HSBC 2015 Annual Report Download - page 214

Report of the Directors: Risk (continued)
Appendix to Risk – Policies and practices
HSBC HOLDINGS PLC
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procedures, and of restricting trading in the more complex derivative products only to offices with appropriate levels of
product expertise and robust control systems.
Market risk measures
Monitoring and limiting market risk exposures
Our objective is to manage and control market risk exposures while maintaining a market profile consistent with our risk
appetite.
We use a range of tools to monitor and limit market risk exposures including sensitivity analysis, value at risk and stress
testing.
Sensitivity analysis
Sensitivity analysis measures the impact of individual market factor movements on specific instruments or portfolios, including
interest rates, foreign exchange rates and equity prices, such as the effect of a one basis point change in yield. We use
sensitivity measures to monitor the market risk positions within each risk type. Sensitivity limits are set for portfolios, products
and risk types, with the depth of the market being one of the principal factors in determining the level of limits set.
Value at risk
(Audited)
Value at risk (‘VaR’) is a technique that estimates the potential losses on risk positions as a result of movements in market
rates and prices over a specified time horizon and to a given level of confidence. The use of VaR is integrated into market risk
management and is calculated for all trading positions regardless of how we capitalise those exposures. Where there is not an
approved internal model, we use the appropriate local rules to capitalise exposures.
In addition, we calculate VaR for non-trading portfolios to have a complete picture of risk. Our models are predominantly
based on historical simulation. VaR is calculated at a 99% confidence level for a one-day holding period. Where we do not
calculate VaR explicitly, we use alternative tools as summarised in the Market Risk Stress Testing table on page 213.
Our VaR models derive plausible future scenarios from past series of recorded market rates and prices, taking into account
inter-relationships between different markets and rates such as interest rates and foreign exchange rates. The models also
incorporate the effect of option features on the underlying exposures.
The historical simulation models used incorporate the following features:
• historical market rates and prices are calculated with reference to foreign exchange rates and commodity prices, interest
rates, equity prices and the associated volatilities;
• potential market movements utilised for VaR are calculated with reference to data from the past two years; and
• VaR measures are calculated to a 99% confidence level and use a one-day holding period.
The nature of the VaR models means that an increase in observed market volatility will lead to an increase in VaR without any
changes in the underlying positions.
We are committed to the ongoing development of our in-house risk models.
VaR model limitations
Although a valuable guide to risk, VaR should always be viewed in the context of its limitations. For example:
• the use of historical data as a proxy for estimating future events may not encompass all potential events, particularly those
which are extreme in nature;
• the use of a holding period assumes that all positions can be liquidated or the risks offset during that period. This may not
fully reflect the market risk arising at times of severe illiquidity, when the holding period may be insufficient to liquidate or
hedge all positions fully;
• the use of a 99% confidence level, by definition, does not take into account losses that might occur beyond this level of
confidence;
• VaR is calculated on the basis of exposures outstanding at the close of business and therefore does not necessarily reflect
intra-day exposures; and
• VaR is unlikely to reflect loss potential on exposures that only arise under conditions of significant market movement.
Risk not in VaR framework
Our VaR model is designed to capture significant basis risks such as CDS versus bond, asset swap spreads and cross-currency
basis. Other basis risks which are not completely covered in VaR, such as the Libor tenor basis, are complemented by our risk
not in VaR (‘RNIV’) calculations, and are integrated into our capital framework.