HSBC 2011 Annual Report Download - page 202

HSBC HOLDINGS PLC
Report of the Directors: Operating and Financial Review (continued)
Risk > Appendix – Risk policies and practices > Market risk
200
Stress testing results provide senior management with an assessment of the financial effect such events would have
on our profit.
Trading portfolios
(Audited)
Our control of market risk in the trading portfolios is based on a policy of restricting individual operations to trading
within a list of permissible instruments authorised for each site by Group Risk, of enforcing rigorous new product
approval procedures, and of restricting trading in the more complex derivative products only to offices with
appropriate levels of product expertise and robust control systems.
Credit spread risk
The risk associated with movements in credit spreads is primarily managed through sensitivity limits, stress testing
and VAR.
Credit spread risk also arises on credit derivative transactions entered into by Global Banking in order to manage the
risk concentrations within the corporate loan portfolio and so enhance capital efficiency. The mark-to-market of these
transactions is reflected in the income statement.
Gap risk
Even for transactions that are structured to render the risk to HSBC negligible under a wide range of market
conditions or events, there exists a remote possibility that a gap event could lead to loss. A gap event could arise from
a significant change in market price with no accompanying trading opportunity, with the result that the threshold is
breached beyond which the risk profile changes from no risk to full exposure to the underlying structure. Such
movements may occur, for example, when, in reaction to an adverse event or unexpected news announcement, the
market for a specific investment becomes illiquid, making hedging impossible.
Given their characteristics, these transactions make little or no contribution to VAR or to traditional market risk
sensitivity measures. We capture their risks within our stress testing scenarios and monitor gap risk on an ongoing
basis. We regularly consider the probability of gap loss, and fair value adjustments are booked against this risk.
ABS/MBS exposures
The ABS/MBS exposures within the trading portfolios are managed within sensitivity and VAR limits as described
on page 199, and are included within the stress testing scenarios described above.
Non-trading portfolios
(Audited)
The principal objective of market risk management of non-trading portfolios is to optimise net interest income.
Interest rate risk in non-trading portfolios arises principally from mismatches between the future yield on assets
and their funding cost, as a result of interest rate changes. Analysis of this risk is complicated by having to make
assumptions on embedded optionality within certain product areas such as the incidence of mortgage prepayments,
and from behavioural assumptions regarding the economic duration of liabilities which are contractually repayable
on demand such as current accounts.
Our control of market risk in the non-trading portfolios is based on transferring the risks to the books managed by
Global Markets or the local ALCO. The net exposure is typically managed through the use of interest rate swaps
within agreed limits. The VAR for these portfolios is included within the Group VAR.
Credit spread risk
The risk associated with movements in credit spreads is primarily managed through sensitivity limits, stress testing,
and VAR for those portfolios where VAR is calculated. We have introduced credit spread as a separate risk type
within our VAR models on a global basis. The VAR shows the effect on income from a one-day movement in credit
spreads over a two-year period, calculated to a 99% confidence interval.