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.



	December 31, 2014				December 31, 2013
	Derivative assets		Derivative liabilities		Derivative assets		Derivative liabilities
	(in millions)
Derivatives accounted for as fair value hedges⁽¹⁾
OTC-cleared⁽²⁾	$	1	$	206	$	75	$	20
Bilateral OTC⁽²⁾	4		268		203		192
Interest rate contracts	5		474		278		212

Derivatives accounted for as cash flow hedges⁽¹⁾
Foreign exchange contracts - bilateral OTC⁽²⁾	45		—		—		3

OTC-cleared⁽²⁾	8		6		16		—
Bilateral OTC⁽²⁾	—		161		16		62
Interest rate contracts	8		167		32		62

Total derivatives accounted for as hedges	58		641		310		277

Trading derivatives not accounted for as hedges⁽³⁾
Exchange-traded⁽²⁾	46		43		82		32
OTC-cleared⁽²⁾	16,862		17,557		24,218		25,468
Bilateral OTC⁽²⁾	28,370		28,398		31,097		30,451
Interest rate contracts	45,278		45,998		55,397		55,951

Exchange-traded⁽²⁾	—		13		7		16
Bilateral OTC⁽²⁾	22,219		20,826		15,422		14,565
Foreign exchange contracts	22,219		20,839		15,429		14,581

Equity contracts - bilateral OTC⁽²⁾	1,635		1,632		1,413		1,412

Exchange-traded⁽²⁾	59		18		181		6
Bilateral OTC⁽²⁾	1,013		591		1,402		815
Precious metals contracts	1,072		609		1,583		821

OTC-cleared⁽²⁾	604		730		576		604
Bilateral OTC⁽²⁾	3,518		3,288		4,079		4,104
Credit contracts	4,122		4,018		4,655		4,708

Other derivatives not accounted for as hedges⁽¹⁾

Interest rate contracts - bilateral OTC⁽²⁾	768		88		470		91

Foreign exchange contracts - bilateral OTC⁽²⁾	—		44		—		44

Equity contracts - bilateral OTC⁽²⁾	757		167		789		148

Precious metals contracts - bilateral OTC⁽²⁾	—		5		—		36

Credit contracts - bilateral OTC⁽²⁾	73		9		9		11

Total derivatives	75,982		74,050		80,055		78,080

Less: Gross amounts of receivable / payable subject to enforceable master netting agreements⁽⁴⁾⁽⁶⁾	63,913		63,913		68,616		68,616
Less: Gross amounts of cash collateral received / posted subject to enforceable master netting agreements⁽⁵⁾⁽⁶⁾	4,811		1,724		3,870		2,116
Net amounts of derivative assets / liabilities presented in the balance sheet	7,258		8,413		7,569		7,348

Less: Gross amounts of financial instrument collateral received / posted subject to enforceable master netting agreements but not offset in the consolidated balance sheet	1,837		4,398		1,641		3,094
Net amounts of derivative assets / liabilities	$	5,421	$	4,015	$	5,928	$	4,254


⁽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 26, "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 (U.S. dollar and non-U.S. dollar 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.

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 decreased the carrying amount of our debt by $4 million during 2014, compared with an increase in the carrying amount of our debt of $2 million during 2013. We amortized $8 million and $14 million of basis adjustments related to terminated and/or re-designated fair value hedge relationships of our debt during 2014 and 2013, respectively. The total accumulated unamortized basis adjustments for terminated fair value hedges amounted to increases in the carrying amount of our debt of $21 million and $33 million as of December 31, 2014 and 2013, respectively. Basis adjustments for active fair value hedges of available-for-sale ("AFS") securities increased the carrying amount of the securities by $541 million during 2014, compared with an increase of $775 million during 2013. Total accumulated unamortized basis adjustments for active fair value hedges of available-for-sale securities amounted to an increase in the carrying amount of $458 million as of December 31, 2014, compared with a decrease of $84 million as of December 31, 2013.

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						Net Ineffective Gain (Loss) Recognized
	Interest Income (Expense)			Other Income			Interest Income (Expense)			Other Income			Other Income
	(in millions)
Year Ended December 31, 2014
Interest rate contracts/AFS Securities	$	(246	)	$	(684	)	$	375		$	668		$	(16	)
Interest rate contracts/subordinated debt	9			(4		)	(22		)	4			—
Total	$	(237	)	$	(688	)	$	353		$	672		$	(16	)

Year Ended December 31, 2013
Interest rate contracts/AFS Securities	$	(202	)	$	821		$	427		$	(801	)	$	20
Interest rate contracts/commercial loans	—			(2		)	—			—			(2		)
Interest rate contracts/subordinated debt	16			—			(61		)	2			2
Total	$	(186	)	$	819		$	366		$	(799	)	$	20

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 (loss) 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 December 31, 2014 and 2013, active cash flow hedge relationships extend or mature through July 2036. During 2014, $6 million of losses related to terminated and/or re-designated cash flow hedge relationships were amortized to earnings from accumulated other comprehensive income (loss) compared with losses of $10 million during 2013. During the next twelve months, we expect to amortize $11 million of remaining losses to earnings resulting from these terminated and/or re-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)
	2014			2013			2014			2013				2014		2013
	(in millions)

Foreign exchange contracts	$	2		$	—	Interest income (expense)	$	—		$	—		Other income	$	—	$	—
Interest rate contracts	(127		)	190		Interest income (expense)	(6		)	(10		)	Other income	—		—
Total	$	(125	)	$	190		$	(6	)	$	(10	)		$	—	$	—

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:



	Location of Gain (Loss) Recognized in Income on Derivatives	Amount of Gain (Loss) Recognized in Income on Derivatives Year Ended December 31,
	Location of Gain (Loss) Recognized in Income on Derivatives	2014			2013
		(in millions)
Interest rate contracts	Trading revenue	$	166		$	(348	)
Interest rate contracts	Residential mortgage banking revenue	63			(61		)
Foreign exchange contracts	Trading revenue	21			655
Equity contracts	Trading revenue	—			5
Precious metals contracts	Trading revenue	65			24
Credit contracts	Trading revenue	(253		)	83
Total		$	62		$	358

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:



	Location of Gain (Loss) Recognized in Income on Derivatives	Amount of Gain (Loss) Recognized in Income on Derivatives Year Ended December 31,
	Location of Gain (Loss) Recognized in Income on Derivatives	2014			2013
		(in millions)
Interest rate contracts	Gain (loss) on instruments designated at fair value and related derivatives	$	439		$	(303	)
Interest rate contracts	Residential mortgage banking revenue	(1		)	(5		)
Foreign exchange contracts	Gain (loss) on instruments designated at fair value and related derivatives	20			(70		)
Equity contracts	Gain (loss) on instruments designated at fair value and related derivatives	442			774
Precious metals contracts	Gain (loss) on instruments designated at fair value and related derivatives	11			—
Credit contracts	Gain (loss) on instruments designated at fair value and related derivatives	1			2
Credit contracts	Other income	32			(7		)
Total		$	944		$	391

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. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position as of December 31, 2014, was $7,006 million for which we had posted collateral of $6,136 million. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a liability position as of December 31, 2013, was $5,614 million for which we had posted collateral of $5,059 million. Substantially all of the collateral posted is in the form of cash or securities available-for-sale. See Note 26, "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+ by Moody’s and Standard & Poor's ("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 of our long term ratings. 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.



	Single-notch downgrade		Two-notch downgrade
Moody’s	A2		A3
	(in millions)
Amount of additional collateral to be posted upon downgrade	$	45	$	363



	Single-notch downgrade		Two-notch downgrade
S&P	A+		A
	(in millions)
Amount of additional collateral to be posted upon downgrade	$	—	$	45

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



At December 31,	2014		2013
	(in millions)
Interest rate:
Futures and forwards	$	87,406	$	175,468
Swaps	3,096,382		3,645,085
Options written	70,903		85,021
Options purchased	83,524		87,735
	3,338,215		3,993,309
Foreign Exchange:
Swaps, futures and forwards	866,835		804,278
Options written	117,088		82,817
Options purchased	118,350		84,835
Spot	58,700		52,193
	1,160,973		1,024,123
Commodities, equities and precious metals:
Swaps, futures and forwards	48,263		41,123
Options written	18,015		21,531
Options purchased	23,452		21,723
	89,730		84,377
Credit derivatives	240,737		355,286
Total	$	4,829,655	$	5,457,095