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Fair values of financial instruments not carried at fair value
 12 Months Ended
Dec. 31, 2019
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. These are 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. These are 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. These are financial instruments valued using valuation techniques where one or more significant inputs are unobservable.
Financial instruments carried at fair value and bases of valuation

2019
2018

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
186,653

62,639

4,979

254,271

178,100

53,271

6,759

238,130

Financial assets designated and otherwise mandatorily measured at fair value through profit or loss
26,505

9,373

7,749

43,627

23,125

12,494

5,492

41,111

Derivatives
1,728

239,131

2,136

242,995

1,868

203,534

2,423

207,825

Financial investments
271,467

84,087

2,023

357,577

263,885

78,882

2,000

344,767

Liabilities
















Trading liabilities
66,925

16,192

53

83,170

66,300

18,073

58

84,431

Financial liabilities designated at fair value
9,549

149,901

5,016

164,466

6,815

136,362

5,328

148,505

Derivatives
1,331

235,864

2,302

239,497

2,845

201,234

1,756

205,835

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 2019
 
 
 
 
 
 
 
Transfers from Level 1 to Level 2
5,257

3,304

1,332

24

278

—

—

Transfers from Level 2 to Level 1
3,486

2,726

673

111

220

—

117

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

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 and Markets and Corporate Centre fair value adjustments
 
 
 
 
 
2019
2018
 
GB&M

Corporate Centre

GB&M

Corporate Centre

 
$m

$m

$m

$m

Type of adjustment
 
 
 
 
Risk-related
1,040

125

1,042

138

– bid-offer
428

79

430

76

– uncertainty
115

1

99

6

– credit valuation adjustment
355

38

442

52

– debt valuation adjustment
(126
)
—

(198
)
—

– funding fair value adjustment
241

7

256

4

– other
27

—

13

—

Model-related
71

3

79

3

– model limitation
68

3

79

3

– other
3

—

—

—

Inception profit (Day 1 P&L reserves)
72

—

85

—

At 31 Dec
1,183

128

1,206

141

Bid-offer
IFRS 13 ‘Fair value measurement’ requires the 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 debt valuation adjustments
The credit valuation adjustment (‘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 debt valuation adjustment (‘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 funding fair value adjustment (‘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

Trading assets

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

Derivatives

Total

Trading liabilities

Designated at fair value

Derivatives

Total

 
$m

$m

$m

$m

$m

$m

$m

$m

$m

Private equity including strategic investments
716

4

7,289

—

8,009

4

—

—

4

Asset-backed securities
874

934

28

—

1,836

—

—

—

—

Loans held for securitisation
—

1

39

—

40

—

—

—

—

Structured notes
—

3

—

—

3

47

5,016

—

5,063

Derivatives with monolines
—

—

—

66

66

—

—

—

—

Other derivatives
—

—

—

2,070

2,070

—

—

2,302

2,302

Other portfolios
433

4,037

393

—

4,863

2

—

—

2

At 31 Dec 2019
2,023

4,979

7,749

2,136

16,887

53

5,016

2,302

7,371

 
 
 
 
 
 
 
 
 
 
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

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 investment (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 invest-ments

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 2019
 
2,000

6,759

5,492

2,423

58

5,328

1,756

Total gains/(losses) recognised in profit or loss
 
6

(112
)
598

278

(4
)
195

930

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

(112
)
—

278

(4
)
—

930

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

—

598

—

—

195

—

– gains less losses from financial investments at fair value through other comprehensive income
 
10

—

—

—

—

—

—

– expected credit loss charges and other credit risk charges
 
(4
)
—

—

—

—

—

—

Total gains/(losses) recognised in other comprehensive income (‘OCI’)
1
269

76

(1
)
49

1

18

52

– financial investments: fair value gains/(losses)
 
261

—

—

—

—

—

—

– exchange differences
 
8

76

(1
)
49

1

18

52

Purchases
 
271

2,206

2,353

—

8

157

—

New issuances
 
—

154

—

—

6

1,601

—

Sales
 
(10
)
(895
)
(276
)
—

(9
)
(193
)
—

Settlements
 
(329
)
(2,107
)
(434
)
(100
)
(7
)
(1,048
)
(162
)
Transfers out
 
(471
)
(1,558
)
(23
)
(710
)
(9
)
(1,079
)
(473
)
Transfers in
 
287

456

40

196

9

37

199

At 31 Dec 2019
 
2,023

4,979

7,749

2,136

53

5,016

2,302

Unrealised gains/(losses) recognised in profit or loss relating to assets and liabilities held at 31 Dec 2019
 
(4
)
(22
)
477

279

—

57

(407
)
– net income from financial instruments held
for trading or managed on a fair value basis
 
—

(22
)
—

279

—

—

(407
)
– changes in fair value of other financial
instruments mandatorily measured at fair
value through profit or loss
 
—

—

477

—

—

57

—

– loan impairment recoveries and other credit
risk provisions
 
(4
)
—

—

—

—

—

—

 
 
 
 
 
 
 
 
 

Movement in Level 3 financial instruments (continued)
 
 
 
Assets
Liabilities
 
 
Financial invest-ments

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

– 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

—

—

—

—

—

—

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

– 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
)
– 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
 
—

—

—

—

—

—

—

1
Included in ‘financial investments: fair value gains/(losses)’ in the current year 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
 
 
2019
2018
 
 
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
255

(230
)
—

—

269

(257
)
—

—

Designated and otherwise mandatorily measured at fair value through profit or loss
 
532

(417
)
—

—

394

(310
)
—

—

Financial investments
 
48

(53
)
22

(22
)
34

(36
)
23

(22
)
At 31 Dec
 
835

(700
)
22

(22
)
697

(603
)
23

(22
)
1
Derivatives, trading assets and trading liabilities are presented as one category to reflect the manner in which these instruments are risk managed.
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 2019. 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
 
 
2019
2018
 
 
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
 
8,009

4

See below
See below
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
Asset-backed securities
2
1,836

—

 
 
 
 
 
 
 
 
 
 
– CLO/CDO
 
373

—

Market proxy
Prepayment rate
0%
9%
0%
9%
0%
10%
0%
10%
 
 
 
 
Market proxy
Bid quotes
0
100
0
100
0
100
50
100
– other ABSs
 
1,463

—

Market proxy
Bid quotes
0
101
61
98
0
271
71
99
Loans held for securitisation
 
40

—

 
 
 
 
 
 
 
 
 
 
Structured notes
 
3

5,063

 
 
 
 
 
 
 
 
 
 
– equity-linked notes
 
—

3,768

Model –
Option model
Equity volatility
5%
90%
6%
56%
8%
79%
13%
53%
 
 
 


Model – Option model
Equity correlation
9%
93%
9%
93%
17%
93%
40%
77%
– FX-linked notes
 
—

1,046

Model – Option model
FX volatility
1%
23%
3%
22%
1%
27%
3%
25%
– other
 
3

249

 
 
 
 
 
 
 
 
 
 
Derivatives with monolines
 
66

—

Model – Discounted
cash flow
Credit spread
0.4%
2%
0.4%
2%
0.2%
1%
0.2%
1%
Other derivatives
 
2,070

2,302

 
 
 
 
 
 
 
 
 
 
– Interest rate derivatives:
 
 

 

 
 
 
 
 
 
 
 
 
 
   securitisation swaps
 
314

640

Model – Discounted
cash flow
Prepayment
rate
6%
7%
6%
7%
6%
7%
6%
7%
   long-dated swaptions
 
838

51

Model – Option model
IR volatility
8%
22%
8%
21%
13%
39%
14%
36%
   other
 
255

155

 
 
 
 
 
 
 
 
 
 
– FX derivatives:
 
 

 

 
 
 
 
 
 
 
 
 
 
   FX options
 
93

218

Model – Option model
FX volatility
1%
25%
5%
11%
1%
27%
7%
12%
   other
 
119

104

 
 
 
 
 
 
 
 
 
 
– Equity derivatives:
 
 

 

 
 
 
 
 
 
 
 
 
 
    long-dated single stock options
 
230

293

Model – Option model
Equity volatility
0%
89%
7%
74%
5%
83%
5%
81%
   other
 
78

712

 
 
 
 
 
 
 
 
 
 
– Credit derivatives:
 
 

 

 
 
 
 
 
 
 
 
 
 
   other
 
143

129

 
 
 
 
 
 
 
 
 
 
Other portfolios
 
4,863

2

 
 
 
 
 
 
 
 
 
 
– structured certificates
 
1,515

—

Model – Discounted cash flow
Credit volatility
4%
4%
4%
4%
2%
4%
2%
4%
– repurchase agreements
 
1,604

—

 
 
 
 
 
 
 
 
 
 
– other
3
1,744

2

 
 
 
 
 
 
 
 
 
 
At 31 Dec 2019
 
16,887

7,371

 
 
 
 
 
 
 
 
 
 
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
 
 
2019

2018

 
Footnotes

$m

$m

Valuation technique using observable inputs: Level 2
 
 
 
Assets at 31 Dec
 
 
 
– derivatives
 
2,002

707

– financial investments
 
—

—

– designated and otherwise mandatorily measured at fair value through profit or loss
1
61,964

23,513

Liabilities at 31 Dec
 




– designated at fair value
 
30,303

25,049

– derivatives
 
2,021

2,159

1
In 2019, due to the restructuring of the Group’s Asia and UK operations to meet resolution and recovery requirements, changes in the terms of financial assets have resulted in the derecognition of principal amounts of $33.3bn, relating to financial assets measured at amortised cost. Under the revised terms, financial assets with principal amounts of $33.3bn (2018: nil) measured on fair value basis have been recognised.
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 2019










Assets










Loans and advances to banks
69,203

—

68,508

739

69,247

Loans and advances to customers
1,036,743

—

10,365

1,027,178

1,037,543

Reverse repurchase agreements – non-trading
240,862

16

240,199

691

240,906

Financial investments – at amortised cost
85,735

26,202

62,572

287

89,061

Liabilities
 


 
 
 
Deposits by banks
59,022

—

58,951

—

58,951

Customer accounts
1,439,115

—

1,439,362

150

1,439,512

Repurchase agreements – non-trading
140,344

—

140,344

—

140,344

Debt securities in issue
104,555

—

104,936

—

104,936

Subordinated liabilities
24,600

—

28,861

385

29,246












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


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.
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 in 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
 
 
2019
2018
 
 
Carrying amount

Fair value1

Carrying amount

Fair value1

 
Footnotes
$m

$m

$m

$m

Assets at 31 Dec
 
 
 
 
 
Loans and advances to HSBC undertakings
 
10,218

10,504

56,144

56,801

Financial investments – at amortised cost
2
16,106

16,121





Liabilities at 31 Dec
 
 
 
 
 
Amounts owed to HSBC undertakings
 
464

464

949

949

Debt securities in issue
 
56,844

59,140

50,800

51,552

Subordinated liabilities
 
18,361

22,536

17,715

20,224

1
Fair values (other than Level 1 financial investments) were determined using valuation techniques with observable inputs (Level 2).
2
The 2019 period includes $16.1bn (2018: nil) of investments in highly liquid securities.