HSBC 2006 Annual Report Download - page 410

HSBC HOLDINGS PLC
Notes on the Financial Statements (continued)
Note 47
408
Non-trading transactions
• Non-trading transactions, which were those undertaken for hedging purposes as part of HSBC’s risk
management strategy against cash flows, assets, liabilities or positions, were measured on an accrual basis.
Non-trading transactions included qualifying hedges and positions that synthetically altered the characteristics
of specified financial instruments.
• Non-trading transactions were accounted for on an equivalent basis to the underlying assets, liabilities or net
positions. Any gains or losses arising were recognised on the same basis as those arising from the related assets,
liabilities or positions.
• To qualify as a hedge, a derivative was required effectively to reduce the price, foreign exchange or interest rate
risk of the asset, liability or anticipated transaction to which it was linked and be capable of designation as a
hedge at inception of the derivative contract. Accordingly, changes in the market value of the derivative were
required to be highly correlated to changes in the market value of the underlying hedged item at inception of the
hedge and over the life of the hedge contract. If these criteria were met, the derivative was accounted for on the
same basis as the underlying hedged item. Derivatives used for hedging purposes included swaps, forwards and
futures. Interest rate swaps were also used to alter synthetically the interest rate characteristics of financial
instruments. In order to qualify for synthetic alteration, a derivative instrument had to be linked to specific
individual, or pools of similar, assets or liabilities by the notional principal and interest rate risks of the
associated instruments, and had to achieve a result that was consistent with defined risk management objectives.
If these criteria were met, accruals based accounting was applied, i.e. income or expense was recognised and
accrued to the next settlement date in accordance with the contractual terms of the agreement.
• Any gain or loss arising on the termination of a qualifying derivative was deferred and amortised to earnings
over the original life of the terminated contract. Where the underlying asset, liability or position was sold or
terminated, the qualifying derivative was immediately marked to market and any gain or loss arising was taken
to the income statement.
US GAAP
• The accounting under SFAS 133 ‘Accounting for derivative instruments and hedging activities’ is generally
consistent with that under IAS 39, which HSBC has followed in its IFRSs reporting from 1 January 2005, as
described above. However, specific assumptions regarding hedge effectiveness under US GAAP are not
permitted by IAS 39.
• The requirements of SFAS 133 have been effective from 1 January 2001.
• During 2006, HSBC’s US operating subsidiaries discontinued the use of the ‘shortcut method’. The US GAAP
‘shortcut method’ permits an assumption of zero ineffectiveness in hedges of interest rate risk with an interest
rate swap provided specific criteria have been met. IAS 39 does not permit such an assumption, requiring a
measurement of actual ineffectiveness at each designated effectiveness testing date.
• However, IFRSs allow greater flexibility in the designation of the hedged item. Under US GAAP, all contractual
cash flows must form part of the designated relationship, whereas IAS 39 permits the designation of identifiable
benchmark interest cash flows only.
• Certain issued structured notes are classified as trading liabilities under IFRSs, but not under US GAAP. Under
IFRSs, these notes will be held at fair value, with changes in fair value reflected in the income statement. Under
US GAAP, if the embedded derivative would otherwise require bifurcation, an irrevocable election may be made
to initially and subsequently measure the entire issued note at fair value, with changes in fair value recognised
through income. This election is made under US GAAP when the underlying issued notes are classified as
trading liabilities under IFRS. If the embedded derivative is clearly and closely related to the host contract, the
issued note will be held at amortised cost in its entirety, with changes in the amortised cost reflected in the
income statement.
• Under US GAAP, derivatives receivable and payable with the same counterparty may be reported net on the
balance sheet when there is an executed ISDA Master Netting Arrangement covering enforceable jurisdictions.
These contracts do not meet the requirements for offset under IAS 32 and hence are presented gross on the
balance sheet under IFRSs.