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Fair values of financial instruments not carried at fair value
 12 Months Ended
Dec. 31, 2018
Fair Value Measurement [Abstract]  
Fair values of financial instruments not carried at fair value
12
Fair values of financial instruments carried at fair value
Control framework
Fair values are subject to a control framework designed to ensure that they are either determined or validated by a function independent of the risk taker.
Where fair values are determined by reference to externally quoted prices or observable pricing inputs to models, independent price determination or validation is used. For inactive markets, HSBC sources alternative market information, with greater weight given to information that is considered to be more relevant and reliable. Examples of the factors considered are price observability, instrument comparability, consistency of data sources, underlying data accuracy and timing of prices.
For fair values determined using valuation models, the control framework includes development or validation by independent support functions of the model logic, inputs, model outputs and adjustments. Valuation models are subject to a process of due diligence before becoming operational and are calibrated against external market data on an ongoing basis.
Changes in fair value are generally subject to a profit and loss analysis process and are disaggregated into high-level categories including portfolio changes, market movements and other fair value adjustments.
The majority of financial instruments measured at fair value are in GB&M. GB&M’s fair value governance structure comprises its Finance function, Valuation Committees and a Valuation Committee Review Group. Finance is responsible for establishing procedures governing valuation and ensuring fair values are in compliance with accounting standards. The fair values are reviewed by the Valuation Committees, which consist of independent support functions. These committees are overseen by the Valuation Committee Review Group, which considers all material subjective valuations.
Financial liabilities measured at fair value
In certain circumstances, HSBC records its own debt in issue at fair value, based on quoted prices in an active market for the specific instrument. When quoted market prices are unavailable, the own debt in issue is valued using valuation techniques, the inputs for which are either based on quoted prices in an inactive market for the instrument or are estimated by comparison with quoted prices in an active market for similar instruments. In both cases, the fair value includes the effect of applying the credit spread that is appropriate to HSBC’s liabilities. The change in fair value of issued debt securities attributable to the Group’s own credit spread is computed as follows: for each security at each reporting date, an externally verifiable price is obtained or a price is derived using credit spreads for similar securities for the same issuer. Then, using discounted cash flow, each security is valued using a Libor-based discount curve. The difference in the valuations is attributable to the Group’s own credit spread. This methodology is applied consistently across all securities.
Structured notes issued and certain other hybrid instruments are included within trading liabilities and are measured at fair value. The credit spread applied to these instruments is derived from the spreads at which HSBC issues structured notes.
Gains and losses arising from changes in the credit spread of liabilities issued by HSBC recorded in other comprehensive income, reverse over the contractual life of the debt, provided that the debt is not repaid at a premium or a discount.
Fair value hierarchy
Fair values of financial assets and liabilities are determined according to the following hierarchy:
•
Level 1 – valuation technique using quoted market price: financial instruments with quoted prices for identical instruments in active markets that HSBC can access at the measurement date.
•
Level 2 – valuation technique using observable inputs: financial instruments with quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in inactive markets and financial instruments valued using models where all significant inputs are observable.
•
Level 3 – valuation technique with significant unobservable inputs: financial instruments valued using valuation techniques where one or more significant inputs are unobservable.
Financial instruments carried at fair value and bases of valuation

2018
2017

Level 1

Level 2

Level 3

Total

Level 1

Level 2

Level 3

Total


$m

$m

$m

$m

$m

$m

$m

$m

Recurring fair value measurements
at 31 Dec
















Assets
















Trading assets
178,100

53,271

6,759

238,130

181,168

101,775

5,052

287,995

Financial assets designated and otherwise mandatorily measured at fair value through profit or loss
23,125

12,494

5,492

41,111

N/A

N/A

N/A

N/A

Derivatives
1,868

203,534

2,423

207,825

1,017

216,357

2,444

219,818

Financial assets designated at fair value

N/A

N/A

N/A

N/A

24,622

3,382

1,460

29,464

Financial investments
263,885

78,882

2,000

344,767

227,943

104,692

3,432

336,067

Liabilities
















Trading liabilities
66,300

18,073

58

84,431

62,710

117,451

4,200

184,361

Financial liabilities designated at fair value
6,815

136,362

5,328

148,505

4,164

90,265

—

94,429

Derivatives
2,845

201,234

1,756

205,835

1,635

213,242

1,944

216,821

The increase in Level 3 assets in 2018 was primarily due to new private equity investments and new derivative transactions with unobservable inputs.
Transfers between Level 1 and Level 2 fair values
 
Assets
Liabilities
 
Financial investments

Trading assets

Designated
and otherwise mandatorily measured at fair value

Derivatives

Trading liabilities

Designated at fair value

Derivatives

 
$m

$m

$m

$m

$m

$m

$m

At 31 Dec 2018
 
 
 
 
 
 
 
Transfers from Level 1 to Level 2
367

435

2

1

79

—

—

Transfers from Level 2 to Level 1
17,861

4,959

85

128

1,821

—

138

At 31 Dec 2017
 
 
 
 
 
 
 
Transfers from Level 1 to Level 2
2,231

1,507

—

—

35

—

—

Transfers from Level 2 to Level 1
11,173

1,384

—

—

683

—

—

Transfers between levels of the fair value hierarchy are deemed to occur at the end of each quarterly reporting period. Transfers into and out of levels of the fair value hierarchy are primarily attributable to observability of valuation inputs and price transparency.
Fair value adjustments
Fair value adjustments are adopted when HSBC determines there are additional factors considered by market participants that are not incorporated within the valuation model. Movements in the level of fair value adjustments do not necessarily result in the recognition of profits or losses within the income statement, such as when models are enhanced and therefore fair value adjustments may no longer be required.
Global Banking & Markets (‘GB&M’) and Corporate Centre fair value adjustments
 
2018
2017
 
GB&M

Corporate Centre

GB&M

Corporate Centre

 
$m

$m

$m

$m

Type of adjustment
 
 
 
 
Risk-related
1,042

138

1,078

79

– bid-offer
430

76

413

5

– uncertainty
99

6

91

8

– credit valuation adjustment (‘CVA’)
442

52

420

59

– debit valuation adjustment (‘DVA’)
(198
)
—

(82
)
—

– funding fair value adjustment (‘FFVA’)
256

4

233

7

– other
13

—

3

—

Model-related
79

3

92

13

– model limitation
79

3

92

6

– other
—

—

—

7

Inception profit (Day 1 P&L reserves) (Note 15)
85

—

106

—

At 31 Dec
1,206

141

1,276

92

Bid-offer
IFRS 13 ‘Fair value measurement’ requires use of the price within the bid-offer spread that is most representative of fair value. Valuation models will typically generate mid-market values. The bid-offer adjustment reflects the extent to which bid-offer costs would be incurred if substantially all residual net portfolio market risks were closed using available hedging instruments or by disposing of or unwinding the position.
Uncertainty
Certain model inputs may be less readily determinable from market data, and/or the choice of model itself may be more subjective. In these circumstances, an adjustment may be necessary to reflect the likelihood that market participants would adopt more conservative values for uncertain parameters and/or model assumptions than those used in HSBC’s valuation model.
Credit and debit valuation adjustments
The CVA is an adjustment to the valuation of over-the-counter (‘OTC’) derivative contracts to reflect the possibility that the counterparty may default and that HSBC may not receive the full market value of the transactions.
The DVA is an adjustment to the valuation of OTC derivative contracts to reflect the possibility that HSBC may default, and that it may not pay the full market value of the transactions.
HSBC calculates a separate CVA and DVA for each legal entity, and for each counterparty to which the entity has exposure. With the exception of central clearing parties, all third-party counterparties are included in the CVA and DVA calculations, and these adjustments are not netted across Group entities.
HSBC calculates the CVA by applying the probability of default (‘PD’) of the counterparty, conditional on the non-default of HSBC, to HSBC’s expected positive exposure to the counterparty and multiplying the result by the loss expected in the event of default. Conversely, HSBC calculates the DVA by applying the PD of HSBC, conditional on the non-default of the counterparty, to the expected positive exposure of the counterparty to HSBC and multiplying the result by the loss expected in the event of default. Both calculations are performed over the life of the potential exposure.
For most products HSBC uses a simulation methodology, which incorporates a range of potential exposures over the life of the portfolio, to calculate the expected positive exposure to a counterparty. The simulation methodology includes credit mitigants, such as counterparty netting agreements and collateral agreements with the counterparty.
The methodologies do not, in general, account for ‘wrong-way risk’. Wrong-way risk is an adverse correlation between the counterparty’s probability of default and the mark-to-market value of the underlying transaction. The risk can either be general, perhaps related to the currency of the issuer country, or specific to the transaction concerned. When there is significant wrong-way risk, a trade-specific approach is applied to reflect this risk in the valuation.
Funding fair value adjustment
The FFVA is calculated by applying future market funding spreads to the expected future funding exposure of any uncollateralised component of the OTC derivative portfolio. The expected future funding exposure is calculated by a simulation methodology, where available, and is adjusted for events that may terminate the exposure, such as the default of HSBC or the counterparty. The FFVA and DVA are calculated independently.
Model limitation
Models used for portfolio valuation purposes may be based upon a simplified set of assumptions that do not capture all current and future material market characteristics. In these circumstances, model limitation adjustments are adopted.
Inception profit (Day 1 P&L reserves)
Inception profit adjustments are adopted when the fair value estimated by a valuation model is based on one or more significant unobservable inputs. The accounting for inception profit adjustments is discussed in Note 1.
Fair value valuation bases
Financial instruments measured at fair value using a valuation technique with significant unobservable inputs – Level 3
 
Assets
Liabilities
 
Financial investments

Held for trading

Designated and otherwise mandatorily measured at fair value through profit or loss

Derivatives

Total

Held for trading

Designated at fair value

Derivatives

Total

 
$m

$m

$m

$m

$m

$m

$m

$m

$m

Private equity including strategic investments
427

20

5,106

—

5,553

12

—

—

12

Asset-backed securities
1,030

1,140

32

—

2,202

—

—

—

—

Loans held for securitisation
—

—

49

—

49

—

—

—

—

Structured notes
—

3

—

—

3

46

5,328

—

5,374

Derivatives with monolines
—

—

—

65

65

—

—

—

—

Other derivatives
—

—

—

2,358

2,358

—

—

1,755

1,755

Other portfolios
543

5,596

305

—

6,444

—

—

1

1

At 31 Dec 2018
2,000

6,759

5,492

2,423

16,674

58

5,328

1,756

7,142

 
 
 
 
 
 
 
 
 
 
 
Assets
Liabilities
 
Available
for sale

Held for trading

Designated at fair value

Derivatives

Total

Held for trading

Designated at fair value

Derivatives

Total

 
$m

$m

$m

$m

$m

$m

$m

$m

$m

Private equity including strategic investments
2,012

38

1,458

—

3,508

20

—

—

20

Asset-backed securities
1,300

1,277

—

—

2,577

—

—

—

—

Loans held for securitisation
—

24

—

—

24

—

—

—

—

Structured notes
—

3

—

—

3

4,180

—

—

4,180

Derivatives with monolines
—

—

—

113

113

—

—

—

—

Other derivatives
—

—

—

2,331

2,331

—

—

1,944

1,944

Other portfolios
120

3,710

2

—

3,832

—

—

—

—

At 31 Dec 2017
3,432

5,052

1,460

2,444

12,388

4,200

—

1,944

6,144

Level 3 instruments are present in both ongoing and legacy businesses. Loans held for securitisation, derivatives with monolines, certain ‘other derivatives’ and predominantly all Level 3 ABSs are legacy positions. HSBC has the capability to hold these positions.
Private equity including strategic investments
The fair value of a private equity investments (including strategic investments) is estimated on the basis of an analysis of the investee’s financial position and results, risk profile, prospects and other factors; by reference to market valuations for similar entities quoted in an active market; or the price at which similar companies have changed ownership.
Asset-backed securities
While quoted market prices are generally used to determine the fair value of the asset-backed securities (‘ABSs’), valuation models are used to substantiate the reliability of the limited market data available and to identify whether any adjustments to quoted market prices are required. For certain ABSs, such as residential mortgage-backed securities, the valuation uses an industry standard model with assumptions relating to prepayment speeds, default rates and loss severity based on collateral type, and performance, as appropriate. The valuations output is benchmarked for consistency against observable data for securities of a similar nature.
Structured notes
The fair value of Level 3 structured notes is derived from the fair value of the underlying debt security, and the fair value of the embedded derivative is determined as described in the paragraph below on derivatives. These structured notes comprise principally equity-linked notes issued by HSBC, which provide the counterparty with a return linked to the performance of equity securities and other portfolios. Examples of the unobservable parameters include long-dated equity volatilities and correlations between equity prices, and interest and foreign exchange rates.
Derivatives
OTC derivative valuation models calculate the present value of expected future cash flows, based upon ‘no arbitrage’ principles. For many vanilla derivative products, the modelling approaches used are standard across the industry. For more complex derivative products, there may be some differences in market practice. Inputs to valuation models are determined from observable market data wherever possible, including prices available from exchanges, dealers, brokers or providers of consensus pricing. Certain inputs may not be observable in the market directly, but can be determined from observable prices via model calibration procedures or estimated from historical data or other sources.
Reconciliation of fair value measurements in Level 3 of the fair value hierarchy
Movement in Level 3 financial instruments
 
 
Assets
Liabilities
 
 
Financial investments

Trading assets

Designated and otherwise mandatorily measured at fair value through profit or loss

Derivatives

Trading liabilities

Designated at fair value

Derivatives

 
Footnotes
$m

$m

$m

$m

$m

$m

$m

At 1 Jan 2018
 
1,767

5,080

3,958

2,444

93

4,107

1,949

Total gains/(losses) recognised in profit or loss
 
251

284

608

597

(4
)
(637
)
255

– net income from financial instruments held for trading or managed on a fair value basis
 
—

284

—

597

(4
)
—

255

– net income from assets and liabilities of insurance businesses, including related derivatives, measured at fair value through profit or loss
 
—

—

—

—

—

—

—

– changes in fair value of other financial instruments mandatorily measured at fair value through profit or loss
 
—

—

608

—

—

(637
)
—

– gains less losses from financial investments at fair value through other comprehensive income
 
251

—

—

—

—

—

—

– expected credit loss charges and other credit risk charges
 
—

—

—

—

—

—

—

–
fair value gains transferred to the income statement on disposal
 
—

—

—

—

—

—

—

Total gains/(losses) recognised in other comprehensive income (‘OCI’)
1
17

(274
)
(107
)
(113
)
(3
)
(144
)
(82
)
– financial investments: fair value gains/(losses)
 
15

—

—

—

—

—

—

– cash flow hedges: fair value gains/(losses)
 
—

—

6

6

—

—

2

–
fair value gains transferred to the income statement on disposal
 
—

—

—

—

—

—

—

– exchange differences
 
2

(274
)
(113
)
(119
)
(3
)
(144
)
(84
)
Purchases
 
275

4,377

2,172

—

3

76

—

New issuances
 
—

975

—

—

6

2,442

—

Sales
 
(51
)
(1,589
)
(395
)
—

(11
)
—

—

Settlements
 
(141
)
(2,021
)
(541
)
(191
)
(2
)
(32
)
(18
)
Transfers out
 
(685
)
(1,402
)
(285
)
(337
)
(24
)
(1,112
)
(464
)
Transfers in
 
567

1,329

82

23

—

628

116

At 31 Dec 2018
 
2,000

6,759

5,492

2,423

58

5,328

1,756

Unrealised gains/(losses) recognised in profit or loss relating to assets and liabilities held at 31 Dec 2018
 
—

(5
)
199

342

(5
)
274

(351
)
– net income from financial instruments held
for trading or managed on a fair value basis
 
—

(5
)
—

342

(5
)
—

(351
)
– net income from assets and liabilities of
insurance businesses, including related derivatives
measured at fair value through profit or loss

 
—

—

—

—

—

—

—

– changes in fair value of other financial
instruments mandatorily measured at fair
value through profit or loss
 
—

—

199

—

—

274

—

– loan impairment recoveries and other credit
risk provisions
 
—

—

—

—

—

—

—

Movement in Level 3 financial instruments (continued)
 
 
Assets
Liabilities
 
 
Available
for sale

Held for
trading

Designated
at fair value
through profit
or loss

Derivatives

Held for
trading

Designated
at fair value
through profit
or loss

Derivatives

 
Footnotes
$m

$m

$m

$m

$m

$m

$m

At 1 Jan 2017
 
3,476

6,489

730

2,752

3,582

37

2,300

Total gains/(losses) recognised in profit or loss
 
351

(188
)
(107
)
152

154

(5
)
400

– trading income/(expense) excluding net interest income
 
—

(188
)
—

152

154

—

400

– net income from other financial instruments designated at fair value
 
—

—

(107
)
—

—

(5
)
—

– gains less losses from financial investments
 
313

—

—

—

—

—

—

– loan impairment charges and other credit risk provisions (‘LICs’)
 
38

—

—

—

—

—

—

Total gains/(losses) recognised in other comprehensive income (‘OCI’)
1
71

106

7

188

169

1

120

– available-for-sale investments: fair value gains/(losses)
 
(30
)
—

—

—

—

—

—

– cash flow hedges: fair value gains/(losses)
 
—

(1
)
3

(23
)
—

—

(35
)
– exchange differences
 
101

107

4

211

169

1

155

Purchases
 
200

1,503

1,127

2

5

—

23

New issuances
 
—

—

—

1

1,915

—

—

Sales
 
(939
)
(3,221
)
(130
)
(8
)
(12
)
—

(12
)
Settlements
 
(69
)
(331
)
(166
)
(60
)
(998
)
—

(123
)
Transfers out
 
(565
)
(149
)
(3
)
(885
)
(678
)
(33
)
(1,030
)
Transfers in
 
907

843

2

302

63

—

266

At 31 Dec 2017
 
3,432

5,052

1,460

2,444

4,200

—

1,944

Unrealised gains/(losses) recognised in profit or loss relating to assets and liabilities held at 31 Dec 2017

 
16

(110
)
(146
)
218

(117
)
—

(397
)
– trading income/(expense) excluding net interest income
 
—

(110
)
—

218

(117
)
—

(397
)
– net income from other financial instruments designated at fair value
 
—

—

(146
)
—

—

—

—

– loan impairment charges and other credit risk provisions
 
16

—

—

—

—

—

—

1
Included in ‘Available-for-sale investments: fair value gains/(losses)’ in prior years or 'Debt Instruments at fair value through other comprehensive income’ in 2018 and ‘Exchange differences’ in the consolidated statement of comprehensive income.
Transfers between levels of the fair value hierarchy are deemed to occur at the end of each quarterly reporting period. Transfers into and out of levels of the fair value hierarchy are primarily attributable to observability of valuation inputs and price transparency.
Effect of changes in significant unobservable assumptions to reasonably possible alternatives
Sensitivity of Level 3 fair values to reasonably possible alternative assumptions
 
 
2018
2017
 
 
Reflected in profit or loss
Reflected in OCI
Reflected in profit or loss
Reflected in OCI
 
 
Favourable
changes

Un-
favourable
changes

Favourable
changes

Un-
favourable
changes

Favourable
changes

Un-
favourable
changes

Favourable
changes

Un-
favourable
changes

 
Footnotes
$m

$m

$m

$m

$m

$m

$m

$m

Derivatives, trading assets and trading liabilities
1
269

(257
)
—

—

372

(253
)
—

—

Designated and otherwise mandatorily measured at fair value through profit or loss
 
394

(310
)
—

—

89

(74
)
—

—

Financial investments
 
34

(36
)
23

(22
)
53

(30
)
128

(149
)
At 31 Dec
 
697

(603
)
23

(22
)
514

(357
)
128

(149
)
1
Derivatives, trading assets and trading liabilities are presented as one category to reflect the manner in which these instruments are risk managed.
Sensitivity of Level 3 fair values to reasonably possible alternative assumptions by instrument type
 
2018
2017
 
Reflected in profit or loss
Reflected in OCI
Reflected in profit or loss
Reflected in OCI
 
Favourable
changes

Un-
favourable
changes

Favourable
changes

Un-
favourable
changes

Favourable
changes

Un-
favourable
changes

Favourable
changes

Un-
favourable
changes

 
$m

$m

$m

$m

$m

$m

$m

$m

Private equity including strategic investments
400

(317
)
—

—

142

(105
)
117

(102
)
Asset-backed securities
62

(34
)
23

(22
)
66

(39
)
3

(39
)
Loans held for securitisation
1

(1
)
—

—

1

(1
)
—

—

Structured notes
13

(13
)
—

—

12

(9
)
—

—

Derivatives with monolines
—

—

—

—

—

—

—

—

Other derivatives
157

(153
)
—

—

249

(150
)
—

—

Other portfolios
64

(85
)
—

—

44

(53
)
8

(8
)
At 31 Dec
697

(603
)
23

(22
)
514

(357
)
128

(149
)

The sensitivity analysis aims to measure a range of fair values consistent with the application of a 95% confidence interval. Methodologies take account of the nature of the valuation technique employed, as well as the availability and reliability of observable proxy and historical data.
When the fair value of a financial instrument is affected by more than one unobservable assumption, the above table reflects the most favourable or the most unfavourable change from varying the assumptions individually.
Key unobservable inputs to Level 3 financial instruments
The following table lists key unobservable inputs to Level 3 financial instruments, and provides the range of those inputs at 31 December 2018. The core range of inputs is the estimated range within which 90% of the inputs fall.
Quantitative information about significant unobservable inputs in Level 3 valuations
 
 
Fair value
 
 
2018
2017
 
 
Assets

Liabilities

Valuation
techniques
Key unobservable
inputs
Full range
of inputs
Core range
of inputs1 
Full range
of inputs
Core range
of inputs1 
 
Footnotes
$m

$m

 
 
Lower
Higher
Lower
Higher
Lower
Higher
Lower
Higher
Private equity including
strategic investments
 
5,554

12

See below
See below
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
Asset-backed securities
2
2,202

—

 
 
 
 
 
 
 
 
 
 
– CLO/CDO
 
394

—

Market proxy
Prepayment rate
0%
10%
0%
10%
2%
7%
2%
7%
 
 
 
 
Market proxy
Bid quotes
0
100
50
100
0
101
6
53
– other ABSs
 
1,808

—

Market proxy
Bid quotes
0
271
71
99
0
103
34
98
Loans held for securitisation
 
49

—

 
 
 
 
 
 
 
 
 
 
Structured notes
 
3

5,374

 
 
 
 
 
 
 
 
 
 
– equity-linked notes
 
—

3,882

Model –
Option model
Equity volatility
8%
79%
13%
53%
7%
47%
14%
30%
 
 
 


Model – Option model
Equity correlation
17%
93%
40%
77%
33%
95%
45%
72%
– fund-linked notes
 
—

83

Model – Option model
Fund volatility
21%
21%
21%
21%
6%
15%
6%
15%
– FX-linked notes
 
—

1,382

Model – Option model
FX volatility
1%
27%
3%
25%
3%
20%
4%
13%
– other
 
3

27

 
 
 
 
 
 
 
 
 
 
Derivatives with monolines
 
65

—

Model – Discounted
cash flow
Credit spread
0.2%
1%
0.2%
1%
0.4%
3%
1%
3%
Other derivatives
 
2,358

1,755

 
 
 
 
 
 
 
 
 
 
– Interest rate derivatives:
 
 

 

 
 
 
 
 
 
 
 
 
 
   securitisation swaps
 
233

700

Model – Discounted
cash flow
Prepayment
rate
6%
7%
6%
7%
20%
90%
20%
90%
   long-dated swaptions
 
1,019

27

Model – Option model
IR volatility
13%
39%
14%
36%
8%
41%
15%
31%
   other
 
250

148

 
 
 
 
 
 
 
 
 
 
– FX derivatives:
 
 

 

 
 
 
 
 
 
 
 
 
 
   FX options
 
186

244

Model – Option model
FX volatility
1%
27%
7%
12%
0.7%
50%
5%
11%
   other
 
113

77

 
 
 
 
 
 
 
 
 
 
– Equity derivatives:
 
 

 

 
 
 
 
 
 
 
 
 
 
    long-dated single stock options
 
215

267

Model – Option model
Equity volatility
5%
83%
5%
81%
7%
84%
15%
44%
   other
 
310

216

 
 
 
 
 
 
 
 
 
 
– Credit derivatives:
 
 

 

 
 
 
 
 
 
 
 
 
 
   other
 
32

76

 
 
 
 
 
 
 
 
 
 
Other portfolios
 
6,443

1

 
 
 
 
 
 
 
 
 
 
– structured certificates
 
3,013

—

Model – Discounted cash flow
Credit volatility
2%
4%
2%
4%
2%
4%
2%
4%
– other
3
3,430

1

 
 
 
 
 
 
 
 
 
 
At 31 Dec 2018
 
16,674

7,142

 
 
 
 
 
 
 
 
 
 
1
The core range of inputs is the estimated range within which 90% of the inputs fall.
2
Collateralised loan obligation/collateralised debt obligation.
3
‘Other’ includes a range of smaller asset holdings.
Private equity including strategic investments
Given the bespoke nature of the analysis in respect of each private equity holding, it is not practical to quote a range of key unobservable inputs.
Prepayment rates
Prepayment rates are a measure of the anticipated future speed at which a loan portfolio will be repaid in advance of the due date. They vary according to the nature of the loan portfolio and expectations of future market conditions, and may be estimated using a variety of evidence, such as prepayment rates implied from proxy observable security prices, current or historical prepayment rates and macroeconomic modelling.
Market proxy
Market proxy pricing may be used for an instrument when specific market pricing is not available but there is evidence from instruments with common characteristics. In some cases it might be possible to identify a specific proxy, but more generally evidence across a wider range of instruments will be used to understand the factors that influence current market pricing and the manner of that influence.
Volatility
Volatility is a measure of the anticipated future variability of a market price. It varies by underlying reference market price, and by strike and maturity of the option.
Certain volatilities, typically those of a longer-dated nature, are unobservable and are estimated from observable data. The range of unobservable volatilities reflects the wide variation in volatility inputs by reference market price. The core range is significantly narrower than the full range because these examples with extreme volatilities occur relatively rarely within the HSBC portfolio.
Correlation
Correlation is a measure of the inter-relationship between two market prices and is expressed as a number between minus one and one. It is used to value more complex instruments where the payout is dependent upon more than one market price. There is a wide range of instruments for which correlation is an input, and consequently a wide range of both same-asset correlations and cross-asset correlations is used. In general, the range of same-asset correlations will be narrower than the range of cross-asset correlations.
Unobservable correlations may be estimated based upon a range of evidence, including consensus pricing services, HSBC trade prices, proxy correlations and examination of historical price relationships. The range of unobservable correlations quoted in the table reflects the wide variation in correlation inputs by market price pair.
Credit spread
Credit spread is the premium over a benchmark interest rate required by the market to accept lower credit quality. In a discounted cash flow model, the credit spread increases the discount factors applied to future cash flows, thereby reducing the value of an asset. Credit spreads may be implied from market prices and may not be observable in more illiquid markets.
Inter-relationships between key unobservable inputs
Key unobservable inputs to Level 3 financial instruments may not be independent of each other. As described above, market variables may be correlated. This correlation typically reflects the manner in which different markets tend to react to macroeconomic or other events. Furthermore, the effect of changing market variables on the HSBC portfolio will depend on HSBC’s net risk position in respect of each variable.
HSBC Holdings
Basis of valuing HSBC Holdings’ financial assets and liabilities measured at fair value
 
2018

2017

 
$m

$m

Valuation technique using observable inputs: Level 2
 
 
Assets at 31 Dec
 
 
– derivatives
707

2,388

– financial investments
—

4,264

– designated and otherwise mandatorily measured at fair value through profit or loss
23,513

11,944

Liabilities at 31 Dec




– designated at fair value
25,049

30,890

– derivatives
2,159

3,082

13
Fair values of financial instruments not carried at fair value
Fair values of financial instruments not carried at fair value and bases of valuation


Fair value

Carrying
amount

Quoted market
price
Level 1

Observable
inputs
Level 2

Significant
unobservable
inputs
Level 3

Total


$m

$m

$m

$m

$m

At 31 Dec 2018










Assets










Loans and advances to banks
72,167

—

68,378

3,791

72,169

Loans and advances to customers
981,696

—

10,518

974,559

985,077

Reverse repurchase agreements – non-trading
242,804

81

241,407

1,369

242,857

Financial investments – at amortised cost
62,666

1,790

60,073

216

62,079

Liabilities
 


 
 
 
Deposits by banks
56,331

—

56,308

—

56,308

Customer accounts
1,362,643

—

1,362,794

151

1,362,945

Repurchase agreements – non-trading
165,884

—

165,884

—

165,884

Debt securities in issue
85,342

—

85,430

—

85,430

Subordinated liabilities
22,437

—

24,968

373

25,341












At 31 Dec 2017










Assets










Loans and advances to banks
90,393

—

87,384

3,007

90,391

Loans and advances to customers
962,964

—

20,029

944,176

964,205

Reverse repurchase agreements – non-trading
201,553

—

200,012

1,526

201,538

Financial investments – at amortised cost
52,919

1,363

52,707

17

54,087

Liabilities










Deposits by banks
69,922

—

69,862

30

69,892

Customer accounts
1,364,462

—

1,353,017

11,608

1,364,625

Repurchase agreements – non-trading
130,002

1

129,995

—

129,996

Debt securities in issue
64,546

—

65,138

—

65,138

Subordinated liabilities
19,826

—

23,740

355

24,095


Other financial instruments not carried at fair value are typically short term in nature and reprice to current market rates frequently. Accordingly, their carrying amount is a reasonable approximation of fair value. They include cash and balances at central banks, items in the course of collection from and transmission to other banks, Hong Kong Government certificates of indebtedness and Hong Kong currency notes in circulation, all of which are measured at amortised cost.
Carrying amount and fair value of loans and advances to customers by industry sector

Carrying amount
Fair value

Not Impaired

Impaired

Total

Not Impaired

Impaired

Total


$m

$m

$m

$m

$m

$m

Loans and advances to customers






Personal
387,957

3,433

391,390

388,761

3,249

392,010

Corporate and commercial
524,531

4,494

529,025

527,022

4,600

531,622

Non-bank financial institutions
61,102

179

61,281

61,265

180

61,445

At 31 Dec 2018
973,590

8,106

981,696

977,048

8,029

985,077

Loans and advances to customers












Personal
370,842

3,920

374,762

371,131

3,257

374,388

Corporate and commercial
510,784

5,970

516,754

512,597

5,769

518,366

Non-bank financial institutions
71,377

71

71,448

71,351

100

71,451

At 31 Dec 2017
953,003

9,961

962,964

955,079

9,126

964,205


Loans and advances to customers are classified as not credit impaired or credit impaired in accordance with the criteria described on page 142.
Valuation
Fair value is an estimate of the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It does not reflect the economic benefits and costs that HSBC expects to flow from an instrument’s cash flow over its expected future life. Our valuation methodologies and assumptions in determining fair values for which no observable market prices are available may differ from those of other companies.
Loans and advances to banks and customers
To determine the fair value of loans and advances to banks and customers, loans are segregated, as far as possible, into portfolios of similar characteristics. Fair values are based on observable market transactions, when available. When they are unavailable, fair values are estimated using valuation models incorporating a range of input assumptions. These assumptions may include: value estimates from third-party brokers reflecting over-the-counter trading activity; forward-looking discounted cash flow models, taking account of expected customer prepayment rates, using assumptions that HSBC believes are consistent with those that would be used by market participants in valuing such loans; new business rates estimates for similar loans; and trading inputs from other market participants including observed primary and secondary trades. From time to time, we may engage a third-party valuation specialist to measure the fair value of a pool of loans.
The fair value of loans reflects expected credit losses at the balance sheet date and estimates of market participants’ expectations of credit losses over the life of the loans, and the fair value effect of repricing between origination and the balance sheet date. For credit-impaired loans, fair value is estimated by discounting the future cash flows over the time period they are expected to be recovered.
Financial investments
The fair values of listed financial investments are determined using bid market prices. The fair values of unlisted financial investments are determined using valuation techniques that incorporate the prices and future earnings streams of equivalent quoted securities.
Deposits by banks and customer accounts
The fair values of on-demand deposits are approximated by their carrying value. For deposits with longer-term maturities, fair values are estimated using discounted cash flows, applying current rates offered for deposits of similar remaining maturities.
Debt securities in issue and subordinated liabilities
Fair values in debt securities is issue and subordinated liabilities are determined using quoted market prices at the balance sheet date where available, or by reference to quoted market prices for similar instruments.
Repurchase and reverse repurchase agreements – non-trading
Fair values of repurchase and reverse repurchase agreements that are held on a non-trading basis provide approximate carrying amounts. This is due to the fact that balances are generally short dated.
HSBC Holdings
The methods used by HSBC Holdings to determine fair values of financial instruments for the purposes of measurement and disclosure are described above.
Fair values of HSBC Holdings’ financial instruments not carried at fair value on the balance sheet
 
 
2018
2017
 
 
Carrying
amount

Fair
value1

Carrying
amount

Fair
value1

 
 
$m

$m

$m

$m

Assets at 31 Dec
 
 
 
 
 
Loans and advances to HSBC undertakings
 
56,144

56,801

76,627

78,534

Liabilities at 31 Dec
 
 
 
 
 
Amounts owed to HSBC undertakings
 
949

949

2,571

2,571

Debt securities in issue
 
50,800

51,552

34,258

36,611

Subordinated liabilities
 
17,715

20,224

15,877

19,596

1
Fair values were determined using valuation techniques with observable inputs (Level 2).