Annual Financial Report - 31 of 54

RNS Number : 0467I

HSBC Holdings PLC

20 March 2015

 



Market risk

	Page		App1		Tables	Page
Market risk in 2014	176
Exposure to market risk	176		221
Overview of market risk in global businesses			221		Types of risk by global business	176
Market risk governance			222
Market risk measures			223
Monitoring and limiting market risk exposures	176		223
Sensitivity analysis	176		223
Value at risk	176		223
Stress testing	176		224		Market risk stress testing	176
Trading portfolios	176		225
Value at risk of the trading portfolios	176				Daily VaR (trading portfolios)	176
					Trading VaR	177
Back-testing	177		224		Back-testing of trading VaR against hypothetical profit and loss for the Group	177
Gap risk			225
De-peg risk			225
ABS/MBS exposures			225
Non-trading portfolios	178		225
Value at risk of the non-trading portfolios	178				Daily VaR (non-trading portfolios)	178
					Non-trading VaR	178
Credit spread risk for available-for-sale debt securities (including SICs)	178		226
Equity securities classified as available for sale	179		226		Fair value of equity securities	179
Market risk balance sheet linkages	179				Balances included and not included in trading VaR	179
					Market risk linkages to the accounting balance sheet	180
Structural foreign exchange exposures	181		226
Non-trading interest rate risk	181		226
Interest rate risk behaviouralisation	181		226
Balance Sheet Management			227
Third-party assets in Balance Sheet Management	181				Third-party assets in Balance Sheet Management	181
Sensitivity of net interest income	181		227		Sensitivity of projected net interest income	182
					Sensitivity of reported reserves to interest rate movements	183
Defined benefit pension schemes	183		228		HSBC's defined benefit pension schemes	183
Additional market risk measures applicable only to the parent company	183		228
Foreign exchange risk	183				HSBC Holdings - foreign exchange VaR	183
Sensitivity of net interest income	184				Sensitivity of HSBC Holdings net interest income to interest rate movements	184
Interest rate repricing gap table	185				Repricing gap analysis of HSBC Holdings	185
1. Appendix to Risk - risk policies and practices.

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.

There were no material changes to our policies and practices for the management of market risk in 2014.

Exposure to market risk

Exposure to market risk is separated into two portfolios:

·  Trading portfolios comprise positions arising from market-making and warehousing of customer-derived positions. The interest rate risk on fixed-rate securities issued by HSBC Holdings is not included in Group VaR. The management of this risk is described on page 222.

·  Non-trading portfolioscomprise 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 (see page 225).

Monitoring and limiting market risk exposures

Our objective is to manage and control market risk exposures while maintaining a market profile consistent with our risk appetite.

We use a range of tools to monitor and limit market risk exposures, including:

·  Sensitivity analysisincludes the sensitivity of net interest income and the sensitivity of structural foreign exchange, which are used to monitor the market risk positions within each risk type;

·  Value at risk ('VaR') is a technique that estimates the potential losses that could occur 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; and

·  In recognition of VaR's limitations we augment VaR with stress testing to evaluate the potential impact on portfolio values of more extreme, though plausible, events or movements in a set of financial variables. Examples of scenarios reflecting current market concerns are the slowdown in mainland China and the potential effects of a sovereign debt default, including its wider contagion effects.

A summary of our market risk management framework including current policies is provided in the Appendix to Risk on page 221.

Market risk in 2014

(Unaudited)

Global financial markets were characterised by low inflation and weak global growth, leading monetary authorities to maintain accommodative policies, using measures such as low interest rates and asset purchases.

With US data showing GDP growth, the US Federal Reserve's asset purchase programme came to an end. Despite this, US dollar bond yields fell further. Market focus switched to actions that the ECB can take to address the issues of low growth and deflation. A sustained period of deflation would have a severe detrimental impact on countries already in recession and with high debt to GDP ratios. 2014 can be characterised as a period of benign rates and equity markets in the G7 group of countries.

Against this backdrop, we maintained an overall defensive risk profile in our trading businesses. Defensive positions are characterised by low net open positions or the purchase of volatility protection via options trades. The lower trading VaR from defensive positioning was offset by an increase caused by lower diversification and regulatory changes to the calibrations used in calculating VaR. Non-trading VaR declined during the year as low interest rates, especially in US dollars, caused the duration of non-trading assets to decrease.

Trading portfolios

(Audited)

Value at risk of the trading portfolios

Trading VaR predominantly resides within Global Markets. This was higher at 31 December 2014 than at 31 December 2013 due to an increase in interest rate trading VaR, the removal of diversification effects within risk not in VaR ('RNIV') and lower portfolio diversification benefit across asset classes.  

The daily levels of total trading VaR over the last year are set out in the graph below.

Daily VaR (trading portfolios), 99% 1 day (US$m)

(Unaudited)

The Group trading VaR for the year is shown in the table below.

Trading VaR, 99% 1 day³⁴

(Audited)

		Foreign        exchange and		Interest				Credit		Portfolio       diversification
		commodity		rate		Equity		spread		incl RNIV35		Total36
		US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2014		9.8		45.4		7.3		12.5		(14.3)		60.7
Average		16.9		39.5		6.9		13.7		(17.8)		59.2
Maximum		34.2		50.6		15.6		20.9				77.8
At 31 December 2013		16.0		33.4		9.2		14.2		(20.7)		52.1
Average		15.2		33.4		5.1		16.5		(20.3)		49.9
Maximum		26.4		71.9		14.1		25.5				81.3

For footnotes, see page 202.

Back-testing

(Unaudited)

In 2014, the Group experienced one loss exception and two profit exceptions.

The loss exception was due primarily to losses from increased volatility in foreign exchange currencies and interest rates in some developed markets combined with flattening yield curves.

The profit exceptions were driven by thetightening of spreads, and exposures to emerging market foreign exchange and interest rates. There is no evidence of model errors or control failures.

The graph below shows the daily trading VaR against hypothetical profit and loss for the Group during 2014. It excludes exceptions that were exempted by the PRA for regulatory capital purposes.

Back-testing of trading VaR against hypothetical profit and loss for the Group (US$m)

(Unaudited)

Non-trading portfolios

(Audited)

Value at risk of the non-trading portfolios

Non-trading VaR of the Group includes contributions from all global businesses. There is no commodity risk in the non-trading portfolios. The decrease of non-trading VaR during 2014 was due primarily to the shortening of the duration in the non-trading book from lower interest rates, especially in US dollars. The credit spread risks component also added to a lower non-trading VaR as a result of the reduction in the overall position combined
with lower volatilities and credit spread baselines utilised in the VaR calculations. This movement included the reduction in credit spread risks relating to the Group's holdings of available-for-sale debt securities (excluding those held in insurance operations which are discussed further on page 194.

In the year, the decline in non-trading interest rate and credit spread VaR components was offset by a decrease in diversification benefit.

The daily levels of total non-trading VaR over the last year are set out in the graph below.

Daily VaR (non-trading portfolios), 99% 1 day (US$m)

(Unaudited)

The Group non-trading VaR for the year is shown in the table below.

Non-trading VaR, 99% 1 day

(Audited)

		Interest                            rate		Credit                      spread		Portfolio        diversification		Total
		US$m		US$m		US$m		US$m
At 31 December 2014		88.2		62.5		(28.5)		122.2
Average		103.3		73.3		(37.4)		139.2
Maximum		147.7		91.9				189.0
At 31 December 2013		150.6		80.4		(76.4)		154.6
Average		145.7		106.6		(82.1)		170.2
Maximum		221.7		135.7				252.3

The management of interest rate risk in the banking book is described further in 'Non-trading interest rate risk' below, including the role of Balance Sheet Management ('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 management of which is described in the relevant sections below. These sections together describe the scope of HSBC's management of market risks in non-trading books.

Credit spread risk for available-for-sale debt securities (including SICs)

The effect of movements in VaR credit spreads on our available-for-sale debt securities was US$81m (2013: US$113m) at 31 December 2014. This sensitivity includes the gross exposure for the securities investment conduits ('SICs') consolidated within our balance sheet based on credit spread VaR. This sensitivity excludes losses which would have been absorbed by the capital note holders.

The decrease in this sensitivity at 31 December 2014 compared with 31 December 2013 was due mainly to reducing the overall positions and lower volatilities and credit spread baselines observed during the year.

Equity securities classified as available for sale

Fair value of equity securities

(Audited)

		2014		2013
		US$bn		US$bn
Private equity holdings37		2.0		2.7
Investment to facilitate ongoing business38		1.2		1.2
Other strategic investments		7.5		5.2
At 31 December		10.7		9.1

For footnotes, see page 202.

The fair value of equity securities classified as available for sale can fluctuate considerably. The table above sets out the maximum possible loss on shareholders' equity from available-for-sale equity securities. The increase in other strategic investments was largely due to the increase in the market value of the Industrial Bank investment offsetting the decrease in private equity holdings from the disposal of various direct and private equity fund investments.

Market risk balance sheet linkages

(Unaudited)

The information below and on page 180 aims to facilitate an understanding of linkages between line items in the balance sheet and positions included in our market risk disclosures, in line with recommendations made by the Enhanced Disclosure Task Force.

Balances included and not included in trading VaR

(Unaudited)

		Balance sheet		Balances included in trading VaR		Balances not included in trading VaR		Primary market risk sensitivities
		US$m		US$m		US$m
At 31 December 2014
Assets
Cash and balances at central banks		129,957				129,957		B
Trading assets		304,193		276,419		27,774		A
Financial assets designated at fair value		29,037				29,037		A
Derivatives		345,008		333,880		11,128		A
Loans and advances to banks		112,149				112,149		B
Loans and advances to customers		974,660				974,660		B
Reverse repurchase agreements - non-trading		161,713				161,713		C
Financial investments		415,467				415,467		A
Liabilities
Deposits by banks		77,426				77,426		B
Customer accounts		1,350,642				1,350,642		B
Repurchase agreements - non-trading		107,432				107,432		C
Trading liabilities		190,572		170,576		19,996		A
Financial liabilities designated at fair value		76,153				76,153		A
Derivatives		340,669		334,199		6,470		A
Debt securities in issue		95,947				95,947		C

The table represents account lines where there is some exposure to market risk according to the following asset classes:

A   Foreign exchange, interest rate, equity and credit spread.

B   Foreign exchange and interest rate.

C   Foreign exchange, interest rate and credit spread.

The table above splits the assets and liabilities into two categories:

·   those that are included in the trading book and are measured by VaR; and

·   those that are not in the trading book and/or are not measured by VaR.

The breakdown of financial instruments included and not included in trading VaR provides a linkage with market risk to the extent that it is reflected in our risk framework. However, it is important to highlight that
the table does not reflect how we manage market risk, since we do not discriminate between assets and liabilities in our VaR model.

The assets and liabilities included in trading VaR give rise to a large proportion of the income included in net trading income. As set out on page 49, HSBC's net trading income in 2014 was US$6,760m (2013: US$8,690m). Adjustments to trading income such as valuation adjustments do not feed the trading VaR model.

Market risk linkages to the accounting balance sheet

Trading assets and liabilities The Group's trading assets and liabilities are in almost all cases originated by GB&M. The assets and liabilities are classified as held for trading if they have been acquired or incurred principally for the purpose of selling or repurchasing in the near term, or form part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent pattern of short-term profit-taking. These assets and liabilities are treated as traded risk for the purposes of market risk management, other than a limited number of exceptions, primarily in Global Banking where the short-term acquisition and disposal of the assets are linked to other non-trading related activities such as loan origination. Financial assets designated at fair value Financial assets designated at fair value within HSBC are predominantly held within the Insurance entities. The majority of these assets are linked to policyholder liabilities for either unit-linked or insurance and investment contracts with DPF. The risks of these assets largely offset the market risk on the liabilities under the policyholder contracts, and are risk managed on a non-trading basis. Financial liabilities designated at fair value Financial liabilities designated at fair value within HSBC are primarily fixed-rate securities issued by HSBC entities for funding purposes. An accounting mismatch would arise if the debt securities were accounted for at amortised cost because the derivatives which economically hedge market risks on the securities would be accounted for at fair value with changes recognised in the income statement. The market risks of these liabilities are treated as non-traded risk, the principal risks being interest rate and/or foreign exchange risks. We also incur liabilities to customers under investment contracts, where the liabilities on unit-linked contracts are based on the fair value of assets within the unit-linked funds. The exposures on these funds are treated as non-traded risk and the principal risks are those of the underlying assets in the funds. Derivative assets and liabilities We undertake derivative activity for three primary purposes; to create risk management solutions for clients, to manage the portfolio risks arising from client business and to manage and hedge our own risks. Most of our derivative exposures arise from sales and trading activities within GB&M and are treated as traded risk for market risk management purposes. Within derivative assets and liabilities there are portfolios of derivatives which are not risk managed on a trading intent basis and are treated as non-traded risk for VaR measurement

purposes. These arise when the derivative was entered into in order to manage risk arising from non-traded exposures. They include non-qualifying hedging derivatives and derivatives qualifying for fair value and cash flow hedge accounting. The use of non-qualifying hedges whose primary risks relate to interest rate and foreign exchange exposure is described on page 181. Details of derivatives in fair value and cash flow hedge accounting relationships are given in Note 16 on the Financial Statements. Our primary risks in respect of these instruments relate to interest rate and foreign exchange risks. Loans and advances to customers The primary risk on assets within loans and advances to customers is the credit risk of the borrower. The risk of these assets is treated as non-trading risk for market risk management purposes. Financial investments Financial investments include assets held on an available-for-sale and held-to-maturity basis. An analysis of the Group's holdings of these securities by accounting classification and issuer type is provided in Note 18 on the Financial Statements and by business activity on page 60. The majority of these securities are mainly held within Balance Sheet Management ('BSM') in GB&M. The positions which are originated in order to manage structural interest rate and liquidity risk are treated as non-trading risk for the purposes of market risk management. Available-for-sale security holdings within insurance entities are treated as non-trading risk and are largely held to back non-linked insurance policyholder liabilities. The other main holdings of available-for-sale assets are the ABSs within GB&M's legacy credit business, which are treated as non-trading risk for market risk management purposes, the principal risk being the credit risk of the obligor. The Group's held-to-maturity securities are principally held within the Insurance business. Risks of held-to-maturity assets are treated as non-trading for risk management purposes. Repurchase (repo) and reverse repurchase (reverse repo) agreements non-trading Reverse repo agreements, classified as assets, are a form of collateralised lending. HSBC lends cash for the term of the reverse repo in exchange for receiving collateral (normally in the form of bonds). Repo agreements, classified as liabilities, are the opposite of reverse repo, allowing HSBC to obtain funding by providing collateral to the lender. Both transaction types are treated as non-trading risk for market risk management and the primary risk is counterparty credit risk.

For information on the accounting policies applied to financial instruments at fair value, see Note 13 on the Financial Statements.

Structural foreign exchange exposures

(Unaudited)

For our policies and procedures for managing structural foreign exchange exposures, see page 226 of the Appendix to Risk.

For details of structural foreign exchange exposures see Note 33 on the Financial Statements.

Non-trading interest rate risk

(Unaudited)

For our policies regarding the funds transfer pricing process for non-trading interest rate risk and liquidity and funding risk, see pages 226 and 219, respectively, of the Appendix to Risk.

Asset, Liability and Capital Management ('ALCM') is responsible for measuring and controlling non-trading interest rate risk under the supervision of the Risk Management Meeting. Its primary responsibilities are:

·   to define the rules governing the transfer of non-trading interest rate risk from the global businesses to BSM;

·   to define the rules governing the interest rate risk behaviouralisation applied to non-trading assets/liabilities (see below);

·   to ensure that all market interest rate risk that can be neutralised is transferred from the global businesses to BSM; and

·   to define the rules and metrics for monitoring the residual interest rate risk in the global businesses, including any market risk that cannot be neutralised.

The different types of non-trading interest rate risk and the controls which we use to quantify and limit exposure to these risks can be categorised as follows:

·   risk which is transferred to BSM and managed by BSM within a defined market risk mandate, predominantly through the use of fixed rate liquid assets (government bonds) held in available-for-sale portfolios and/or interest rate derivatives which are part of fair value hedging or cash flow hedging relationships. This non-trading interest rate risk is reflected in non-trading VaR, as well as in our net interest income (see below) or economic value of equity ('EVE') sensitivity;

·   risk which remains outside BSM because it cannot be hedged or which arises due to our behaviouralised transfer pricing assumptions. This risk is not reflected in non-trading VaR, but is captured by our net interest income or EVE sensitivity and corresponding limits are part of our global and regional risk appetite statements for non-trading interest rate risk. A typical example would be margin compression created by unusually low rates in key currencies;

·   basis risk which is transferred to BSM when it can be hedged. Any residual basis risk remaining in the global businesses is reported to ALCO. This risk is not reflected in non-trading VaR, but is captured by our net interest income or EVE sensitivity. A typical example would be a managed rate savings product transfer-priced using a Libor-based interest rate curve; and

·   model risks which cannot be captured by non-trading VaR, net interest income or EVE sensitivity, but are controlled by our stress testing framework. A typical example would be prepayment risk on residential mortgages or pipeline risk.

Interest rate risk behaviouralisation

For our policies regarding interest risk behaviouralisation, see page 226 of the Appendix to Risk.

Third-party assets in Balance Sheet Management

(Unaudited)

For our BSM governance framework, see page 227 of the Appendix to Risk.

Third-party assets in BSM decreased by 9% during 2014. Deposits with central banks reduced by US$31bn, predominantly in Europe due to a combination of reduced repo activity and a decrease in balances with the ECB as deposit rates became negative. Loans and advances to banks decreased by US$6bn, mainly in Hong Kong and the rest of Asia. Financial investments reduced by US$8bn due to foreign exchange movements, net sales and maturities in Hong Kong and the Americas, partially offset by the increased deployment of funds into securities in Asia.

Third-party assets in Balance Sheet Management

(Unaudited)

		2014		2013
		US$m		US$m
Cash and balances at central banks		103,008		134,086
Trading assets		4,610		5,547
Financial assets designated at fair value		-		72
Loans and advances1:
- to banks		53,842		59,355
- to customers		1,931		2,146
Reverse repurchase agreements		59,172		58,968
Financial investments		306,763		314,427
Other		2,470		3,700
At 31 December		531,796		578,301

For footnote, see page 202.

Sensitivity of net interest income

(Unaudited)

The table below sets out the effect on our future accounting net interest income (excluding insurance) of an incremental 25 basis points parallel rise or fall in all yield curves worldwide at the beginning of each quarter during the 12 months from 1 January 2015. The sensitivities shown represent the change in the base case projected net interest income that would be expected under the two rate scenarios assuming that all other non-interest rate risk variables remain constant, and there are no management actions. In deriving our base case net interest income projections the re-pricing rate of assets and liabilities used is derived from current yield curves. The interest rate sensitivities are indicative and based on simplified scenarios. The limitations of this analysis are discussed in the Appendix to Risk on page 227.

Assuming no management response, a sequence of such rises ('up-shock') would increase planned net interest income for 2015 by US$885m (2014: US$938m), while a sequence of such falls ('down-shock') would decrease planned net interest income by US$2,089m (2014: US$1,734m).

The net interest income ('NII') sensitivity of the Group can be split into three key components; the structural sensitivity arising from the four global businesses excluding BSM and Markets, the sensitivity of the funding of the trading book (Markets) and the sensitivity of BSM.

The structural sensitivity is positive in a rising rate environment and negative in a falling rate environment. The sensitivity of the funding of the trading book is negative in a rising rate environment and positive in a falling rate environment, and in terms of the impact on profit the change in net interest income would be expected to be offset by a similar change in net trading income. The sensitivity of BSM will depend on its position. Typically, assuming no management response, the sensitivity of BSM is negative in a rising rate environment and positive in a falling rate environment.

The NII sensitivity figures below also incorporate the effect of any interest rate behaviouralisation applied and the effect of any assumed repricing across products under the specific interest rate scenario. They do not incorporate the effect of any management decision to change the HSBC balance sheet composition.

See page 227 in the Risk Appendix for more information about interest rate behaviouralisation and the role of BSM.

The NII sensitivity in BSM arises from a combination of the techniques that BSM use to mitigate the transferred interest rate risk and the methods they use to optimise net revenues in line with their defined risk mandate. The figures in the table below do not incorporate the effect of any management decisions within BSM, but in reality it is likely that there would be some short-term adjustment in BSM positioning to offset the NII effects of the specific interest rate scenario where necessary.

The NII sensitivity arising from the funding of the trading book is comprised of the expense of funding trading assets, while the revenue from these trading assets is reported in net trading income. This leads to an asymmetry in the NII sensitivity figures which is cancelled out in our global business results, where we include both net interest income and net trading income. It is likely, therefore, that the overall effect on profit before tax of the funding of the trading book will be much less pronounced than shown in the figures below.

The up-shock sensitivity remained broadly unchanged in 2014. The down-shock sensitivity increased predominantly due to a change in BSM's interest rate risk profile in US dollars.

Sensitivity of projected net interest income³⁹

(Unaudited)

		US dollar bloc US$m		Rest of Americas bloc US$m		Hong Kong dollar bloc US$m		Rest of Asia bloc US$m		Sterling bloc US$m		Euro bloc US$m		Total US$m
Change in 2015 projected net interest income arising from a shift in yield curves of:
+25 basis points at the beginning of each quarter		209		(9)		245		265		321		(146)		885
-25 basis points at the beginning of each quarter		(521)		(1)		(494)		(259)		(783)		(31)		(2,089)
Change in 2014 projected net interest income arising from a shift in yield curves of:
+25 basis points at the beginning of each quarter		(107)		12		327		236		598		(128)		938
-25 basis points at the beginning of each quarter		(291)		(23)		(412)		(233)		(761)		(14)		(1,734)

For footnote, see page 202.

We monitor the sensitivity of reported reserves to interest rate movements on a monthly basis by assessing the expected reduction in valuation of available-for-sale portfolios and cash flow hedges due to parallel movements of plus or minus 100bps in all yield curves. These particular exposures form only a part of our
overall interest rate exposures. The accounting treatment of our remaining interest rate exposures, while economically largely offsetting the exposures shown in the below table, does not require revaluation movements to go to reserves.

The table below describes the sensitivity of our reported reserves to the stipulated movements in yield curves and the maximum and minimum month‑end figures during the year. The sensitivities are indicative and based on simplified scenarios.  The change in sensitivity of reported reserves is predominantly due to a reduction in the available-for-sale securities portfolio.

Sensitivity of reported reserves to interest rate movements

(Unaudited)

		US$m		Maximum impact US$m		Minimum impact US$m
At 31 December 2014
+ 100 basis point parallel move in all yield curves		(3,696)		(5,212)		(3,696)
As a percentage of total shareholders' equity		(1.9%)		(2.7%)		(1.9%)
- 100 basis point parallel move in all yield curves		3,250		4,915		3,250
As a percentage of total shareholders' equity		1.7%		2.6%		1.7%
At 31 December 2013
+ 100 basis point parallel move in all yield curves		(5,762)		(5,992)		(5,507)
As a percentage of total shareholders' equity		(3.2%)		(3.3%)		(3.0%)
- 100 basis point parallel move in all yield curves		5,634		5,786		4,910
As a percentage of total shareholders' equity		3.1%		3.2%		2.7%

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.

HSBC's defined benefit pension schemes

(Audited)

		2014		2013
		US$bn		US$bn
Liabilities (present value)		42.1		40.5
		%		%
Assets:
Equities		18		18
Debt securities		68		70
Other (including property)		14		12
At 31 December		100		100

For details of our defined benefit schemes, see Note 6 on the Financial Statements, and for pension risk management see page 200.

Additional market risk measures applicable only to the parent company

(Audited)

The principal tools used in the management of market risk are VaR for foreign exchange rate risk and the projected sensitivity of HSBC Holdings' net interest income to future changes in yield curves and interest rate gap repricing tables for interest rate risk.

Foreign exchange risk

Total foreign exchange VaR arising within HSBC Holdings in 2014 was as follows:

HSBC Holdings - foreign exchange VaR

(Audited)

		2014                US$m		2013                 US$m
At 31 December		29.3		54.1
Average		42.1		51.1
Minimum		29.3		46.7
Maximum		50.0		64.1

The foreign exchange risk largely arises from loans to subsidiaries of a capital nature that are not denominated in the functional currency of either the provider or the recipient and which are accounted for as financial assets. Changes in the carrying amount of these loans due to foreign exchange rate differences are taken directly to HSBC Holdings' income statement. These loans, and most of the associated foreign exchange exposures, are eliminated on consolidation.

 

Sensitivity of net interest income

(Audited)

HSBC Holdings monitors net interest income sensitivity over a five year time horizon reflecting the longer-term perspective on interest rate risk management appropriate to a financial services holding company. These sensitivities assume that any issuance where HSBC Holdings has an option to reimburse at a future call date is called at this date. The table below sets out the effect on HSBC Holdings' future net interest income over a five
year time horizon of incremental 25 basis point parallel falls or rises in all yield curves worldwide at the beginning of each quarter during the 12 months from 1 January 2015.

Assuming no management actions, a sequence of such rises would increase planned net interest income for the next five years by US$600m (2013: increase of US$602m), while a sequence of such falls would decrease planned net interest income by US$539m (2013: decrease of US$464m).

Sensitivity of HSBC Holdings' net interest income to interest rate movements³⁹

(Audited)

		US dollar                            bloc		Sterling                            bloc		Euro                            bloc		Total
		US$m		US$m		US$m		US$m
Change in projected net interest income as at 31 December arising from a shift in yield curves
2014
of + 25 basis points at the beginning of each quarter
0-1 year		78		9		2		89
2-3 years		281		17		34		332
4-5 years		138		17		24		179
of - 25 basis points at the beginning of each quarter
0-1 year		(58)		(9)		(1)		(68)
2-3 years		(276)		(16)		(12)		(304)
4-5 years		(138)		(17)		(12)		(167)
2013
of + 25 basis points at the beginning of each quarter
0-1 year		104		(14)		2		92
2-3 years		382		(93)		38		327
4-5 years		245		(101)		38		182
of - 25 basis points at the beginning of each quarter
0-1 year		(53)		13		(2)		(42)
2-3 years		(300)		91		(33)		(242)
4-5 years		(243)		101		(38)		(180)

For footnote, see page 202.

The interest rate sensitivities tabulated above are indicative and based on simplified scenarios. The figures represent hypothetical movements in net interest income based on our projected yield curve scenarios, HSBC Holdings' current interest rate risk profile and assumed changes to that profile during the next five years. Changes to assumptions concerning the risk profile over the next five years can have a significant impact on the net interest income sensitivity for that period. However, the figures do not take into account
the effect of actions that could be taken to mitigate this interest rate risk.

Interest rate repricing gap table

The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included within the Group VaR but is managed on a repricing gap basis. The interest rate repricing gap table below analyses the full-term structure of interest rate mismatches within HSBC Holdings' balance sheet.

Repricing gap analysis of HSBC Holdings

(Audited)

		Total		Up to                1 year		From over 1         to 5 years		From over 5      to 10 years		More than           10 years	Non-interest               bearing
		US$m		US$m		US$m		US$m		US$m		US$m
Cash at bank and in hand:
- balances with HSBC undertakings		249		-		-		-		-		249
Derivatives		2,771		-		-		-		-		2,771
Loans and advances to HSBC undertakings		43,910		41,603		290		1,093		-		924
Financial investments in HSBC undertakings		4,073		3,010		-		731		-		332
Investments in subsidiaries		96,264		-		-		-		-		96,264
Other assets		597		-		-		-		-		597
		147,8641
Total assets		147,864		44,613		290		1,824		-		101,137
				(1						-
Amounts owed to HSBC undertakings		(2,892)		(1,877)		-		-		-		(1,015)
Financial liabilities designated at fair values		(18,679)		(850)		(5,472)		(5,400)		(4,263)		(2,694)
Derivatives		(1,169)		-		-		-		-		(1,169)
Debt securities in issue		(1,009)		-		-		(1,013)		-		4
Other liabilities		(1,415)		-		-		-		-		(1,415)
Subordinated liabilities		(17,255)		(779)		(3,766)		(2,000)		(10,195)		(515)
Total equity		(105,445)		-		-		-		-		(105,445)
		(
Total liabilities and equity		(147,864)		(3,506)		(9,238)		(8,413)		(14,458)		(112,249)
Off-balance sheet items attracting interest rate sensitivity		-		(21,525)		7,295		7,400		5,763		1,067
		-
Net interest rate risk gap at 31 December 2014		-		19,582		(1,653)		811		(8,695)		(10,045)
Cumulative interest rate gap		-		19,582		17,929		18,740		10,045		-

Cash at bank and in hand:
- balances with HSBC undertakings		407		357		-		-		-		50
Derivatives		2,789		-		-		-		-		2,789
Loans and advances to HSBC undertakings		53,344		49,979		290		1,239		645		1,191
Financial investments in HSBC undertakings		1,210		300		-		731		-		179
Investments in subsidiaries		92,695		-		-		-		-		92,695
Other assets		391		-		-		-		-		391
Total assets		150,836		50,636		290		1,970		645		97,295
Amounts owed to HSBC undertakings		(11,685)		(10,865)		-		-		-		(820)
Financial liabilities designated at fair values		(21,027)		(1,928)		(4,655)		(7,810)		(4,325)		(2,309)
Derivatives		(704)		-		-		-		-		(704)
Debt securities in issue		(2,791)		(1,722)		-		-		(1,069)		-
Other liabilities		(1,375)		-		-		-		-		(1,375)
Subordinated liabilities		(14,167)		-		(3,030)		(2,066)		(8,912)		(159)
Total equity		(99,087)		-		-		-		-		(99,087)
Total liabilities and equity		(150,836)		(14,515)		(7,685)		(9,876)		(14,306)		(104,454)
Off-balance sheet items attracting interest rate sensitivity		-		(18,620)		4,382		9,876		4,421		(59)
Net interest rate risk gap at 31 December 2013		-		17,501		(3,013)		1,970		(9,240)		(7,218)
Cumulative interest rate gap		-		17,501		14,488		16,458		7,218		-

Operational risk

(Unaudited)

Operational risk	186		228
Operational risk management framework	186				Three lines of defence	186
					Operational risk management framework	187
Operational risk in 2014	187
Frequency and amount of operational risk losses	188				Frequency of operational risk incidents by risk category	189
					Distribution of operational risk losses in US dollars by risk category	228
Compliance risk	189		229
Legal risk			229
Global security and fraud risk			230
Systems risk			231
Vendor risk management			231
1   Appendix to Risk - risk policies and practices.

Operational risk is relevant to every aspect of our business and covers a wide spectrum of issues, in particular legal, compliance, security and fraud. Losses arising from breaches of regulation and law, unauthorised activities, error, omission, inefficiency, fraud, systems failure or external events all fall within the definition of operational risk.

Responsibility for minimising operational risk lies with HSBC's management and staff. Each regional, global business, country, business unit and functional head is required to maintain oversight over the operational risks and internal controls of the business and operational activities for which they are responsible.

A summary of our current policies and practices regarding operational risk is provided in the Appendix to Risk on page 228.

Operational risk management framework

The Group Operational Risk function and the operational risk management framework ('ORMF') directs business management in discharging their responsibilities.

The ORMF defines minimum standards and processes, and the governance structure for operational risk and internal control across the Group. To implement the ORMF a 'three lines of defence' model is used for the management of risk, as described below:

Three lines of defence

A diagrammatic representation of the ORMF is presented on page 187.

Activity to embed the use of our operational risk management framework continued in 2014. At the same time, we are streamlining operational risk management processes and harmonising framework components and risk management processes. This is expected to lead to a stronger operational risk management culture and more forward-looking risk insights to enable businesses to determine whether material risks are being managed within the Group's risk appetite and whether further action is required. In addition, the Security and Fraud Risk and Financial Crime Compliance functions have built a Financial Intelligence Unit ('FIU') which provides intelligence on the potential risks of financial crime posed by customers and business prospects to enable better risk management decision-making. The FIU provides context and expertise to identify, assess and understand financial crime risks holistically in clients, sectors and markets.

Articulating our risk appetite for material operational risks helps the organisation understand the level of risk HSBC is willing to accept. The Group operational risk appetite statement is approved annually by the GRC. The Group risk appetite statement, which includes operational risk appetite metrics, was approved by the HSBC Holdings Board. Monitoring operational risk exposure against risk appetite on a regular basis and implementing our risk acceptance process drives risk awareness in a forward-looking manner. It assists management in determining whether further action is required.

Operational risk and control assessments ('RCAs') are performed by individual business units and functions. The risk and control assessment process is designed to provide business areas and functions with a forward looking view of operational risks and an assessment of the effectiveness of controls, and a tracking mechanism for action plans so that they can proactively manage operational risks within acceptable levels. Risk and control assessments are reviewed and updated at least annually.

Operational risk management framework

·   RCAs are used to inform the evaluation of the effectiveness of controls over top risks.

·   Key Indicators are used to help monitor the risks and controls.

·   Scenarios provide management with a quantified view of our top and emerging operational risks.

·   Internal incidents are used to forecast typical losses.

·   External sources are used to inform the assessment of extreme scenarios.

·  

Appropriate means of mitigation and controls are considered. These include:

·   making specific changes to strengthen the internal control environment;

·   investigating whether cost-effective insurance cover is available to mitigate the risk; and

·   other means of protecting us from loss.

In addition, an enhanced scenario analysis process has been implemented across material legal entities to improve the quantification and management of material risks.

Operational risk in 2014

During 2014, our operational risk profile continued to be dominated by compliance and legal risks as referred to under 'Top and emerging risks' on page 118. Losses were realised relating to events that occurred in previous years. These events included the possible historical mis-selling of payment protection insurance ('PPI') products in the UK (see Note 29 on the Financial Statements). A number of mitigating actions continue to be taken to prevent future mis-selling incidents.

The incidence of regulatory and other proceedings against financial service firms is increasing. Proposed changes relating to capital and liquidity requirements, remuneration and/or taxes could increase our cost of doing business, reducing future profitability. We remain subject to a number of regulatory proceedings including investigations and reviews by various national regulatory, competition and enforcement authorities relating to certain past submissions made by panel banks and the process for making submissions in connection with the
setting of Libor and other interbank offered and benchmark interest rates. There are also investigations into foreign exchange, precious metals and credit default swap-related activities in progress. In response, we have undertaken a number of initiatives, including the restructuring of our Compliance sub-functions, enhancing our governance and oversight, measures to implement Global Standards as described on page 26 and other measures put in place designed to ensure we have the appropriate people, processes and procedures to manage emerging risks and new products and business.

For further details see 'Compliance risk' on page 189 and for details of the investigations and legal proceedings see Note 40 on the Financial Statements.

In November 2014, the UK FCA and the US Commodity Futures Trading Commission ('CFTC') each announced having concluded regulatory settlements with a number of banks, including HSBC Bank plc, in connection with their respective investigations of trading and other conduct involving foreign exchange benchmark rates. Under the settlement terms, HSBC Bank plc agreed to pay a financial penalty to the FCA and a civil monetary penalty to the CFTC and to undertake various remedial actions. For further information, see Note 40 on the Financial Statements.

We have undertaken a review of our compliance with the fixed-sum unsecured loan agreement requirements of the UK Consumer Credit Act ('CCA'). A liability has been recognised within 'Accruals, deferred income and other liabilities' for the repayment of interest to customers where annual statements did not remind them of their right to partially prepay the loan, notwithstanding that the customer loan documentation did include this right.

There is uncertainty as to whether other technical requirements of the CCA have been met, for which we have assessed an additional contingent liability. For further details see Note 40 on the Financial Statements.

We have settled claims by the US Federal Housing Finance Agency in relation to the purchase of mortgage backed securities by the Federal National Mortgage Associations ('Fannie Mae') and the Federal Home Loan Mortgage Association ('Freddie Mac') between 2005 and 2007. For further information, see Note 40 on the Financial Statements.

Other operational risks included:

·   fraud risks: the threat of fraud perpetrated by or against our customers, especially in retail and commercial banking, may grow during adverse economic conditions. We increased monitoring, analysed root causes and reviewed internal controls to enhance our defences against external attacks and reduce the level of loss in these areas. In addition, Group Security and Fraud Risk worked closely with the global businesses to continually assess these threats as they evolved and adapt our controls to mitigate these risks;

·   level of change creating operational complexity: the Global Risk function is engaged with business management in business transformation initiatives to ensure robust internal controls are maintained, including through participation in all relevant management committees. The Global Transactions Team has developed an enhanced risk management framework to be applied to the management of disposal risks;

·   information security: the security of our information and technology infrastructure is crucial for maintaining our banking services and protecting our customers and the HSBC brand. A failure of the control framework which protects this could have implications for the wider financial sector and result in direct financial loss and/or the loss of customer data and other sensitive information which could undermine both our reputation and our ability to retain the trust of our customers. Programmes of work have been ongoing to strengthen internal security controls to prevent unauthorised access to our systems which may affect live services or facilitate data loss or fraud.In common with other banks and multinational organisations, we continue to be a target of increasingly sophisticated cyber-attacks such as 'distributed denial of service' attacks which can affect the availability of customer-facing websites. In addition, reliance on standard internet technologies, protocols and services means we are subject to wide-scale remediation when flaws are reported in these technologies. Lessons learnt from attacks experienced within the industry and information sharing with other financial institutions, government agencies and external intelligence
providers allows us to develop a better understanding of our own susceptibilities and to develop scenarios to test against. They will continue to be a focus of ongoing initiatives to strengthen the control environment. Significant investment has already been made in enhancing controls around data access, the heightened monitoring of potential cyber-attacks and continued training to raise staff awareness. This is an area that will require continual investment in our operational processes and contingency plans;

·   vendor risk management: we continue to focus on the management of vendor risks including making good progress with the implementation of the supplier performance management programme with our most important suppliers. Additional focus is put on the screening of suppliers to enable HSBC to identify if any suppliers are on a sanctions list and to exit such relationships. Vendor risk management is a core element of third party risk management; and

·   compliance with regulatory agreements and orders: Failure to implement our obligations under the DPAs could have a material adverse effect on our results and operations. Legal proceedings are discussed in Note 40 on the Financial Statements and further details regarding compliance risk are set out below.

Other operational risks are also monitored and managed through the use of the ORMF.

Further information on the nature of these risks is provided in 'Top and emerging risks' on page 118.

Frequency and amount of operational risk losses

The profile of operational risk incidents and associated losses is summarised below, showing the distribution of operational risk incidents in terms of their frequency of occurrence and total loss amount in US dollars.

Operational losses rose in 2014, driven by UK customer redress programme charges and settlements relating to legal and regulatory matters.

As in 2013, the operational risk incident profile in 2014 comprised both high frequency, low impact events and high impact events that occurred much less frequently. For example, losses due to external fraud incidents such as credit card fraud occurred more often than other types of event, but the amounts involved were often small in value. By contrast, operational risk incidents in the compliance category were relatively low frequency events, but the total cost was significant.

The number of fraud cases was broadly unchanged during 2014 due to the continued strong control environment.

Losses due to significant historical events, including the possible mis-selling of PPI products in the UK and the incidence of regulatory matters described in Note 40 on the Financial Statements remained substantial in 2014.

Frequency of operational risk incidents by risk category (individual loss >US$10k)

Distribution of operational risk losses in US dollars by risk category

Compliance risk

(Unaudited)

Compliance risk is the risk that we fail to observe the letter and spirit of all relevant laws, codes, rules, regulations and standards of good market practice, and incur fines and penalties and suffer damage to our business as a consequence.

In 2014, we completed the restructuring of our Compliance sub-function within Global Risk into two new sub-functions: Financial Crime Compliance and Regulatory Compliance, appropriately supported by shared Compliance Chief Operating Officer, Assurance and Reputational Risk Management teams. We continue to ensure that the Compliance sub-functions, through
their operation and the execution of the Group strategy, including measures to implement Global Standards, are well positioned to meet increased levels of regulation and scrutiny from regulators and law enforcement agencies. In addition, the measures we have put in place are designed to ensure we have the appropriate people, processes and procedures to manage emerging risks and new products and business.

Enhanced global AML and sanctions policies, incorporating risk appetite, were approved by the Board in January 2014. The policies adopt and seek to enforce the highest or most effective standards globally, including a globally consistent approach to knowing our customers.

The policies are being implemented in phases through the development and application of procedures required to embed them in our day to day business operations globally. The overriding policy objective is for every employee to engage in only 'the right kind of business, conducted in the right way'.

HSBC has fulfilled all of the requirements imposed by the DANY DPA, which expired by its terms at the end of the two-year period of that agreement in December 2014. Breach of the US DPA at any time during its term may allow the DoJ to prosecute HSBC Holdings or HSBC Bank USA in relation to the matters which are the subject of the US DPA. For further information, see 'Regulatory commitments and consent orders' on page 120.

In May 2014, the Board approved a globally consistent approach to the management of regulatory conduct designed to ensure we deliver fair outcomes for our customers and conduct orderly and transparent operations in financial markets. Implementation of the global conduct approach is managed through the global lines of business and functions and covers all our business and operational activities. Examples of these activities are disclosed in 'Conduct of business' on page 121.

It is clear that the level of inherent compliance risk that we face will continue to remain high for the foreseeable future. However, we consider that good progress is being made and will continue to be made in ensuring that we are well placed to effectively manage those risks.

 

END

 

 

ACSURVARVWAOUAR