not qualify
for hedge accounting are reported in ‘Net trading income’, except for derivatives managed in conjunction with
financial instruments designated at fair value, where gains and losses are reported in ‘Net income from financial