Derivative Financial Instruments

Our business activities involve analysis, evaluation, acceptance and management of some degree of risk or combination of risks. Accordingly, we have comprehensive risk management policies to address potential financial risks, which include credit risk, liquidity risk, market risk, and operational risks. Our risk management policy is designed to identify and analyze these risks, to set appropriate limits and controls, and to monitor the risks and limits continually by means of reliable and up-to-date administrative and information systems. Our risk management policies are primarily carried out in accordance with practice and limits set by the HSBC Group Management Board. The HSBC North America Asset Liability Committee ("HSBC North America ALCO") meets regularly to review risks and approve appropriate risk management strategies within the limits established by the HSBC Group Management Board. Additionally, the Risk Committee of our Board of Directors receives regular reports on our interest rate and liquidity risk positions in relation to the established limits. In accordance with the policies and strategies established by HSBC North America ALCO, in the normal course of business, we historically entered into various transactions involving derivative financial instruments. These derivative financial instruments primarily are used as economic hedges to manage risk.

Objectives for Holding Derivative Financial Instruments Market risk (which includes interest rate and foreign currency exchange risks) is the possibility that a change in underlying market rate inputs will cause a financial instrument to decrease in value or become more costly to settle. The mix of receivables on our balance sheet and the corresponding market risk is changing as we manage the liquidation of our receivable portfolio. We maintain an overall risk management strategy that utilizes derivative financial instruments to mitigate our exposure to fluctuations caused by changes in currency exchange rates related to our debt liabilities. We manage our exposure to foreign currency exchange risk primarily through the use of cross currency interest rate swaps. Historically, we managed our exposure to interest rate risk through the use of interest rate swaps with the main objective of managing the interest rate volatility due to a mismatch in the duration of our assets and liabilities.

We have entered into currency swaps to convert both principal and interest payments on debt issued in one currency to the appropriate functional currency. Interest rate swaps are contractual agreements between two counterparties for the exchange of periodic interest payments generally based on a notional principal amount and agreed-upon fixed or floating rates. The majority of our interest rate swaps were used to manage our exposure to changes in interest rates by converting floating rate debt to fixed rate or by converting fixed rate debt to floating rate.

To manage our exposure to changes in interest rates, we entered into currency swaps and historically interest rate swap agreements which have been designated as cash flow hedges under derivative accounting principles, or are treated as non-qualifying hedges. We currently utilize the long-haul method to assess effectiveness of all derivatives designated as hedges.

We do not manage credit risk or the changes in fair value due to the changes in credit risk by entering into derivative financial instruments such as credit derivatives or credit default swaps.

Credit Risk of Derivatives By utilizing derivative financial instruments, we are exposed to counterparty credit risk. Counterparty credit risk is the risk that the counterparty to a transaction fails to perform according to the terms of the contract. We manage the counterparty credit (or repayment) risk in derivative instruments through established credit approvals, risk control limits, collateral, and ongoing monitoring procedures. We utilize HSBC affiliates as the provider of our derivatives. We have never suffered a loss due to counterparty credit failure.

At September 30, 2017 and December 31, 2016, we had derivative contracts for our continuing operations with a notional amount of $419 million and $1.8 billion, respectively, which are outstanding with HSBC Bank USA, National Association (together with its subsidiaries, "HSBC Bank USA"). Derivative financial instruments are generally expressed in terms of notional principal or contract amounts which are much larger than the amounts potentially at risk for nonpayment by counterparties. Derivative agreements require that payments be made to, or received from, the counterparty when the fair value of the agreement reaches a certain level. When the fair value of our agreements with the affiliate counterparty requires the posting of collateral, it is provided in either the form of cash and recorded on the balance sheet, consistent with third party arrangements, or in the form of securities which are not recorded on our balance sheet. The fair value of our agreements with the affiliate counterparty required us to provide collateral to the affiliate of $35 million at September 30, 2017 and $317 million at December 31, 2016, all of which was provided in cash. These amounts are offset against the fair value amount recognized for derivative instruments that have been offset under the same master netting arrangement and recorded in our balance sheet as derivative financial assets or derivative related liabilities which are included as a component of other assets and other liabilities, respectively.

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 and collateral, and therefore are not representative of our exposure. The table below also presents the amounts of counterparty netting and cash collateral that have been offset in the consolidated balance sheet.



	September 30, 2017						December 31, 2016
	Derivative Financial Assets			Derivative Financial Liabilities			Derivative Financial Assets			Derivative Financial Liabilities
	(in millions)
Derivatives⁽¹⁾
Derivatives accounted for as cash flow hedges associated with debt:
Currency swaps	$	—		$	(41	)	$	—		$	(58	)
Cash flow hedges	—			(41		)	—			(58		)

Non-qualifying hedge activities:
Derivatives associated with debt carried at fair value:
Cross currency interest rate swaps	17			(13		)	15			(286		)
Derivatives associated with debt carried at fair value	17			(13		)	15			(286		)
Total derivatives	17			(54		)	15			(344		)
Less: Gross amounts offset in the balance sheet⁽²⁾	(17		)	53			(15		)	332
Net amounts of derivative financial assets and liabilities presented in the balance sheet⁽³⁾	$	—		$	(1	)	$	—		$	(12	)


⁽¹⁾	All of our derivatives are bilateral over-the-counter derivatives.


⁽²⁾	Represents the netting of derivative receivable and payable balances for the same counterparty under an enforceable netting agreement. Gross amounts offset in the balance sheet includes cash collateral paid of $35 million at September 30, 2017 and $317 million at December 31, 2016. At September 30, 2017 and December 31, 2016, we did not have any financial instrument collateral received/posted.


⁽³⁾	At September 30, 2017 and December 31, 2016, we had not received any cash not subject to an enforceable master netting agreement.

Fair Value Hedges At September 30, 2017 and December 31, 2016, we do not have any active fair value hedges. We recorded fair value adjustments to the carrying value of our debt for terminated fair value hedges which decreased the debt balance by $14 million at September 30, 2017 and $15 million at December 31, 2016.

Cash Flow Hedges Cash flow hedges include currency swaps to convert debt issued from one currency into U.S. dollar fixed rate debt and have historically also included interest rate swaps to convert our variable rate debt to fixed rate debt by fixing future interest rate resets of floating rate debt. Gains and losses on derivative instruments designated as cash flow hedges are reported in accumulated other comprehensive income (loss) and totaled losses of less than $1 million at both September 30, 2017 and December 31, 2016. We expect less than $1 million of currently unrealized net losses will be reclassified to earnings within one year. However, these reclassified unrealized losses will be offset by decreased interest expense associated with the variable cash flows of the hedged items and will result in no significant impact to our earnings.

The following table provides the gain or loss recorded on our cash flow hedging relationships.



	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)	Gain (Loss) Recognized In Income on Derivative (Ineffective Portion)
	2017		2016				2017		2016				2017		2016
	(in millions)						(in millions)						(in millions)
Three Months Ended September 30,
Interest rate swaps	$	—	$	—		Interest expense	$	—	$	—		Derivative related income (expense)	$	—	$	—
Currency swaps	—		—			Interest expense	—		—			Derivative related income (expense)	1		3
Total	$	—	$	—			$	—	$	—			$	1	$	3

Nine Months Ended September 30,
Interest rate swaps	$	—	$	18		Interest expense	$	—	$	—		Derivative related income (expense)	$	—	$	—
Currency swaps	—		(1		)	Interest expense	—		(7		)	Derivative related income (expense)	4		8
Total	$	—	$	17			$	—	$	(7	)		$	4	$	8

Non-Qualifying Hedging Activities As discussed in prior filings, during 2016 we terminated all of the interest rate swaps in our portfolio of non-qualifying hedges which we had previously used to minimize our exposure to changes in interest rates. Accordingly, there was no derivative related income (expense) for the three or nine months ended September 30, 2017 or for the three months ended September 30, 2016. Derivative related expense for interest rate contracts for the nine months ended September 30, 2016 was a loss of $117 million.

We have elected the fair value option for certain issuances of our fixed rate debt and have entered into currency swaps and historically interest rate swaps related to debt carried at fair value. The currency swaps and historically the interest rate swaps associated with this debt are non-qualifying hedges but are considered economic hedges and realized gains and losses are reported as gain (loss) on debt designated at fair value and related derivatives within other revenues. The derivatives related to fair value option debt are included in the notional amount of derivative contracts table below.

The following table provides the gain or loss recorded on the derivatives related to fair value option debt. See Note 5, "Fair Value Option," for further discussion.



	Location of Gain (Loss) Recognized in Income on Derivative	Amount of Gain (Loss) Recognized in Derivative Related Income (Expense)
		Three Months Ended September 30,					Nine Months Ended September 30,
		2017		2016			2017			2016
		(in millions)
Cross currency interest rate contracts	Gain (loss) on debt designated at fair value and related derivatives	$	—	$	(5	)	$	(10	)	$	(2	)
Total		$	—	$	(5	)	$	(10	)	$	(2	)

Notional Amount of Derivative Contracts The following table provides the notional amounts of derivative contracts.



	September 30, 2017		December 31, 2016
	(in millions)
Derivatives designated as hedging instruments:
Currency swaps	$	203	$	203
Non-qualifying hedges:
Derivatives associated with debt carried at fair value:
Cross currency interest rate swaps	216		1,562
Total	$	419	$	1,765