HSBC 2015 Annual Report Download - page 216

Report of the Directors: Risk (continued)
Appendix to Risk – Policies and practices
HSBC HOLDINGS PLC
214
Back-testing
We routinely validate the accuracy of our VaR models by back-testing them against both actual, which replaced clean profit
and loss from 1 August 2015, and hypothetical profit and loss against the corresponding VaR numbers. Hypothetical profit and
loss excludes non-modelled items such as fees, commissions and revenues of intra-day transactions.
We would expect on average to see two or three profits and two or three losses in excess of VaR at the 99% confidence level
over a one-year period. The actual number of profits or losses in excess of VaR over this period can therefore be used to gauge
how well the models are performing.
We back-test our Group VaR at various levels which reflect a full legal entity scope of HSBC, including entities that do not have
local permission to use VaR for regulatory purposes.
Gap risk
Certain products, such as non-recourse margin loans, are not exposed to small day-to-day moves in market rates or prices, but
are exposed large discontinuous moves. Such movements may occur, for example, when, in reaction to an adverse event or
unexpected news announcement, some parts of the market move far beyond their normal volatility range and become
temporarily illiquid. Products which exhibit exposure only to large discontinuous moves (gap risk) are not well captured by VaR
measures or traditional market risk sensitivity measures. HSBC has implemented additional stress measurement and controls
over such products.
In 2015, gap risk exposure was primarily due to non-recourse loan transactions, mostly for corporate clients, where the
collateral against the loan is limited to the posted assets. Upon occurrence of a gap event, the value of the collateral could fall
below the outstanding loan amount.
We did not incur any notable gap loss in 2015.
De-peg risk
For certain currencies (pegged or managed) the spot exchange rate is pegged at a fixed-rate (typically to US dollars or euros),
or managed within a predefined band around a pegged rate. De-peg risk is the risk of the peg or managed band changing or
being abolished, and moving to a floating regime.
HSBC has extensive experience in managing fixed and managed currency regimes. Using stressed scenarios on spot rates, we
are able to analyse how de-peg events would affect the positions held by HSBC. We monitor such scenarios to pegged or
managed currencies, such as the Hong Kong dollar, renminbi and Middle Eastern currencies, and limit any potential losses that
would occur. This historical VaR measures, which may not fully capture the risk involved in holding positions in pegged or
managed currencies, as such currencies may not have experienced a de-peg event during the historical timeframe being
considered.
ABS/MBS exposures
The ABS/MBS (asset and mortgage-backed securities) exposures within the trading portfolios are managed within sensitivity
and VaR limits as described on page 167, and are included within the stress testing scenarios described above.
Non-trading portfolios
(Audited)
Most of the Group’s non-trading VaR relates to Balance Sheet Management (‘BSM’) or local treasury management functions.
Contributions to Group non-trading VaR are driven by interest rates and credit spread risks arising from all global businesses.
There is no commodity market risk in the non-trading portfolios.
Non-trading VaR also includes the interest rate risk of non-trading financial instruments held by the global businesses and
transferred into portfolios managed by BSM or local treasuries. In measuring, monitoring and managing risk in our non-trading
portfolios, VaR is just one of the tools used. The management of interest rate risk in the banking book is described further in
‘Non-trading interest rate risk’ below, including the role of BSM.
Non-trading VaR excludes equity risk on available-for-sale securities, structural foreign exchange risk, and interest rate risk on
fixed-rate securities issued by HSBC Holdings, the scope and management of which are described in the relevant sections
below.
Our control of market risk in the non-trading portfolios is based on transferring the assessed market risk of non-trading assets
and liabilities created outside BSM or Markets, to the books managed by BSM, provided the market risk can be neutralised.
The net exposure is typically managed by BSM through the use of fixed-rate government bonds (liquid assets held in available-
for-sale books) and interest rate swaps. The interest rate risk arising from fixed-rate government bonds held within available-
for-sale portfolios is reflected within the Group’s non-traded VaR. Interest rate swaps used by BSM are typically classified as
either a fair value hedge or a cash flow hedge and are included within the Group’s non-traded VaR. Any market risk that
cannot be neutralised in the market is managed by local ALCOs in segregated ALCO books.