HSBC 2012 Annual Report Download - page 271

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Overview Operating & Financial Review Corporate Governance Financial Statements Shareholder Information
functional currencies of which are currencies other than the US dollar. An entity’s functional currency is that of
the primary economic environment in which the entity operates.
Exchange differences on structural exposures are recognised in other comprehensive income. We use the US dollar
as our presentation currency in our consolidated financial statements because the US dollar and currencies linked
to it form the major currency bloc in which we transact and fund our business. Our consolidated balance sheet is,
therefore, affected by exchange differences between the US dollar and all the non-US dollar functional currencies
of underlying subsidiaries.
We hedge structural foreign exchange exposures only in limited circumstances. Our structural foreign exchange
exposures are managed with the primary objective of ensuring, where practical, that our consolidated capital ratios
and the capital ratios of individual banking subsidiaries are largely protected from the effect of changes in exchange
rates. This is usually achieved by ensuring that, for each subsidiary bank, the ratio of structural exposures in a given
currency to risk-weighted assets denominated in that currency is broadly equal to the capital ratio of the subsidiary in
question.
We may also transact hedges where a currency in which we have structural exposures is considered likely to revalue
adversely, and it is possible in practice to transact a hedge. Any hedging is undertaken using forward foreign
exchange contracts which are accounted for under IFRSs as hedges of a net investment in a foreign operation, or by
financing with borrowings in the same currencies as the functional currencies involved.
Sensitivity of net interest income
(Unaudited)
A principal part of our management of market risk in non-trading portfolios is to monitor the sensitivity of projected
net interest income under varying interest rate scenarios (simulation modelling). We aim, through our management
of market risk in non-trading portfolios, to mitigate the effect of prospective interest rate movements which could
reduce future net interest income, while balancing the cost of such hedging activities on the current net revenue
stream.
Entities apply a combination of scenarios and assumptions relevant to their local businesses, and standard scenarios
which are required throughout HSBC. The latter are consolidated to illustrate the combined pro forma effect on our
consolidated net interest income.
Projected net interest income sensitivity figures represent the effect of the pro forma movements in net interest
income based on the projected yield curve scenarios and the Group’s current interest rate risk profile. This effect,
however, does not incorporate actions which would probably be taken by Balance Sheet Management or in the
business units to mitigate the effect of interest rate risk. In reality, Balance Sheet Management seeks proactively to
change the interest rate risk profile to minimise losses and optimise net revenues. The net interest income sensitivity
calculations assume that interest rates of all maturities move by the same amount in the up shock scenario. Rates are
not assumed to become negative in the down shock scenario which may, in certain currencies, effectively result in
non-parallel shock. In addition, the net interest income sensitivity calculations take account of the effect on net
interest income of anticipated differences in changes between interbank interest rates and interest rates over which
the entity has discretion in terms of the timing and extent of rate changes.
Defined benefit pension schemes
(Audited)
Market risk arises within our defined benefit pension schemes to the extent that the obligations of the schemes are
not fully matched by assets with determinable cash flows. Pension scheme obligations fluctuate with changes in
long-term interest rates, inflation, salary levels and the longevity of scheme members. Pension scheme assets include
equities and debt securities, the cash flows of which change as equity prices and interest rates (and credit risk) vary.
There is a risk that market movements in equity prices and interest rates could result in asset values which, taken
together with regular ongoing contributions, are insufficient over time to cover the level of projected obligations
and these, in turn, could increase with a rise in inflation and members living longer. Management, together with
the trustees who act on behalf of the pension scheme beneficiaries, assess these risks using reports prepared by
independent external actuaries, take action and, where appropriate, adjust investment strategies and contribution
levels accordingly.