HSBC 2009 Annual Report Download - page 170

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
Fair values of financial instruments > Carried at fair value
168
All net positions in non-derivative financial
instruments, and all derivative portfolios, are valued
at bid or offer prices as appropriate. Long positions
are marked at bid prices; short positions are marked
at offer prices.
The fair value of a portfolio of financial
instruments is calculated as the product of the
number of units and its quoted price and no block
discounts are applied.
Fair value adjustments
The valuation models applied for ‘level 2’ and ‘level
3’ assets incorporate assumptions that HSBC
believes would be made by a market participant to
establish fair value. Fair value adjustments are
adopted when HSBC considers that there are
additional factors that would be considered by a
market participant that are not incorporated within
the valuation model. The magnitude of fair value
adjustments depends upon many entity-specific
factors, including modelling sophistication, the
nature of products traded, and the size and type
of risk exposures. For this reason, fair value
adjustments may not be comparable across the
banking industry.
HSBC classifies fair value adjustments as either
‘risk-related’ or ‘model-related’. They form part of
the portfolio fair value and are incorporated within
the balance sheet values of the product types to
which they have been applied. The majority of these
adjustments relate to Global Banking and Markets.
The magnitude and types of fair value adjustment
adopted by Global Banking and Markets are listed
in the following table:
Global Banking and Markets fair value adjustments
At 31 December
2009 2008
US$m US$m
Type:
Risk-related ........................................................................................................................................... 2,955 3,796
Bid-offer ........................................................................................................................................... 528 811
Uncertainty ....................................................................................................................................... 223 319
Credit risk adjustment ...................................................................................................................... 2,172 2,658
Other ................................................................................................................................................. 32 8
Model-related ........................................................................................................................................ 457 487
Model limitation ............................................................................................................................... 391 381
Other ................................................................................................................................................. 66 106
Inception profit (Day 1 P&L reserves) ................................................................................................. 260 204
Total ...................................................................................................................................................... 3,672 4,487
The quantum of fair value adjustments has
reduced by US$815 million during the year.
Movements in the level of fair value adjustments do
not necessarily result in the recognition of profits or
losses within the income statement. For example,
following enhancement of a model to incorporate an
additional factor, the model value will have changed
and so the fair value adjustment in respect of that
factor will no longer be required. Similarly, if a
position is unwound at a price inclusive of the fair
value adjustment, then the fair value adjustment base
will decrease, but no profit or loss will result.
The major movements occurred in the bid-offer
and credit risk adjustment categories. The reduction
of US$283 million in the bid-offer adjustment in
2009 largely reflected decreasing market bid-offer
spreads as the market stabilised following the
turmoil seen in the latter part of 2008.
The reduction of US$486 million in the credit
risk adjustment in 2009 reflected the release of
US$716 million due to the commutation of
transactions with monoline insurers, which did not
result in any material gain or loss being recognised
in the income statement. It also reflected lower OTC
derivative counterparty exposures, resulting from the
tightening of credit spreads, the steepening of yield
curves and the recovery in equity markets during the
year, offset by increased probability of counterparty
default.
Risk-related adjustments
‘Risk-related’ adjustments are driven, in part, by
the magnitude of HSBC’s market or credit risk
exposure, and by external market factors, such as
the size of market spreads.
Bid-Offer
IAS 39 requires that portfolios are marked at bid or
offer, as appropriate. Bid prices represent the price at
which a long position could be sold and offer prices