HSBC 2010 Annual Report Download - page 147

145
Overview Operating & Financial Review Governance Financial Statements Shareholder Information
Market risk
(Audited)
Market risk is the risk that movements in market
factors, including foreign exchange rates and
commodity prices, interest rates, credit spreads and
equity prices, will reduce our income or the value of
our portfolios.
We separate exposures to market risk into
trading and non-trading portfolios. Trading portfolios
include positions arising from market-making,
position-taking and others designated as marked
to market.
Non-trading portfolios include positions that
primarily arise from the interest rate management
of our retail and commercial banking assets and
liabilities, financial investments designated as
available for sale and held to maturity, and exposures
arising from our insurance operations.
Market risk arising in our insurance businesses
is discussed in ‘Risk management of insurance
operations’ on pages 155 to 171.
Monitoring and limiting market risk
exposure
(Audited)
Our objective is to manage and control market risk
exposures in order to optimise return on risk while
maintaining a market profile consistent with our
status as one of the world’s largest banking and
financial services organisations.
The management of market risk is principally
undertaken in Global Markets using risk limits
approved by the GMB. Limits are set for portfolios,
products and risk types, with market liquidity being
a primary factor in determining the level of limits
set. Group Risk, an independent unit within GMO, is
responsible for our market risk management policies
and measurement techniques. Each major operating
entity has an independent market risk management
and control function which is responsible for
measuring market risk exposures in accordance with
the policies defined by Group Risk, and monitoring
and reporting these exposures against the prescribed
limits on a daily basis.
Each operating entity is required to assess the
market risks arising on each product in its business
and to transfer them to either its local Global
Markets unit for management, or to separate books
managed under the supervision of the local Asset and
Liability Management Committee (‘ALCO’). Our
aim is to ensure that all market risks are consolidated
within operations that have the necessary skills,
tools, management and governance to manage them
professionally. In certain cases where the market
risks cannot be fully transferred, we use simulation
modelling to identify the impact of varying scenarios
on valuations and net interest income.
We employ a range of tools to monitor and limit
market risk exposures. These include sensitivity
analysis, value at risk (‘VAR’) and stress testing.
Sensitivity analysis
(Unaudited)
We use sensitivity measures to monitor the market
risk positions within each risk type, for example, the
present value of a basis point movement in interest
rates for interest rate risk. 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)
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 VAR models we use are based
predominantly on historical simulation. These
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.
Our historical simulation models assess
potential market movements with reference to data
from the past two years and calculate VAR to a 99%
confidence level and for a one-day holding period.
Although a valuable guide to risk, VAR should always be
viewed in the context of its limitations:
• 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 one-day holding period assumes that all
positions can be liquidated or the risk offset in one day. This
may not fully reflect the market risk arising at times of
severe illiquidity, when a one-day 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 significant market moves.