Discounting change magnifies HSBC FVA loss

UK bank's funding charge jumps 75% to $460m

HSBC sign
HSBC: latest to post FVA loss

HSBC recorded a funding valuation adjustment (FVA) charge of $263 million in its annual report last month, making it the 16th major bank to reflect the cost of funding uncollateralised derivatives in its income statement.

There was a quirk in the bank's announcement, though: a separate decision to embrace a new, lower discounting rate for uncollateralised swaps pushed the total fair value change to $460 million.

Out of the $263 million reduction in net trading income, $164 million came from the bank's rates business, and $97 million from its credit business – roughly a 60%/40% split. Other businesses racked up a charge of $2 million. These charges reflect the funding costs arising when a bank is in-the-money on a client trade but is not receiving collateral, but has to post it to a counterparty in an offsetting hedge.

The $197 million adjustment that makes up the balance of the $460 million change reflects the bank's shift to the overnight indexed swap (OIS) curve for discounting future cashflows for its uncollateralised trades in the second half of 2014, bringing it into line with the bank's collateralised portfolio.

The OIS rate, being lower than Libor, results in larger present values for trades. This seems to have triggered the $197 million increase in the FVA balance, but the mechanics are not explained in the report and HSBC's investor relations team were unable to clarify further.

Uncollateralised trades are often still discounted at Libor. One quant at a large global bank says OIS discounting of uncollateralised derivatives offers a neat way of adding valuation adjustments on top of a default- and funding-free price, thereby taking care of overlaps.

A spokesperson from HSBC echoes this point, describing OIS as "the benchmark rate used by the business and it is used consistently. It simplifies the computation and means all of the derivatives are valued using OIS in the first instance".

HSBC's announcement came soon after that of Credit Suisse, which took a Sfr279 million ($299 million) loss in its fourth-quarter results. Bank of America Merrill Lynch and Morgan Stanley also reported FVA losses in their fourth-quarter earnings statements.

HSBC's report suggested FVA was calculated as a spread above Libor, but did not give any further details. The industry is still divided on what funding spread should be used to calculate the adjustment. Recently, some quants have rejected the idea that FVA should be reported in earnings – instead, they say, it belongs in equity.

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