Derivative Financial Instruments

In the normal course of business, the derivative instruments entered into are for trading, market making and risk management purposes. For financial reporting purposes, a derivative instrument is designated in one of the following categories: (a) financial instruments held for trading, (b) hedging instruments designated as a qualifying hedge under derivative and hedge accounting principles or (c) a non-qualifying economic hedge. The derivative instruments held are predominantly swaps, futures, options and forward contracts. All derivatives are stated at fair value. Where we enter into enforceable master netting arrangements with counterparties, the master netting arrangements permit us to net those derivative asset and liability positions and to offset cash collateral held and posted with the same counterparty.

The following table presents the fair value of derivative contracts by major product type on a gross basis. Gross fair values exclude the effects of both counterparty netting as well as collateral, and therefore are not representative of our exposure. The table below presents the amounts of counterparty netting and cash collateral that have been offset in the consolidated balance sheet, as well as cash and securities collateral posted and received under enforceable credit support agreements that do not meet the criteria for netting. Derivative assets and liabilities which are not subject to an enforceable master netting agreement, or are subject to a netting agreement that we have not yet determined to be enforceable, have not been netted in the table below. Where we have received or posted collateral under credit support agreements, but have not yet determined such agreements are enforceable, the related collateral also has not been netted in the table below.



	June 30, 2013				December 31, 2012
	Derivative assets		Derivative liabilities		Derivative assets		Derivative liabilities
	(in millions)
Derivatives accounted for as fair value hedges⁽¹⁾
OTC-cleared ⁽²⁾	$	48	$	5	$	—	$	15
Bilateral OTC ⁽²⁾	136		349		10		860
Interest rate contracts	184		354		10		875

Derivatives accounted for as cash flow hedges ⁽¹⁾
Interest rate contracts - bilateral OTC ⁽²⁾	116		124		47		236
Trading derivatives not accounted for as hedges⁽³⁾
Exchange-traded ⁽²⁾	72		83		99		82
OTC-cleared ⁽²⁾	18,411		—		17,204		16,663
Bilateral OTC ⁽²⁾	37,923		56,648		53,562		53,705
Interest rate contracts	56,406		56,731		70,865		70,450

Exchange-traded ⁽²⁾	5		4		4		25
Bilateral OTC ⁽²⁾	16,125		15,539		13,795		13,576
Foreign exchange contracts	16,130		15,543		13,799		13,601

Equity contract - bilateral OTC ⁽²⁾	1,332		1,334		1,287		1,291

Exchange-traded ⁽²⁾	767		148		135		19
Bilateral OTC ⁽²⁾	2,874		1,909		656		719
Precious metals contracts	3,641		2,057		791		738

OTC-cleared ⁽²⁾	584		—		511		437
Bilateral OTC ⁽²⁾	5,308		5,926		6,617		6,910
Credit contracts	5,892		5,926		7,128		7,347

Other derivatives not accounted for as hedges⁽¹⁾
Interest rate contracts - bilateral OTC ⁽²⁾	602		93		901		97

Foreign exchange contracts - bilateral OTC ⁽²⁾	22		54		52		17

Equity contracts - bilateral OTC ⁽²⁾	506		224		472		126

Precious metals contracts - bilateral OTC ⁽²⁾	8		51		—		—

Credit contracts - bilateral OTC ⁽²⁾	13		10		1		4

Total derivatives	84,852		82,501		95,353		94,782

Less: Gross amounts of receivable / payable subject to enforcable master netting agreements ^{(4) (6)}	69,353		69,353		78,244		78,244
Less: Gross amounts of cash collateral received / posted subject to enforcable master netting agreements ^{(5) (6)}	5,047		1,937		5,123		1,336
Net amounts of derivative assets / liabilities presented in the balance sheet	10,452		11,211		11,986		15,202

Less: Gross amounts of financial instrument collateral received / posted subject to enforcable master netting agreements but not offset in the consolidated balance sheet	1,209		3,435		627		4,887
Net amounts of derivative assets / liabilities	$	9,243	$	7,776	$	11,359	$	10,315


⁽¹⁾	Derivative assets/liabilities related to cash flow hedges, fair value hedges and derivative instruments held for purposes other than for trading are recorded in other assets / interest, taxes and other liabilities on the consolidated balance sheet.

⁽²⁾

Over-the-counter (OTC) derivatives include derivatives executed and settled bilaterally with counterparties without the use of an organized exchange or central clearing house. The credit risk associated with bilateral OTC derivatives is managed through master netting agreements and obtaining collateral. OTC-cleared derivatives are executed bilaterally in the OTC market but then novated to a central clearing counterparty, whereby the central clearing counterparty becomes the counterparty to both of the original counterparties. Exchange traded derivatives are executed directly on an organized exchange that provides pre-trade price transparency. Credit risk is minimized for OTC-cleared derivatives and exchange traded derivatives through daily margining required by central clearing counterparties.


⁽³⁾	Trading related derivative assets/liabilities are recorded in trading assets/trading liabilities on the consolidated balance sheet.


⁽⁴⁾	Represents the netting of derivative receivable and payable balances for the same counterparty under enforceable netting agreements.


⁽⁵⁾	Represents the netting of cash collateral posted and received by counterparty under enforceable credit support agreements.


⁽⁶⁾	Netting is performed at a counterparty level in cases where enforceable master netting and credit support agreements are in place, regardless of the type of derivative instrument. Therefore, we have not attempted to allocate netting to the different types of derivative instruments shown in the table above.

See Note 19, "Guarantee Arrangements, Pledged Assets and Collateral" for further information on offsetting related to resale and repurchase agreements and securities borrowing and lending arrangements.

Derivatives Held for Risk Management Purposes Our risk management policy requires us to identify, analyze and manage risks arising from the activities conducted during the normal course of business. We use derivative instruments as an asset and liability management tool to manage our exposures in interest rate, foreign currency and credit risks in existing assets and liabilities, commitments and forecasted transactions. The accounting for changes in fair value of a derivative instrument will depend on whether the derivative has been designated and qualifies for hedge accounting.

We designate derivative instruments to offset the fair value risk and cash flow risk arising from fixed-rate and floating-rate assets and liabilities as well as forecasted transactions. We assess the hedging relationships, both at the inception of the hedge and on an ongoing basis, using a regression approach to determine whether the designated hedging instrument is highly effective in offsetting changes in the fair value or the cash flows attributable to the hedged risk. Accounting principles for qualifying hedges require us to prepare detailed documentation describing the relationship between the hedging instrument and the hedged item, including, but not limited to, the risk management objective, the hedging strategy and the methods to assess and measure the ineffectiveness of the hedging relationship. We discontinue hedge accounting when we determine that the hedge is no longer highly effective, the hedging instrument is terminated, sold or expired, the designated forecasted transaction is not probable of occurring, or when the designation is removed by us.

Fair Value Hedges In the normal course of business, we hold fixed-rate loans and securities and issue fixed-rate senior and subordinated debt obligations. The fair value of fixed-rate (USD and non-USD denominated) assets and liabilities fluctuates in response to changes in interest rates or foreign currency exchange rates. We utilize interest rate swaps, forward and futures contracts and foreign currency swaps to minimize the effect on earnings caused by interest rate and foreign currency volatility.

For reporting purposes, changes in fair value of a derivative designated in a qualifying fair value hedge, net of changes in the fair value of the hedged asset or liability attributable to the hedged risk, are recorded in current period earnings. We recognized net gains of $17 million and $12 million during the three and six months ended June 30, 2013, respectively, compared with net losses of $30 million and $20 million during the three and six months ended June 30, 2012, respectively, which are reported in other income in the consolidated statement of income which represents the ineffective portion of all fair value hedges. The interest accrual related to the derivative contract is recognized in interest income.

The changes in the fair value of the hedged item designated in a qualifying hedge are captured as an adjustment to the carrying amount of the hedged item (basis adjustment). If the hedging relationship is terminated and the hedged item continues to exist, the basis adjustment is amortized over the remaining life of the hedged item. We recorded basis adjustments for active fair value hedges which increased the carrying amount of our debt by $1 million during the six months ended June 30, 2013, respectively, compared with a decrease in the carrying amount of our debt by $1 million and $6 million during the three and six months ended June 30, 2012, respectively. We amortized $3 million and $7 million of basis adjustments related to terminated and/or re-designated fair value hedge relationships during the three and six months ended June 30, 2013, respectively, compared with $3 million and $6 million during the three and six months ended June 30, 2012, respectively. The total accumulated unamortized basis adjustment amounted to an increase in the carrying amount of our debt of $41 million and $49 million as of June 30, 2013 and December 31, 2012, respectively. Basis adjustments for active fair value hedges of available-for-sale securities increased the carrying amount of the securities by $445 million and $600 million during the three and six months ended June 30, 2013, respectively, compared with an increase in the carrying amount of the securities by $481 million and $187 million during the three and six months ended June 30, 2012. Total accumulated unamortized basis adjustments for active fair value hedges of available-for-sale securities amounted to an increase in carrying amount of $154 million and $836 million as of June 30, 2013 and December 31, 2012, respectively.

The following table presents information on gains and losses on derivative instruments designated and qualifying as hedging instruments in fair value hedges and the hedged items in fair value hedges and their location on the consolidated statement of income.



	Gain (Loss) on Derivative						Gain (Loss) on Hedged Items
	Interest Income (Expense)			Other Income			Interest Income (Expense)			Other Income
	(in millions)
Three Months Ended June 30, 2013
Interest rate contracts/AFS Securities	$	(55	)	$	397		$	111		$	(380	)
Interest rate contracts/subordinated debt	4			—			(15		)	—
Total	$	(51	)	$	397		$	96		$	(380	)

Three Months Ended June 30, 2012
Interest rate contracts/AFS Securities	$	(39	)	$	(582	)	$	162		$	552
Interest rate contracts/subordinated debt	(13		)	1			(15		)	(1		)
Total	$	(52	)	$	(581	)	$	147		$	551

Six Months Ended June 30, 2013
Interest rate contracts/AFS Securities	$	(111	)	$	567		$	225		$	(554	)
Interest rate contracts/subordinated debt	8			(1		)	(30		)	1
Total	$	(103	)	$	566		$	195		$	(553	)

Six Months Ended June 30, 2012
Interest rate contracts/AFS Securities	$	(84	)	$	(285	)	$	341		$	265
Interest rate contracts/subordinated debt	(27		)	6			(30		)	(6		)
Total	$	(111	)	$	(279	)	$	311		$	259

Cash Flow Hedges We own or issue floating rate financial instruments and enter into forecasted transactions that give rise to variability in future cash flows. As a part of our risk management strategy, we use interest rate swaps, currency swaps and futures contracts to mitigate risk associated with variability in the cash flows. Changes in fair value of a derivative instrument associated with the effective portion of a qualifying cash flow hedge are recognized initially in other comprehensive income. When the cash flows for which the derivative is hedging materialize and are recorded in income or expense, the associated gain or loss from the hedging derivative previously recorded in accumulated other comprehensive income is reclassified into earnings in the same accounting period in which the designated forecasted transaction or hedged item affects earnings. If a cash flow hedge of a forecasted transaction is de-designated because it is no longer highly effective, or if the hedge relationship is terminated, the cumulative gain or loss on the hedging derivative to that date will continue to be reported in accumulated other comprehensive income (loss) unless it is probable that the hedged forecasted transaction will not occur by the end of the originally specified time period as documented at the inception of the hedge, at which time the cumulative gain or loss is released into earnings. As of June 30, 2013 and December 31, 2012, active cash flow hedge relationships extend or mature through July 2036. During the three and six months ended June 30, 2013, $3 million and $7 million, respectively, of losses related to terminated and/or re-designated cash flow hedge relationships were amortized to earnings from accumulated other comprehensive income compared with $4 million and $8 million during the three and six months ended June 30, 2012, respectively. During the next twelve months, we expect to amortize $10 million of remaining losses to earnings resulting from these terminated and/or de-designated cash flow hedges. The interest accrual related to the derivative contract is recognized in interest income.

The following table presents information on gains and losses on derivative instruments designated and qualifying as hedging instruments in cash flow hedges (including amounts recognized in AOCI from all terminated cash flow hedges) and their locations on the consolidated statement of income.



	Gain (Loss) Recognized in AOCI on Derivative (Effective Portion)					Location of Gain (Loss) Reclassified from AOCI into Income (Effective Portion)	Gain (Loss) Reclassed From AOCI into Income (Effective Portion)						Location of Gain (Loss) Recognized in Income on the Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Gain (Loss) Recognized in Income on the Derivative (Ineffective Portion)
	2013		2012				2013			2012				2013		2012
	(in millions)
Three Months Ended June 30,
Interest rate contracts	$	84	$	(68	)	Interest income (expense)	$	(3	)	$	(4	)	Other income	$	1	$	—

Six Months Ended June 30,
Interest rate contracts	$	119	$	(10	)	Interest income (expense)	$	(7	)	$	(8	)	Other income	$	—	$	—

Trading Derivatives and Non-Qualifying Hedging Activities In addition to risk management, we enter into derivative instruments for trading and market making purposes, to repackage risks and structure trades to facilitate clients’ needs for various risk taking and risk modification purposes. We manage our risk exposure by entering into offsetting derivatives with other financial institutions to mitigate the market risks, in part or in full, arising from our trading activities with our clients. In addition, we also enter into buy-protection credit derivatives with other market participants to manage our counterparty credit risk exposure. Where we enter into derivatives for trading purposes, realized and unrealized gains and losses are recognized in trading revenue or residential mortgage banking revenue. Credit losses arising from counterparty risk on over-the-counter derivative instruments and offsetting buy protection credit derivative positions are recognized as an adjustment to the fair value of the derivatives and are recorded in trading revenue.

We have elected the fair value option for certain fixed rate long-term debt issuances as well as hybrid instruments which include all structured notes and structured deposits and have entered into certain derivative contracts related to these debt issuances and hybrid instruments carried at fair value. These derivative contracts are non-qualifying hedges but are considered economic hedges. We have also entered into credit default swaps which are designated as economic hedges against the credit risks within our loan portfolio. In the event of an impairment loss occurring in a loan that is economically hedged, the impairment loss is recognized as provision for credit losses while the gain on the credit default swap is recorded as other income. In addition, we also from time to time have designated certain forward purchase or sale of to-be-announced (“TBA”) securities to economically hedge mortgage servicing rights. Changes in the fair value of TBA positions, which are considered derivatives, are recorded in residential mortgage banking revenue. Derivative instruments designated as economic hedges that do not qualify for hedge accounting are recorded at fair value through profit and loss. Realized and unrealized gains and losses are recognized in gain (loss) on instruments designated at fair value and related derivatives, other income or residential mortgage banking revenue while the derivative asset or liability positions are reflected as other assets or other liabilities

The following table presents information on gains and losses on derivative instruments held for trading purposes and their locations on the consolidated statement of income.



		Amount of Gain (Loss) Recognized in Income on Derivatives
	Location of Gain (Loss)	Three Months Ended June 30,						Six Months Ended June 30,
	Recognized in Income on Derivatives	2013			2012			2013			2012
		(in millions)
Interest rate contracts	Trading revenue	$	(468	)	$	(2	)	$	(382	)	$	16
Interest rate contracts	Residential mortgage banking revenue	(34		)	38			(41		)	21
Foreign exchange contracts	Trading revenue	716			246			578			645
Equity contracts	Trading revenue	4			42			2			60
Precious metals contracts	Trading revenue	19			16			61			52
Credit contracts	Trading revenue	(69		)	(450		)	78			(678		)
Total		$	168		$	(110	)	$	296		$	116

The following table presents information on gains and losses on derivative instruments held for non-qualifying hedging activities and their locations on the consolidated statement of income.



		Amount of Gain (Loss) Recognized in Income on Derivatives
	Location of Gain (Loss)	Three Months Ended June 30,						Six Months Ended June 30,
	Recognized in Income on Derivatives	2013			2012			2013			2012
	(in millions)
Interest rate contracts	Gain (loss) on instruments designated at fair value and related derivatives	$	(176	)	$	195		$	(238	)	$	105
Interest rate contracts	Residential mortgage banking revenue	5			(2		)	4			5
Foreign exchange contracts	Gain (loss) on instruments designated at fair value and related derivatives	(24		)	36			(55		)	50
Equity contracts	Gain (loss) on instruments designated at fair value and related derivatives	(75		)	(118		)	240			246
Precious metals contracts	Gain (loss) on instruments designated at fair value and related derivatives	(42		)	—			(42		)	—
Credit contracts	Gain (loss) on instruments designated at fair value and related derivatives	1			1			1			2
Credit contracts	Other income	3			(2		)	3			(5		)
Total		$	(308	)	$	110		$	(87	)	$	403

Credit-Risk Related Contingent Features We enter into total return swap, interest rate swap, cross-currency swap and credit default swap contracts, amongst others which contain provisions that require us to maintain a specific credit rating from each of the major credit rating agencies. Sometimes the derivative instrument transactions are a part of broader structured product transactions. If HSBC Bank USA’s credit ratings were to fall below the current ratings, the counterparties to our derivative instruments could demand us to post additional collateral. The amount of additional collateral required to be posted will depend on whether HSBC Bank USA is downgraded by one or more notches and whether the downgrade is in relation to long-term or short-term ratings. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position as of June 30, 2013, is $7.1 billion for which we have posted collateral of $5.6 billion. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position as of December 31, 2012, is $8.7 billion for which we have posted collateral of $7.9 billion. Substantially all of the collateral posted is in the form of securities available-for-sale. See Note 19, “Guarantee Arrangements, Pledged Assets and Collateral,” for further details.

In the event of a credit downgrade, we currently do not expect HSBC Bank USA’s long-term ratings to go below A2 and A+ or the short-term ratings to go below P-2 and A-1 by Moody’s and S&P, respectively. The following tables summarize our obligation to post additional collateral (from the current collateral level) in certain hypothetical commercially reasonable downgrade scenarios. It is not appropriate to accumulate or extrapolate information presented in the tables below to determine our total obligation because the information presented to determine the obligation in hypothetical rating scenarios is not mutually exclusive.



Moody’s	Long-Term Ratings
Short-Term Ratings	A1		A2		A3
	(in millions)
P-1	$	—	$	1	$	182
P-2	1		28		182



S&P	Long-Term Ratings
Short-Term Ratings	AA-		A+		A
	(in millions)
A-1+	$	—	$	27	$	27
A-1	16		16		197

We would be required to post $17 million of additional collateral on total return swaps and certain other transactions if HSBC Bank USA is downgraded by S&P and Moody’s by two notches on our long term rating accompanied by one notch downgrade in our short term rating.

Notional Value of Derivative Contracts The following table summarizes the notional values of derivative contracts.



	June 30, 2013		December 31, 2012
	(in billions)
Interest rate:
Futures and forwards	$	209.9	$	313.9
Swaps	3,400.3		2,842.6
Options written	19.1		43.3
Options purchased	22.3		44.2
	3,651.6		3,244.0
Foreign Exchange:
Swaps, futures and forwards	830.8		743.7
Options written	79.7		54.9
Options purchased	80.2		55.5
Spot	69.9		56.3
	1,060.6		910.4
Commodities, equities and precious metals:
Swaps, futures and forwards	49.9		48.1
Options written	21.8		21.0
Options purchased	22.2		21.4
	93.9		90.5
Credit derivatives	419.2		484.9
Total	$	5,225.3	$	4,729.8