2008 Interim Report Section 1

RNS Number : 6154A

HSBC Holdings PLC

04 August 2008

Fair values of financial instruments

The classification of financial instruments is determined in accordance with the accounting policies set out on pages 347 to 361 of the Annual Report and Accounts 2007. The following is a description of HSBC's control framework surrounding the determination of fair values, its methods of determining fair value, and a quantification of its exposure to financial instruments measured at fair value.

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

Financial instruments measured at fair value on an ongoing basis include trading assets and liabilities, instruments designated at fair value, derivatives, and financial investments classified as available for sale (including treasury and other eligible bills, debt securities, and equity securities).

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. To this end, ultimate responsibility for the determination of fair values lies with Finance, which reports functionally to the Group Finance Director. Finance establishes the accounting policies and procedures governing valuation, and is responsible for ensuring that these comply with all relevant accounting standards.

For fair values determined by reference to external quotation or evidenced pricing parameters, independent price determination or validation is utilised. In less liquid markets, direct observation
of a traded price may not be possible. In these circumstances, HSBC will source alternative market information to validate the financial instrument's fair value. Greater weight will be given to information that is considered to be more relevant and reliable. The factors that are considered in this regard are, inter alia:

the extent to which prices may be expected to represent genuine traded or tradeable prices;
the degree of similarity between financial instruments;
the degree of consistency between different sources;
the process followed by the pricing provider to derive the data;
the elapsed time between the date to which the market data relates and the balance sheet date; and
the manner in which the data was sourced.

The results of the independent price validation process is reported to senior management, and adjustments to fair values resulting from considerations of the above information are recorded where appropriate.

For fair values determined using a valuation model, the model being a logical framework for the capture and processing of necessary valuation inputs, the control framework may include, as applicable, independent development or validation of the logic within valuation models, the inputs to those models, any adjustments required outside the valuation models, and, where possible, model outputs.

The results of the independent validation process are reported to, and considered by, Valuation Committees. Valuation Committees are composed
of valuation experts from several independent support functions (Product Control, Market Risk Management, Derivative Model Review Group and Finance) in addition to senior trading management. Any adjustments made to the assessed fair values as a result of the validation process are reported to senior management.

Determination of fair value

Fair values are determined according to the following hierarchy:

(a) Quoted market price: financial instruments with quoted prices for identical instruments in active markets.

(b) Valuation technique using observable inputs: 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.

(c) Valuation technique with significant non-observable inputs: financial instruments valued using valuation techniques where one or more significant inputs are not observable.

The best evidence of fair value is a quoted price in an actively traded market. In the event that the market for a financial instrument is not active, a valuation technique is used. The majority of valuation techniques employ only observable
market data, and so the reliability of the fair value measurement is high. However, certain financial instruments are valued on the basis of valuation techniques that feature one or more significant market inputs that are not observable. For these instruments, the fair value derived is more judgemental. 'Not observable' in this context means that there is little or no current market data available from which to determine the level at which an arm's length transaction would be likely to occur, but it generally does not mean that there is no market data available at all upon which to base a determination of fair value (consensus pricing data may, for example, be used). Furthermore, the majority of the fair value derived from a valuation technique with significant non-observable inputs may in some cases still be attributable to the observable inputs. Consequently, the impact of uncertainty in the determination of the unobservable inputs will generally only give rise to a degree of uncertainty about the overall fair value of the financial instrument being measured. To assist in understanding the extent and the range of this uncertainty, additional information is provided in respect of instruments valued using non-observable inputs in the section headed 'Effect of changes in significant non-observable assumptions to reasonably possible alternatives' below.

In certain circumstances, primarily where debt is hedged with interest rate derivatives or structured notes issued, HSBC uses fair value to measure the carrying value of its own debt in issue. Where available, fair value is based upon quoted prices in an active market for the specific instrument concerned. Where unavailable, these instruments are valued using valuation techniques, the inputs of which are based either upon quoted prices in an inactive market for the specific instrument concerned, or estimated by comparison with quoted prices in an active market for similar instruments. The fair value of these instruments therefore includes the effect of applying the credit spread which is appropriate to HSBC's liabilities. For all issued debt securities, discounted cash flow modelling is utilised to isolate that element of the change in fair value that may be attributed to HSBC credit spread movements rather than movements in other market factors such as benchmark interest rates or foreign exchange rates.

Structured notes issued and certain other hybrid instrument liabilities 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. These market spreads are significantly smaller than credit spreads observed for plain vanilla debt or in the credit default swap markets.

Gains and losses arising from changes in the credit spread of liabilities issued by HSBC reverse over the contractual life of the debt, provided that the debt is not repaid early.

All net positions in non-derivative financial instruments, and all derivative portfolios, are valued at bid or offer prices as appropriate. Long positions are marked at bid prices; short positions are marked at offer prices.

The fair values of large holdings of non-derivative financial instruments are based on a multiple of the value of a single instrument, and do not include block adjustments for the size of the holding.

The valuation techniques used when quoted market prices are not available incorporate certain assumptions that HSBC believes would be made by a market participant to establish fair value. When HSBC considers that there are additional considerations not included within the valuation model, appropriate adjustments may be made. Examples of such adjustments are:

Credit risk adjustment: an adjustment to reflect the creditworthiness of OTC derivative counterparties.
Market data/model uncertainty: an adjustment to reflect uncertainties in fair values based on unobservable market data inputs (for example, as a result of illiquidity) or in areas where the choice of valuation model is particularly subjective.
Inception profit ('day 1 P&L reserves'): for financial instruments valued at inception, on the basis of one or more significant unobservable inputs, the difference between transaction price and model value (as adjusted) at inception is not recognised in the consolidated income statement, but is deferred. This is referred to as a 'day 1' profit or loss reserve. An analysis of the movement in deferred inception profit is provided on page 221.

Transaction costs are not included in the fair value calculation. Trade origination costs such as brokerage fees and post-trade costs are included in operating expenses. The future costs of administering the OTC derivative portfolio are also not included in fair value, but are expensed as incurred.

Private equity

HSBC's private equity positions are generally classified as available for sale and are not traded in active markets. In the absence of an active market, an investment's fair value is estimated on the basis of an analysis of the investee's financial position and results, risk profile, prospects and other factors, as well as by reference to market valuations for similar entities quoted in an active market, or the price at which similar companies have changed ownership. The exercise of judgement is required because of uncertainties inherent in estimating fair value for private equity investments.

Debt securities, treasury and other eligible bills, and equities

The fair value of these instruments are based on quoted market prices from an exchange, dealer, broker, industry group or pricing service, when available. When unavailable, the fair value is determined by reference to quoted market prices for similar instruments.

Illiquidity and a lack of transparency in the market for debt securities backed by US sub-prime mortgages has resulted in less observable data being available. While quoted market prices are generally used to determine the fair value of these securities, 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.

In the absence of quoted market prices, fair value is determined using valuation techniques. The inputs to these valuation techniques are derived from observable market data and, where relevant, assumptions in respect of unobservable inputs. In respect of ABSs and mortgages, the assumptions may include prepayment speeds, default rates and loss severity based on collateral type, and performance as appropriate.

Derivatives

OTC (i.e. non-exchange traded) derivatives are valued using valuation models. Valuation models calculate the present value of expected future cash flows, based upon 'no-arbitrage' principles. For many vanilla derivative products, such as interest rate swaps and European options, 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. Finally, some inputs are not observable, but can generally be estimated from historical data or other sources. Examples of inputs that are generally observable include foreign exchange spot and forward rates, benchmark interest rate curves and volatility surfaces for commonly traded option products. Examples of inputs that may be unobservable include volatility surfaces, in whole or in part, for less commonly traded option products, and correlations between market factors.

Loans including leveraged loans and loans held for securitisation

Loans held at fair value are valued from broker quotes and/or market data consensus providers when available. In the absence of an observable market, the fair value is determined using valuation techniques including discounted cash flow models, which incorporate assumptions regarding an appropriate credit spread for the loan derived from other market instruments issued by the same or comparable entities.

Structured notes

For structured notes whose fair value is derived from a valuation technique, the fair value will be derived from the fair value of the underlying debt security as described above, and the fair value of the embedded derivative determined as described in the section above on derivatives.

Fair value valuation bases

The following table provides an analysis of the various bases described above which have been deployed for valuing financial assets and financial liabilities measured at fair value in the consolidated financial statements:

Bases of valuing financial assets and liabilities measured at fair value

		Valuation techniques:
	Quoted market price	using observable inputs	with significant non-observable inputs	Total
	US$m	US$m	US$m	US$m
At 30 June 2008
Assets
Trading assets	224,459	234,478	14,600	473,537
Financial assets designated at fair value	22,884	17,352	550	40,786
Derivatives	7,208	247,894	5,562	260,664
Financial investments: available-for-sale	92,881	162,860	7,986	263,727

Liabilities
Trading liabilities	143,134	188,130	9,347	340,611
Financial liabilities at fair value	27,097	62,503	158	89,758
Derivatives	7,998	240,779	2,580	251,357

At 31 December 2007
Assets
Trading assets	209,339	222,678	13,951	445,968
Financial assets designated at fair value	28,565	12,694	305	41,564
Derivatives	8,132	175,493	4,229	187,854
Financial investments: available-for-sale	77,045	187,677	8,510	273,232

Liabilities
Trading liabilities	140,629	167,967	5,984	314,580
Financial liabilities at fair value	37,709	52,230	-	89,939
Derivatives	8,879	171,444	3,070	183,393

Financial assets and liabilities measured at fair value with significant unobservable inputs are concentrated in trading assets and liabilities. At 30 June 2008 this represented 3 per cent of these assets and liabilities (31 December 2007: 3 per cent).

Financial instruments measured at fair value using a valuation technique with significant unobservable inputs

	Assets					Liabilities
	Available for sale	Held for trading	Designated at fair value through profit or loss		Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m	US$m		US$m	US$m	US$m		US$m	US$m
At 30 June 2008
Private equity investments	2,904	43		56	-	-		-	-
Asset-backed securities	4,495	3,655		-	-	-		-	-
Leveraged finance	-	3,376		-	-	-		-	-
Loans held for securitisation	-	4,125		-	-	-		-	-
Structured notes	-	240		-	-	7,548		-	-
Derivatives with monolines	-	-		-	1,284	-		-	-
Other derivatives	-	-		-	4,278	-		-	2,580
Other portfolios	587	3,161		494	-	1,799		158	-

	7,986	14,600		550	5,562	9,347		158	2,580

At 31 December 2007
Private equity investments	3,037	-		-	-	-		-	-
Asset-backed securities	4,223	2,073		-	-	300		-	-
Leveraged finance	-	3,349		-	-	-		-	-
Loans held for securitisation	-	5,100		-	-	-		-	-
Structured notes	-	-		-	-	5,396		-	-
Derivatives with monolines	-	-		-	1,010	-		-	-
Other derivatives	-	-		-	3,219	-		-	3,070
Other portfolios	1,250	3,429		305	-	288		-	-

	8,510	13,951		305	4,229	5,984		-	3,070

At 30 June, 2008 available-for-sale assets using a valuation technique with significant unobservable inputs, principally comprise various ABSs and private equity investments similar to the position at 31 December 2007. The reduction in financial instruments measured at fair value using a valuation technique with significant unobservable inputs in the first half of 2008 is due to an improvement in the liquidity of unquoted equity securities recognised within 'Other portfolios'.

Trading assets valued using a valuation technique with significant unobservable inputs principally comprise various ABSs, loans held for syndication, leveraged loans underwritten by HSBC, and other portfolios. Other portfolios include holdings in various bonds, preference shares and corporate and mortgage loans. The increase in the period largely reflects the reduced availability of market observable inputs for the valuation of certain ABSs which necessitated reclassifying some of the existing exposures. This has been partially offset by a fall in the amount of bonds and mortgage loans classified in this category as a result of reduced asset valuations.

Derivative products valued using valuation techniques with significant unobservable inputs include certain types of correlation products, such as foreign exchange basket options, foreign exchange-interest rate hybrid transactions and long-dated option transactions. Examples of the latter are equity options, interest rate and foreign exchange options and certain credit derivatives. Credit derivatives include tranched credit default swap transactions. The increase in derivative assets during the period was mainly due to the reclassification of certain leveraged credit derivative transactions because widening credit spreads have increased the significance of unobservable credit spread volatilities.

Trading liabilities valued using a valuation technique with significant unobservable inputs have increased in the period in line with the issuance of equity linked structured note transactions. HSBC issues these notes to investors which provide the counterparty with a return that is linked to the performance of certain equity securities. The valuation of these securities is dependent upon the implied volatility of the reference equities which is often not observable for the maturity of the note.

Effect of changes in significant unobservable assumptions to reasonably possible alternatives

As discussed above, the fair value of financial instruments are, in certain circumstances, measured using valuation techniques that incorporate assumptions that are not evidenced by prices from observable current market transactions in the same instrument and cannot be based on observable market data. The following table shows the sensitivity of fair values to reasonably possible alternative assumptions:

	Reflected in profit/(loss)		Reflected in equity
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m
At 30 June 2008
Derivatives/trading assets/trading liabilities1	1,176	(962)	-	-
Financial assets/liabilities designated at fair value	33	(28)	-	-
Financial investments: available for sale	-	-	860	(936)

At 31 December 2007
Derivatives/trading assets/trading liabilities1	602	(415)	-	-
Financial assets/liabilities designated at fair value	30	(30)	-	-
Financial investments: available for sale	-	-	529	(591)

1 Derivatives, trading assets and trading liabilities are presented as one category to reflect the manner in which these financial instruments are risk-managed.

The increase in the effect of changes in significant unobservable inputs in relation to derivatives, trading assets and trading liabilities in the period primarily reflects increased uncertainty in determining the fair value of credit derivative transactions executed against certain monoline insurers. In addition, there has been a general increase in structured derivative business exposures and the valuation measurement uncertainty of certain ABSs.

Changes in fair value recorded in the income statement

The following table quantifies the changes in fair values recognised in profit or loss during the period in respect of exposures where the fair value of these exposures is estimated using valuation techniques that incorporate significant assumptions that are not evidenced by prices from observable current market transactions in the same instrument, and are not based on observable market data:

the table details the total change in fair value of these instruments; it does not isolate the component of the change that is attributable to the unobservable component;
instruments valued with significant unobservable inputs are frequently dynamically managed with instruments valued using observable inputs; the table does not include any changes in fair value of these latter instruments; and

for assets and liabilities valued using significant unobservable inputs at 30 June 2008 where these inputs were observable at 31 December 2007; the table reflects the full change in fair value of those instruments during the period.

	Half-year to 30 June 2008
	US$m

Recorded profit/(loss) on:
Derivatives/trading assets/ trading liabilities	(1,415)
Financial assets/liabilities designated at fair value	13

The loss in the period primarily reflects reductions in the fair value of credit derivatives reclassified from using a valuation technique with significant observable inputs to significant unobservable inputs. In addition, other reductions occurred due to write-downs of MBSs, mortgage loans acquired for the purpose of securitisation and credit derivative transactions executed against monoline insurers.

Assessing available-for-sale assets for impairment

HSBC's policy on impairment of available-for-sale assets is described on page 116. The following is a description of HSBC's application of that policy.

An impairment review is carried out systematically and periodically of all available-for-sale assets and all available indicators are considered to determine whether there is any objective evidence that an impairment may have occurred, whether the result of a single loss event or the combined effect of several events.

Debt securities

For available-for-sale debt securities, objective evidence includes observable data or information about events specifically relating to the securities, which may result in a shortfall in recovery of future cash flows. These may include a significant financial difficulty of the issuer; a breach of contract, such as a default; bankruptcy or other financial reorganisation; or the disappearance of an active market for that debt security because of financial difficulties relating to the issuer.

These types of specific event and other factors such as information about the issuers' liquidity, business and financial risk exposures, levels of and trends in default for similar financial assets, national and local economic trends and conditions, and the fair value of collateral and guarantees may be considered individually, or in combination, to determine if there is objective evidence of impairment of a debt security.

In assessing whether there is any objective evidence of impairment of available-for-sale ABSs at the balance sheet date, factors such as the performance of underlying collateral, the extent and depth of market price declines and changes in credit ratings are considered.

The population of available-for-sale ABSs at 30 June 2008 which have been identified to be the most at risk of impairment includes residential MBSs backed by sub-prime and Alt-A mortgages originated in the US and CDOs with significant exposure to this sector. The estimated future cash flows of available-for-sale ABSs are assessed to determine whether any of these cash flows are unlikely to be recovered as a result of events occurring before the balance sheet date. The estimated future cash flows of residential MBSs are assessed by determining the future projected cash flows arising on the underlying collateral, taking into consideration the delinquency status of underlying loans, the probability of delinquent loans progressing to default and the subsequent proportion of the advances recoverable. A determination is made of cash flows on loans that are not delinquent as of the assessment date by applying a modelling approach which reflects observed progression rates to default. If the decline in projected cash flows from the underlying collateral exceeds the expected credit support, the investment is considered to be impaired.

The estimated future cash flows of CDOs are assessed by applying management's expectations of losses arising from cumulative defaults on the underlying collateral occurring prior to the balance sheet date. A determination is made as to whether expected future losses will exceed the current credit support available to the CDOs.

Where a security benefits from a contract provided by a monoline insurer that insures payments of principal and interest, the expected recovery on this contract is assessed in determining the total expected credit support available to the ABS.

Equity Securities

Objective evidence of impairment for available-
for-sale equity securities may include specific information about the issuer as detailed above, but may also include information about significant changes that have taken place in the technological, market, economic or legal environments, which provide evidence that the cost of the equity securities may not be recovered. A significant or prolonged decline in the fair value of the asset below its cost is also objective evidence of impairment.

For impairment losses on available-for-sale
debt and equity securities, see pages 103 and 99, respectively.

Fair values of financial instruments not carried at fair value

Financial instruments that are not measured at fair value on the balance sheet include loans and advances to banks and customers, debt securities, deposits by banks, customer accounts, debt securities in issue and subordinated liabilities. Their fair values are, however, provided for information by way of note disclosure and are calculated as described below.

The calculation of fair value incorporates HSBC's estimate of the amount at which financial assets could be exchanged, or financial liabilities settled, between knowledgeable, willing parties in an arm's length transaction. It does not reflect the economic benefits and costs that HSBC expects to flow from the instruments' cash flows over their expected future lives. Other reporting entities may use different valuation methodologies and assumptions in determining fair values for which no observable market prices are available, so comparisons of fair values between entities may not be meaningful and users are advised to exercise caution when using this data.

Since August 2007, the unstable market conditions in the US mortgage lending industry have resulted in a significant reduction in the secondary market demand for US consumer lending assets. Uncertainty over the extent and timing of future credit losses, together with an absence of liquidity for non-prime ABSs, continued to be reflected in a lack of bid prices at 30 June 2008. It is not possible to distinguish from the indicative market prices that are available the relative discount to nominal value within the fair value measurement that reflects cash flow impairment due to expected losses to maturity, from the discount that the market is demanding for holding an illiquid and out of favour asset. Under impairment accounting for loans and advances, there is no need nor requirement to adjust carrying values to reflect illiquidity as the intention is to fund assets until the earlier of prepayment, charge-off or repayment on maturity. Market fair values, on the other hand, reflect both incurred loss and loss expected through the life of the asset, a discount for illiquidity, and a credit spread which reflects the market's current risk preferences rather than the credit spread applicable in the market at the time the loan was underwritten and funded.

The estimated fair values at 31 December 2007 and 30 June 2008 of loans and advances to customers in North America reflect the combined effect of these conditions. This results in fair values that are substantially lower than the carrying value of customer loans held on-balance sheet and lower than would otherwise be reported under more normal market conditions. Accordingly, the fair values reported do not reflect HSBC's estimate of the underlying long-term value of the assets.

Fair values at the balance sheet date of the assets and liabilities set out below are estimated for the purpose of disclosure as follows:

(i) Loans and advances to banks and customers

The fair value of loans and advances is based on observable market transactions, where available. In the absence of observable market transactions, fair value is estimated using discounted cash flow models. Performing loans are grouped, as far as possible, into homogeneous pools segregated by maturity and coupon rates. In general, contractual cash flows are discounted using HSBC's estimate of the discount rate that a market participant would use in valuing instruments with similar maturity, repricing and credit risk characteristics.

The fair value of a loan portfolio reflects both loan impairments at the balance sheet date and estimates of market participants' expectations of credit losses over the life of the loans.

For impaired loans, fair value is estimated by discounting the future cash flows over the time period they are expected to be recovered.

(ii) 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 take into consideration the prices and future earnings streams of equivalent quoted securities.

(iii) Deposits by banks and customer accounts

For the purposes of estimating fair value, deposits by banks and customer accounts are grouped by residual maturity. Fair values are estimated using discounted cash flows, applying current rates offered for deposits of similar remaining maturities. The fair value of a deposit repayable on demand is assumed to be the amount payable on demand at the balance sheet date.

(iv) Debt securities in issue and subordinated liabilities

Fair values are determined using quoted market prices at the balance sheet date where available, or by reference to quoted market prices for similar instruments.

The fair values in this note are stated at a specific date and may be significantly different from the amounts which will actually be paid on the maturity or settlement dates of the instruments. In many cases, it would not be possible to realise immediately the estimated fair values given the size of the portfolios measured. Accordingly, these fair values do not represent the value of these financial instruments to HSBC as a going concern.

For all classes of financial instruments, fair value represents the product of the value of a single instrument, multiplied by the number of instruments held. No block discount or premium adjustments are made.

The fair values of intangible assets related to the businesses which originate and hold the financial instruments subject to fair value measurement, such as values placed on portfolios of core deposits, credit card and customer relationships, are not included above because they are not classified as financial instruments. Accordingly, an aggregation of fair value measurements does not approximate to the value of the organisation as a whole as a going concern.

The following table lists financial instruments whose carrying amount is a reasonable approximation of fair value because, for example, they are short-term in nature or reprice to current market rates frequently:

Assets

Cash and balances at central banks

Items in the course of collection from other banks

Hong Kong Government certificates of indebtedness

Endorsements and acceptances

Short-term receivables within 'Other assets'

Accrued income

Liabilities

Hong Kong currency notes in circulation

Items in the course of transmission to other banks

Endorsements and acceptances

Short-term payables within 'Other liabilities'

Accruals

Fair values of financial instruments which are not carried at fair value on the balance sheet

	At 30 June 2008		At 31 December 2007
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Assets
Loans and advances to banks	256,981	256,944	237,366	237,374
Loans and advances to customers	1,049,200	1,013,869	981,548	951,850
Financial investments: debt securities	11,023	11,159	9,768	10,154

Liabilities
Deposits by banks	154,152	154,284	132,181	132,165
Customer accounts	1,161,923	1,161,845	1,096,140	1,095,727
Debt securities in issue	230,267	226,199	246,579	243,802
Subordinated liabilities	31,517	29,942	24,819	23,853

Fair values of financial investments classified as held for sale which are not carried at fair value on the balance sheet

	At 30 June 2008		At 31 December 2007
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Assets classified as held for sale
Loans and advances to banks and customers	1,852	1,526	14	14
Financial investments: debt securities	37	37	27	27

The above fair values exclude balances relating to the regional French banks sold on 2 July 2008 (see Note 22 on the Financial Statements).

Analysis of loans and advances to customers by geographical segment

	At 30 June 2008		At 31 December 2007
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Loans and advances to customers
Europe	508,960	507,280	452,275	450,010
Hong Kong	99,741	99,368	89,638	89,908
Rest of Asia-Pacific	113,757	113,869	101,852	101,860
North America1	272,490	239,208	289,860	262,123
Latin America	54,252	54,144	47,923	47,949

	1,049,200	1,013,869	981,548	951,850

1 The reasons for the significant difference between carrying amount and fair value of loans and advances to customers in North America are discussed on page 135.

Special purpose entities

This section contains disclosures about HSBC-sponsored SPEs that are included in HSBC's consolidated balance sheet, with a particular focus on SPEs containing exposures affected by recent turmoil in credit markets, and those that are not consolidated by HSBC under IFRSs. In addition to the disclosures about SPEs, information on other off-balance sheet arrangements has been included in this section.

HSBC enters into certain transactions with customers in the ordinary course of business which involve the establishment of SPEs to facilitate or secure customer transactions.

HSBC structures that utilise SPEs are authorised centrally when they are established to ensure appropriate purpose and governance. The activities of SPEs administered by HSBC are closely monitored by senior management. HSBC's involvement with SPE transactions is described below.

HSBC-sponsored SPEs

HSBC sponsors the formation of entities which are designed to accomplish certain narrow and well-defined objectives, such as securitising financial assets or effecting a lease and this requires a form of legal structure that restricts the assets and liabilities within the structure to the single purpose for which it was established. HSBC consolidates these SPEs when the substance of the relationship indicates that HSBC controls them. The qualitative and quantitative factors considered by HSBC when determining if HSBC controls an SPE are described on page 183 of the Annual Report and Accounts 2007.

HSBC reassesses the required consolidation accounting tests whenever there is a change in the substance of a relationship between HSBC and an SPE, for example, when the nature of HSBC's involvement or the governing rules, contractual arrangements or capital structure of the SPE change. The most significant categories of SPEs are discussed in more detail below.

Structured investment vehicles and conduits

Structured investment vehicles

SIVs are SPEs which invest in diversified portfolios of interest-earning assets, generally funded through issues of commercial paper ('CP'), medium-term notes ('MTNs') and other senior debt to take advantage of the spread differentials between the assets in the SIV and the funding cost. Prior to the implementation of Basel II, it was capital efficient to many bank investors to invest in highly-rated investment securities in this way. HSBC sponsored the establishment of two SIVs, Cullinan Finance Limited ('Cullinan') and Asscher Finance Limited ('Asscher'), in 2005 and 2007, respectively. For reasons described in the Annual Report and Accounts 2007, HSBC consolidated Cullinan and Asscher in November 2007.

There are two main challenges for the SIV sector which could force asset sales: an inability to fund in the CP markets, and the sensitivity of the continuing operation of SIVs to changes in the market value of their underlying assets.

In order to remove the risk of having to make forced asset sales, HSBC established three new securities investment conduits (defined below on page 141) to take on the assets held in Cullinan and Asscher. Mazarin Funding Limited ('Mazarin'), an asset backed CP conduit, and Barion Funding Limited ('Barion'), a term-funding vehicle, were set up in respect of Cullinan; and Malachite Funding Limited ('Malachite'), a term-funding vehicle, was set up in respect of Asscher. The investors in the capital notes issued by Cullinan and Asscher had the option of exchanging their existing capital notes for the capital notes of the new conduits. In addition, the new conduits agreed to purchase the assets in Cullinan and Asscher. As a result of this agreement the legal title of all Cullinan and Asscher's assets were transferred to the new conduits. However, the transfer of the assets will be settled over a time period that coincides with the maturity of Cullinan and Asscher's senior debt.

During the first half of 2008, 91.3 per cent of the remaining capital note holders in Asscher and all of the capital note holders in Cullinan elected to exchange their existing holdings for capital notes in the new conduits. The holders of such capital notes bear the risks of any actual losses arising in the new conduits up to US$2.4 billion, being the par value of their respective holdings. Prior to the exchanges of assets against capital note extinguishments, the par value of the capital notes was US$2.6 billion. On consolidation, in November 2007, the carrying value of the capital notes was written down by US$1.3 billion to reflect the fair value of the assets at date of consolidation. During the first half of 2008, further impairment charges of US$134 million have been recognised leaving a US$1.2 billion of first loss protection from capital notes holders.

At 30 June 2008, the assets in Cullinan and Asscher sold to the new conduits but not yet settled were as follows:

	Cullinan	Asscher
	US$bn	US$bn

Mazarin	0.6	-
Barion	3.2	-
Malachite	-	2.2

	3.8	2.2

Mazarin is funded by CP, MTN issuance and term repos, which benefit from a 100 per cent liquidity facility provided by HSBC. Barion and Malachite are funded by term finance provided by HSBC. Unlike the SIVs, where liquidity ultimately relies on the ability to sell assets for cash, the continuing operations of the new conduits are not
as sensitive to market value fluctuations in their underlying assets. On establishment of the new conduits, HSBC concluded that it was appropriate
to consolidate them onto its balance sheet.

Mazarin, Barion and Cullinan

An analysis of the assets held by Mazarin, Barion and Cullinan at 30 June 2008 and 31 December 2007 is set out below:

Ratings analysis of assets

	At 30 June 2008			20071
	Mazarin	Barion	Cullinan	Cullinan
	US$bn	US$bn	US$bn	US$bn
S&P ratings
AAA	9.4	3.0	2.5	22.2
AA	2.7	1.8	0.9	2.9
A	0.4	0.6	0.2	3.1
BBB	0.1	0.2	0.1	0.1
BB	-	0.1	-	-

Total investments	12.6	5.7	3.7	28.3
Cash and other assets	1.1	0.2	0.1	5.0

	13.7	5.9	3.8	33.3

Composition of asset portfolio

	At 30 June 2008			20071
	Mazarin	Barion	Cullinan	Cullinan
	US$bn	US$bn	US$bn	US$bn
Asset class
Structured finance
Residential MBSs	4.4	2.0	0.8	11.2
Commercial MBSs	1.5	0.6	0.9	3.7
Student loan securities	1.7	0.1	0.2	2.2
Vehicle finance loans securities	0.2	0.1	-	0.3
Leverage loan securities	0.8	0.4	0.4	2.0
Other ABSs	1.6	0.2	0.5	6.4

	10.2	3.4	2.8	25.8

1 At 31 December 2007.

	At 30 June 2008			20071
	Mazarin	Barion	Cullinan	Cullinan
	US$bn	US$bn	US$bn	US$bn

Finance
Commercial bank securities and deposits	1.7	1.6	0.8	6.3
Investment bank debt securities	1.8	0.9	0.2	0.7
Finance company debt securities	-	-	-	0.5

	3.5	2.5	1.0	7.5

	13.7	5.9	3.8	33.3

The reduction in Cullinan's asset portfolio from US$33.3 billion at 31 December 2007 to US$3.8 billion at 30 June 2008 reflects asset sales to the new conduits, exchanges of assets against capital note extinguishments with HSBC and third parties, as well as amortisation and fair value movements of the portfolio.

Exposure to US sub-prime and Alt-A

	At 30 June 2008			20071
	Mazarin	Barion	Cullinan	Cullinan
	US$bn	US$bn	US$bn	US$bn
US sub-prime mortgages	0.4	1.5	0.1	3.2
Alt-A	2.5	0.1	0.1	4.4

	2.9	1.6	0.2	7.6

During the first half of 2008, the credit ratings of certain ABSs, many with exposures to US sub-prime and Alt-A mortgages, were downgraded by rating agencies. As at 30 June 2008, 84 per cent remain AAA rated (31 December 2007: all the assets exposed to US sub-prime and Alt-A mortgages were AAA rated).

Total assets by balance sheet classification

	At 30 June 2008			20071
	Mazarin	Barion	Cullinan	Cullinan
	US$bn	US$bn	US$bn	US$bn

Derivative assets	-	-	-	0.2
Loans and advances to banks	0.6	0.1	-	2.4
Financial investments	13.0	5.8	3.8	30.5
Other assets	0.1	-	-	0.2

	13.7	5.9	3.8	33.3

Weighted average maturity of assets

	At 30 June 2008			20071
	Mazarin	Barion	Cullinan	Cullinan
	US$bn	US$bn	US$bn	US$bn

0-6 months	0.2	0.2	0.4	6.1
6-12 months	0.5	0.1	-	1.6
Over 12 months	13.0	5.6	3.4	25.6

	13.7	5.9	3.8	33.3

The weighted average lives of the portfolios at 30 June 2008 were 4.3 years for Mazarin, 4.1 years for Barion and 4.4 years for Cullinan (31 December 2007: 4 years).

Funding structure

	At 30 June 2008			At 31 December 2007
	Total	Provided by HSBC		Total	Provided by HSBC
	US$bn		US$bn	US$bn	US$bn
Mazarin
Capital notes	0.7		-	-	-
Commercial paper	9.9		9.4	-	-
Medium-term notes	2.3		0.6	-	-
Term repos executed	2.4		2.4	-	-

	15.3		12.4	-	-

	At 30 June 2008			At 31 December 2007
	Total	Provided by HSBC		Total	Provided by HSBC
	US$bn		US$bn	US$bn	US$bn
Barion
Capital notes	0.2		-	-	-
Commercial paper	-		-	-	-
Medium-term notes	2.7		2.7	-	-
Term repos executed	3.6		3.6	-	-

	6.5		6.3	-	-

Cullinan
Capital notes	-		-	1.0	-
Commercial paper	2.0		2.0	5.3	2.3
Medium-term notes	1.6		0.3	19.7	3.8
Term repos executed	0.3		0.3	7.1	7.1

	3.9		2.6	33.1	13.2

The weighted average lives of CP funding liabilities were 0.3 years for Mazarin and 0.6 years for Cullinan (2007: 0.56 years), and the weighted average lives of MTN funding liabilities were 4.2 years for Mazarin, 10.9 years for Barion and 0.3 years for Cullinan (2007: 1.13 years). Cullinan's CP and MTN funding will be repaid when they fall due using the proceeds of asset sales to Mazarin and Barion at a pre-agreed price.

1 At 31 December 2007.

HSBC's maximum exposure

Mazarin:

HSBC is exposed to the par value of Mazarin's assets through the provision of a liquidity facility equal to the lesser of the amortised cost of issued super senior debt and the amortised cost of non-defaulted assets.

At 30 June 2008 HSBC's maximum exposure amounted to US$14.2 billion.

First loss protection is provided through the capital notes held by third parties.

Barion:

Barion is term funded by HSBC, consequently HSBC's maximum exposure to the conduit is represented by the amortised cost of the debt required to support the non-cash assets of the vehicle. At 30 June 2008 this amounted to US$6.2 billion.

First loss protection is provided through the capital notes held by third parties.

Cullinan:

As discussed on page 138, Mazarin and Barion agreed to purchase the assets in Cullinan. The capital and liquidity structure of Mazarin and Barion determines HSBC's maximum exposure to Cullinan. At 30 June 2008 HSBC's maximum exposure was US$4.2 billion (31 December 2007: US$32.8 billion).

HSBC's maximum exposure is greater than the present level of funding provided by HSBC to Cullinan because the senior debt in Cullinan held by third parties is expected to benefit from term funding or liq uidity facilities provided by HSBC following the transfer of the assets to Mazarin and Barion.

Malachite and Asscher

An analysis of the assets held by Malachite and Asscher at 30 June 2008 and 31 December 2007 is set out below.

Ratings analysis of assets

	At 30 June 2008		20071
	Malachite	Asscher	Asscher
	US$bn	US$bn	US$bn
S&P ratings
AAA	2.8	2.0	6.1
AA	0.5	0.1	0.4
A	0.2	0.1	0.3
BBB	0.1	-	-

Total investments	3.6	2.2	6.8
Cash and other assets	0.1	-	0.6

	3.7	2.2	7.4

Composition of asset portfolio

	At 30 June 2008		20071
	Malachite	Asscher	Asscher
	US$bn	US$bn	US$bn
Asset class
Structured finance
Residential MBSs	1.3	1.0	3.3
Commercial MBSs	0.3	0.8	1.3
Student loan securities	0.4	-	0.4
Leverage loan securities	0.7	0.1	0.8
Other ABSs	0.2	0.3	0.5

	2.9	2.2	6.3

Finance
Commercial bank securities and deposits	0.3	-	1.0
Investment bank debt securities	0.5	-	0.1
Finance company debt securities	-	-	-

	0.8	-	1.1

	3.7	2.2	7.4

The reduction in Asscher's asset portfolio from US$7.4 billion at 31 December 2007 to US$2.2 billion at 30 June 2008 reflects asset sales to the new conduits, exchanges of assets against capital note extinguishments with HSBC and third parties, as well as amortisation and fair value movements of the portfolio.

Exposure to US sub-prime and Alt-A

	At 30 June 2008		20071
	Malachite	Asscher	Asscher
	US$m	US$m	US$m
US sub-prime mortgages	70	125	316
Alt-A	643	394	1,451

	713	519	1,767

1 At 31 December 2007.

Total assets by balance sheet classification

	At 30 June 2008		20071
	Malachite	Asscher	Asscher
	US$bn	US$bn	US$bn

Derivative assets	-	-	0.1
Loans and advances to banks	0.1	-	0.7
Financial investments	3.6	2.2	6.6

	3.7	2.2	7.4

Weighted average maturity of assets

	At 30 June 2008		20071
	Malachite	Asscher	Asscher
	US$bn	US$bn	US$bn

0-6 months	-	-	0.8
6-12 months	0.2	0.2	0.6
Over 12 months	3.5	2.0	6.0

	3.7	2.2	7.4

1 At 31 December 2007.

The weighted average lives of the portfolios at 30 June 2008 were 4.0 years for Malachite and 2.6 years for Asscher (31 December 2007: 3.7 years).

Funding structure

	At 30 June 2008			At 31 December 2007
	Total	Provided by HSBC		Total	Provided by HSBC
	US$bn		US$bn	US$bn	US$bn
Malachite
Capital notes	0.3		-	-	-
Commercial paper	-		-	-	-
Medium-term notes	0.3		0.3	-	-
Term repos executed	3.6		3.6	-	-

	4.2		3.9	-	-

Asscher
Capital notes	-		-	0.3	-
Commercial paper	-		-	2.0	0.1
Medium-term notes	2.1		0.1	3.5	1.5
Term repos executed	0.2		0.2	1.6	1.1

	2.3		0.3	7.4	2.7

The weighted average lives of MTN funding liabilities for Asscher was 0.1 years (31 December 2007: 1.03 years) and 5.12 years for Malachite. These MTNs will be repaid when they fall due using the proceeds from asset sales to Malachite at a preߛagreed price. There was no outstanding CP at 30 June 2008; the weighted average lives of CP Funding at 31 December 2007 was 0.44 years.

HSBC's maximum exposure

Malachite:

Malachite is term funded by HSBC, consequently HSBC's maximum exposure to the conduit is represented by the amortised cost of the debt required to support the non-cash assets of the vehicle. At 30 June 2008 this amounted to US$3.9 billion.

First loss protection is provided through the capital notes held by third parties.

Asscher:

As discussed on page 138, Malachite agreed to purchase the assets in Asscher. The capital and liquidity structure of Malachite determines HSBC's maximum exposure to Asscher. At 30 June 2008 HSBC's maximum exposure was US$2.3 billion (31 December 2007: US$7.2 billion).

HSBC's maximum exposure is greater than the present level of funding provided by HSBC to Asscher because the senior debt in Asscher held by third parties is not expected to be refinanced in the market following the transfer of the assets to Malachite.

Conduits

HSBC sponsors and manages two types of conduits which issue CP; multi-seller conduits and securities investment conduits. HSBC has consolidated these conduits from inception because it is exposed to the majority of risks and rewards of ownership.

Securities investment conduits

Solitaire purchases highly rated ABSs to facilitate tailored investment opportunities. HSBC's other securities investment conduits, Mazarin, Barion and Malachite evolved from the restructuring of HSBC's sponsored SIVs and are discussed above.

The following tables analyse the assets held by Solitaire at 30 June 2008 is set out below:

Solitaire - Ratings analysis of assets

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn
S&P ratings
AAA	16.0	20.8
AA	0.8	-
A	0.5	-
BBB	0.2	-

Total investments	17.5	20.8
Cash and other assets	0.2	0.8

	17.7	21.6

Solitaire - Composition of asset portfolio

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn
Asset class
Structured finance
Residential MBSs	6.7	9.3
Commercial MBSs	3.5	3.7
Student loan securities	3.1	3.5
Vehicle finance loans securities	0.1	0.1
Leverage loan securities	2.2	2.2
Other ABSs	1.9	2.2

	17.5	21.0

Finance
Commercial bank securities and deposits	0.2	0.6

	17.7	21.6

Solitaire - Exposure to US sub-prime and Alt-A

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

US sub-prime mortgages	1.3	1.9
Alt-A	3.4	5.3

	4.7	7.2

It should be noted that securities purchased by Solitaire typically benefit from substantial transaction specific credit enhancements for example, first loss tranches and/or excess spread, which absorb any credit losses before they would fall on the tranche held by Solitaire.

During the first half of 2008, the credit ratings of certain ABSs, many with exposures to US sub-prime and Alt-A mortgages, were downgraded by rating agencies. As at 30 June 2008 89 per cent remain AAA rated (31 December 2007: all the assets exposed to US sub-prime and Alt-A mortgages were AAA rated).

Solitaire - Total assets by balance sheet classification

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn
Financial instruments designated at fair value	0.1	0.1
Derivative assets	-	0.1
Loans and advances to banks	-	0.2
Financial investments	17.5	20.6
Other assets	0.1	0.6

	17.7	21.6

Solitaire - Weighted average maturity of assets

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

0-6 months	1.4	0.3
6-12 months	-	0.3
Over 12 months	16.3	21.0

	17.7	21.6

The weighted average life of the portfolio at 30 June 2008 was 5.5 years (31 December 2007: 5.3 years).

Solitaire - Funding structure

	Total	Provided by HSBC
	US$bn	US$bn
At 30 June 2008
Commercial paper	21.0	8.0
Term repos executed	0.6	0.6

	21.6	8.6

At 31 December 2007
Commercial paper	23.0	7.8

The weighted average life of CP funding liabilities at 30 June 2008 was 0.1 years (31 December 2007: 0.44 years).

Solitaire - HSBC's maximum exposure

CP issued by Solitaire benefits from a 100 per cent liquidity facility provided by HSBC. First loss credit protection, after any transaction specific credit enhancement (described above) and retained reserves, is provided by HSBC in the form of a letter of credit with a notional value US$1.2 billion at 30 June 2008 (31 December 2007: US$1.2 billion).

HSBC's maximum exposure to Solitaire is limited to the amortised cost of non-cash equivalent assets, which reflects the risk that HSBC may be required to fund the vehicle in the event the debt is redeemed without reinvestment from third parties.

HSBC's maximum exposure at 30 June 2008 amounted to US$21.6 billion (31 December 2007: US$25.7 billion).

Multi-seller conduits

These vehicles were established for the purpose of providing access to flexible market-based sources of finance for HSBC's clients, for example, to finance discrete pools of third party-originated vehicle finance loan receivables. HSBC's principal multi-seller conduits are Regency Assets Limited ('Regency'), Bryant Park Funding Limited LLC ('Bryant Park'), Abington Square Funding LLC ('Abington Square') and Performance Trust.

The multi-seller conduits purchase or fund interests in diversified pools of third party assets financed by the issuance of CP. The cash flows received by the conduits from the third party assets are used to service the funding, and to provide a commercial rate of return for HSBC for structuring, various other administrative services and the liquidity support it provides to the conduits. The asset pools acquired by the conduits are structured so that on the back of the credit enhancement the conduits receive, equating to senior investment grade ratings and the benefit of liquidity facilities typically provided by HSBC, the CP issued by the multi-seller conduits is itself highly rated.

During the first half of 2008, the finance provided by HSBC to Abington Square Funding LLC at the end of 2007 was repaid using the proceeds received from refinancing the assets within the conduit. At 30 June 2008, the conduit did not enter into any new securitisation transactions.

An analysis of the assets held by the multi-seller conduits is set out below:

Multi-seller conduits - Total assets by balance sheet classification

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn
Loans and advances to customers	15.8	14.9
Financial investments	-	0.5
Other assets	0.4	0.4

	16.2	15.8

Composition of collateral supporting multi-seller conduit assets

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn
Asset class
Structured finance
Vehicle loans and equipment leases	4.2	3.6
Consumer receivables	0.7	0.8
Credit card receivables	1.1	1.5
Residential MBSs	1.7	2.0
Commercial MBSs	0.2	0.1
Auto floor plan	2.5	2.0
Trade receivables	2.7	3.1
Other ABSs	2.4	2.3

	15.5	15.4
Finance
Commercial bank securities and deposits	0.2	-
Investment bank securities	0.5	0.4

	0.7	0.4

	16.2	15.8

Exposure to US sub-prime and Alt-A

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

US sub-prime mortgages	-	0.1
Alt-A	-	-

	-	0.1

Weighted average maturity of assets

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

0-6 months	5.8	5.6
6-12 months	1.9	2.5
Over 12 months	8.5	7.7

	16.2	15.8

These revolving credit facilities will predominantly have expected average lives with maturities of less than 12 months, but typically have a range of 1 to 60 months.

Multi-seller conduits - HSBC's maximum exposure

HSBC provides transaction specific liquidity facilities to each of its multi-seller conduits, these are designed to be drawn in order to ensure the repayment of the CP issued. At 30 June 2008, the committed liquidity facilities amounted to US$20.5 billion (31 December 2007: US$21.2 billion).

First loss protection is provided through other transaction specific credit enhancements, for example, over-collateralisation and excess spread. These credit enhancements are provided
by the originator of the assets and not HSBC. In addition, a layer of secondary loss protection is provided by HSBC in the form of a programme wide enhancement facility, and at 30 June 2008 this amounted to US$0.7 billion (31 December 2007: US$0.7 billion). HSBC's maximum exposure is equal to the transaction specific liquidity facilities offered to the multi-seller conduits, as described above.

The liquidity facilities are set to support total commitments and therefore exceed the funded assets as of 30 June 2008.

In consideration of the significant first loss protection afforded by the structure, the credit enhancement and a range of indemnities provided by the various obligors, HSBC carries only a minimal risk of loss from the programme.

Asset analysis by geographical origination

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

Europe	7.3	7.4
Hong Kong	-	-
Rest of Asia-Pacific	1.2	1.0
North America	6.3	6.3
Latin America	1.4	1.1

	16.2	15.8

Money market funds

HSBC has established and manages a number of money market funds which provide customers with tailored investment opportunities. These SPEs have narrow and well-defined objectives and typically HSBC does not have any holdings in the SPEs of sufficient size to represent the majority of the risks and rewards of ownership; accordingly, these funds are not typically consolidated in HSBC.

The structure of assets within the money market funds is designed to meet the liabilities of the funds to their investors who have no recourse other than to the assets in the fund. Typically, money market funds are constrained in their operations should the value of their assets and their rating fall below predetermined thresholds. The risks to HSBC are, therefore, contingent and relate to the reputational damage which could occur if an HSBC-sponsored money market fund was thought to be unable to meet withdrawal requests on a timely basis or in full.

In aggregate, HSBC had established money market funds which had total assets of US$113 billion at 30 June 2008 (31 December 2007: US$92 billion).

These are the main sub-categories of money market funds:

US$78 billion (31 December 2007: US$57 billion) in Constant Net Asset Value ('CNAV') funds, which invest in shorter-dated and highly-rated money market securities with the objective of providing investors with a highly liquid and secure investment;
US$9 billion (31 December 2007: US$12 billion) in French domiciled dynamique ('dynamic') funds and Irish 'enhanced' funds, together Enhanced Variable Net Asset Value ('Enhanced VNAV') funds, which invest in longer-dated money market securities to provide investors with a higher return than traditional money market funds; and
US$26 billion (31 December 2007: US$23 billion) in various other money market Variable Net Asset Value ('VNAV') funds, including funds domiciled in Brazil, France, India, Mexico and other countries.

These money market funds invest in a diverse portfolio of highly-rated debt instruments, including limited holdings in instruments issued by SIVs. At 30 June 2008, these funds' exposure to SIVs was US$1.6 billion (31 December 2007: US$3.9 billion).

Constant Net Asset Value funds

CNAV funds price their assets on an amortised cost basis, subject to the amortised book value of the portfolio being within 50 basis points of its market value. This enables CNAV funds to create and liquidate shares in the fund at a constant price. If the amortised value of the portfolio were to vary by more than 50 basis points from its market value, the CNAV fund would be required to price its assets at market value, and consequently would no longer be able to create or liquidate shares at a constant price. This is commonly known as 'breaking the buck'.

Investments made by the CNAV funds in senior notes issued by SIVs continued to deteriorate in valuation terms during the first half of 2008. These represented only 1.5 per cent of the value of investments in the CNAV funds, but in order to mitigate any forced sale of liquid assets to meet potential redemptions, HSBC provided three additional letters of indemnity in the first half of 2008, bringing the total indemnities provided by HSBC to US$117 million at 30 June 2008 (31 December 2007: US$41 million). The total assets under management ('AUM') of the funds where indemnities have been provided amounted to US$46.8 billion at 30 June 2008 (31 December 2007: US$27.1 billion)

The provision of limited indemnities to these funds did not result in HSBC consolidating the funds because HSBC was not exposed to the majority of the risks and rewards of ownership and the investors continue to bear the first loss.

During the first half of 2008, four of the SIVs in which HSBC's CNAV funds had invested were placed in enforcement, the process by which the winding down of the independent SIVs and repaying secured creditors begins. At 30 June 2008, the CNAV funds held notes issued by third party sponsored SIVs in enforcement amounting to US$0.6 billion (31 December 2007: US$0.3 billion).

HSBC's maximum exposure

HSBC's maximum exposure to consolidated CNAV funds is represented by HSBC's investment in the units of each CNAV fund, and by the maximum limit of the letters of limited indemnity provided to the CNAV funds. HSBC's exposure at 30 June 2008 amounted to US$0.8 billion (31 December 2007: US$1.3 billion) and US$0.1 billion (31 December 2007: US$1.3 billion), for investment in units within the CNAV funds and letters of limited indemnity, respectively.

Enhanced Variable Net Asset Value funds

Enhanced VNAV funds price their assets on a fair value basis and consequently prices may change from one day to the next. These funds pursue an 'enhanced' investment strategy, as part of which investors accept greater credit and duration risk in the expectation of higher returns.

As part of action taken in respect of these funds in the second half of 2007, HSBC acquired the underlying assets and shares in two of its French dynamic money market funds. HSBC's aggregate holding in these funds at 30 June 2008 was €0.6 billion (31 December 2007: €0.9 billion. As a result of continued redemptions by unit holders to 30 June 2008, HSBC's holding in the two funds increased to a level where it obtained the majority of the risks and rewards of ownership, and therefore consolidated these funds.

HSBC's maximum exposure

HSBC's maximum exposure to consolidated and unconsolidated Enhanced VNAV and unconsolidated VNAV funds is represented by HSBC's investment in the units of each fund. HSBC's maximum exposure at 30 June 2008 amounted to US$6.6 billion (31 December 2007: US$5.9 billion) and US$200 million (31 December 2007: US$260 million), for enhanced VNAV and VNAV funds, respectively.

Total assets of HSBC's money market funds which are on-balance sheet by balance sheet classification

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

Trading assets	0.5	0.7
Financial instruments designated at fair value	7.0	5.0

	7.5	5.7

Non-money market investment funds

HSBC through its fund management business has also established a large number of non-money market funds to enable customers to invest in a range of assets, typically equities and debt securities. At the launch of a fund HSBC, as fund manager, typically provides a limited amount of initial capital known as 'seed capital' to enable the fund to start purchasing assets. These holdings are normally redeemed over time. The majority of these funds are off-balance sheet because, in view of HSBC's limited economic interest, HSBC does not have the majority of the risks and rewards of ownership. As the non-money market funds explicitly provide tailored risk to investors, the risk to HSBC is restricted to HSBC's own investments in the funds.

In aggregate, HSBC had established non-money market funds which had total assets of US$276.2 billion at 30 June 2008 (31 December 2007: US$288.8 billion).

These are the main sub-categories of non-money market funds:

US$119.9 billion (31 December 2007: US$132 billion) in specialist funds, which comprise fundamental active specialists and active quantitative specialists;
US$125.2 billion (31 December 2007: US$126.4 billion) in local investment management funds, which invest in domestic products, primarily for retail and private clients; and
US$31.1 billion (31 December 2007: US$30.4 billion) in multi-manager funds, which offer fund of funds and manager of manager products across a diversified portfolio of assets.

Total assets of HSBC's non-money market funds which are on-balance sheet by balance sheet classification

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

Cash	1.1	0.4
Trading assets	0.1	0.5
Financial instruments designated at fair value	6.4	3.0
Financial investments	0.2	0.2

	7.8	4.1

HSBC's maximum exposure

HSBC's maximum exposure to consolidated
and unconsolidated non-money market funds is represented by HSBC's investment in the units of each respective fund. HSBC's exposure at 30 June 2008 amounted to US$6.5 billion (31 December 2007: US$6.0 billion).

Securitisations

HSBC uses SPEs to securitise customer loans and advances it has originated, mainly in order to diversify its sources of funding for asset origination and for capital efficiency. In such cases, the loans and advances are transferred by HSBC to the SPEs for cash, and the SPEs issue debt securities to investors to fund the cash purchases. Credit enhancements to the underlying assets may be used to obtain investment grade ratings on the senior debt issued by the SPEs. Except in one instance, these securitisations are all consolidated by HSBC. HSBC has also established securitisation programmes in the US and Germany where third party originated loans are securitised. The majority of these vehicles are not consolidated by HSBC as it is not exposed to the majority of risks and rewards of ownerships in the SPEs.

In addition, HSBC uses SPEs to mitigate the capital absorbed by some of its originated customer loans and advances. Credit derivatives are used to transfer the credit risk associated with such customer loans and advances to an SPE. These securitisations are commonly known as synthetic securitisations. These SPEs are consolidated where HSBC is exposed to the majority of risks and rewards of ownership.

Total assets of HSBC's securitisations which are on-balance sheet, by balance sheet classification

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

Trading assets	1.8	3.6
Loans and advances to customers	60.4	69.6
Financial investments	-	0.1
Other assets	1.3	1.3
Derivatives	0.3	0.1

	63.8	74.7

These assets include US$1.8 billion (31 December 2007: US$3.6 billion) of exposure to US sub-prime mortgages.

HSBC's maximum exposure

The maximum exposure is the aggregate of any holdings of notes issued by these vehicles and the reserve account positions intended to provide credit support under certain pre-defined circumstances to senior note holders. HSBC is not obligated to provide further funding. At 30 June 2008, HSBC's maximum exposure to consolidated and unconsolidated securitisations amounted to US$31.1 billion (31 December 2007: US$31 billion).

Other

HSBC also establishes SPEs in the normal course of business for a number of purposes, for example, structured credit transactions for customers to provide finance to public and private sector infrastructure projects, and for asset and structured finance ('ASF') transactions.

Structured credit transactions

HSBC provides structured credit transactions to third party professional and institutional investors who wish to obtain exposure, sometimes on a leveraged basis, to a reference portfolio of debt instruments.
In such structures, the investor receives rewards referenced to the underlying portfolio by purchasing notes issued by the SPEs. HSBC enters into contracts with the SPEs, generally in the form of derivatives, in order to pass the required risks and rewards of the reference portfolios to the SPEs. HSBC's risk in relation to the derivative contracts with the SPEs is managed within HSBC's trading market risk framework (see Market Risk on page 183). In certain transactions HSBC is exposed to risk often referred to as gap risk. Gap risk typically arises in transactions where the aggregate potential claims against the SPE by HSBC pursuant to one or more derivatives could be greater than the value of the collateral held by the SPE and securing such derivatives. HSBC often mitigates such gap risk through incorporation of features which allow for deleveraging, a managed liquidation of the portfolio, or other mechanisms embedded in the SPE transaction. Following the operation of such risk reduction mechanisms, HSBC has, in certain circumstances, retained all or a portion of the underlying exposure in the transaction. Where such exposure represents ABSs, such exposure retained has been included in 'Nature and extent of HSBC's exposures' on page 117.

The transactions are facilitated through SPEs to enable the notes issued to the investors to be rated. The SPEs are not consolidated by HSBC because the investors bear substantially all the risks and rewards of ownership through the notes. An exception would be made when HSBC itself holds a majority of the notes issued by particular SPEs.

The total fair value of liabilities (notes issued and derivatives) in structured credit transaction
SPEs was US$21.9 billion at 30 June 2008 (31 December 2007: US$23.6 billion). These amounts included US$0.2 billion (31 December 2007: US$0.1 billion) in SPEs that were consolidated by HSBC.

Other uses of SPEs

HSBC participates in Public-Private Partnerships to provide financial support for infrastructure projects initiated by government authorities. The funding structure is commonly achieved through the use of SPEs. HSBC consolidates these SPEs when it is exposed to the majority of risks and rewards of the vehicles.

HSBC's ASF business specialises in leasing and arranging finance for aircraft and other physical assets, which it is customary to ring-fence through the use of SPEs, and in structured loans and deposits, where SPEs introduce cost efficiencies. HSBC consolidates these SPEs when the substance of the relationship indicates that HSBC controls the SPE.

HSBC's risks and rewards of ownership in these SPEs are in respect of its on-balance sheet assets and liabilities.

Maximum exposures to SPEs

The following tables show the total assets of the various types of SPEs, and the amount and types of funding provided by HSBC to these SPEs. The tables also show HSBC's maximum exposure to the SPEs, and within that exposure the types of liquidity and credit enhancements provided by HSBC. The maximum exposures to SPEs represent HSBC's maximum possible risk exposure that could occur as a result of the Group's arrangements and commitments to SPEs. The maximum amounts are contingent in nature, and may arise as a result of drawdowns under liquidity facilities, where these have been provided, any other funding commitments, or as a result of any loss protection provided by HSBC to the SPEs. The conditions under which such exposure might arise differ depending on the nature of each SPE and HSBC's involvement with it. The aggregation of such maximum exposures across the different forms of SPEs results in a theoretical total maximum exposure number. The elements of the maximum exposure to an SPE are not necessarily additive and a detailed explanation of how maximum exposures are determined is provided under each category of SPE.

HSBC's maximum exposure to consolidated SPEs affected by the recent market turmoil

		Securities			Non-money market funds
	SIVs	investment conduits1	Multi-seller conduits	Enhanced VNAV funds	Specialist funds	Local funds2	Securit- isations3	Other	Total
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
At 30 June 2008
Total assets	6.0	41.0	16.2	7.5	0.8	7.0	63.8	0.2	142.5
Direct lending4	-	-	-	-	-	-	1.8	-	1.8
ABSs4	5.0	33.8	-	-	-	-	-	0.1	38.9
Other	1.0	7.2	16.2	7.5	0.8	7.0	62.0	0.1	101.8

Funding provided by HSBC	2.9	31.2	3.2	6.6	0.3	4.6	0.6	-	49.4
CP	2.0	17.4	3.2	-	-	-	-	-	22.6
MTNs	0.4	3.6	-	-	-	-	0.4	-	4.4
Junior notes	-	-	-	-	-	-	0.2	-	0.2
Term repos executed	0.5	10.2	-	-	-	-	-	-	10.7
Investments in funds	-	-	-	6.6	0.3	4.6	-	-	11.5

Total maximum exposure to consolidated SPEs	6.5	45.9	20.5	6.6	0.3	4.6	30.8	0.1	115.3

Liquidity and credit enhancements
Deal-specific liquidity facilities	-	-	20.5	-	-	-	-	-	20.5
Programme-wide liquidity facilities	0.5	35.7	-	-	-	-	-	-	36.2
Programme-wide limited credit enhancements	-	1.2	0.7	-	-	-	-	-	1.9
Other liquidity and credit enhancements	-	-	-	-	-	-	0.2	-	0.2

		Securities			Non-money market funds
	SIVs	investment conduits1	Multi-seller conduits	Enhanced VNAV funds	Specialist funds	Local funds2	Securit- isations3	Other	Total
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
At 31 December 2007
Total assets	40.7	21.6	15.8	5.7	1.0	3.1	74.7	0.1	162.7
Direct lending4	-	-	-	-	-	-	3.6	-	3.6
ABSs4	36.2	21.0	-	-	-	-	-	-	57.2
Other	4.5	0.6	15.8	5.7	1.0	3.1	71.1	0.1	101.9

Funding provided by HSBC	15.9	7.8	8.6	4.6	0.4	2.8	1.0	-	41.1
CP	2.4	7.8	8.6	-	-	-	-	-	18.8
MTNs	5.3	-	-	-	-	-	0.3	-	5.6
Junior notes	-	-	-	-	-	-	0.7	-	0.7
Term repos executed	8.2	-	-	-	-	-	-	-	8.2
Investments in funds	-	-	-	4.6	0.4	2.8	-	-	7.8

Total maximum exposure to consolidated SPEs	40.0	25.7	21.2	4.6	0.4	2.8	30.6	0.1	125.4

Liquidity and credit enhancements
Deal-specific liquidity facilities	-	-	21.2	-	-	-	-	-	21.2
Programme-wide liquidity facilities	0.8	25.7	-	-	-	-	-	-	26.5
Programme-wide limited credit enhancements	-	0.2	0.7	-	-	-	-	-	0.9
Other liquidity and credit enhancements	-	-	-	-	-	-	0.2	-	0.2

1 The securities investment conduits include Mazarin, Barion, Malachite and Solitaire.

2 Local investment management funds.

3 Also includes consolidated SPEs that hold mortgage loans held at fair value.

4 These assets only include those measured at fair value. For details on the geographical origin of the mortgage loans held at fair value and ABSs, including those represented by MBSs and CDOs held in consolidated SIVs and securities investment conduits, see 'Nature and extent of HSBC's exposures' on page 118. The geographical origin of the loans and receivables held by the multi-seller conduits is disclosed on page 144.

HSBC's maximum exposure to unconsolidated SPEs

	Securitisations1		Money market funds1			Non-money market funds1
	HSBC originated assets	Non-HSBC originated assets2	CNAV funds	Enhanced VNAV funds	VNAV funds	Specialist funds	Local funds3	Multi- manager funds	Other	Total
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
At 30 June 2008
Total assets	0.8	15.0	77.7	1.3	26.3	119.1	118.2	31.1	23.6	413.1

Funding provided by HSBC	-	0.3	0.8	-	0.2	0.1	1.5	-	7.3	10.2
MTNs	-	0.3	-	-	-	-	-	-	7.3	7.6
Investments in funds	-	-	0.8	-	0.2	0.1	1.5	-	-	2.6

Total maximum exposure to unconsolidated SPEs	-	0.3	0.9	-	0.2	0.1	1.5	-	3.0	6.1

Liquidity and credit enhancements
Indemnities	-	-	0.1	-	-	-	-	-	-	0.1

At 31 December 2007
Total assets	0.9	16.0	56.8	6.2	22.3	131.0	123.6	30.0	23.5	410.3

Funding provided by HSBC	-	0.4	1.3	1.3	0.3	0.1	2.6	0.1	7.2	13.3
MTNs	-	0.3	-	-	-	-	-	-	7.2	7.5
Mezzanine notes	-	0.1	-	-	-	-	-	-	-	0.1
Investments in funds	-	-	1.3	1.3	0.3	0.1	2.6	0.1	-	5.7

Total maximum exposure to unconsolidated SPEs	-	0.4	1.3	1.3	0.3	0.1	2.6	0.1	4.4	10.6

1 HSBC's financial investments in off-balance sheet money market funds and non-money market funds have been classified as available-for-sale securities, and measured at fair value. HSBC's financial investments in off-balance sheet securitisations have been classified as trading assets and available-for-sale securities, and measured at fair value.

2 In the US, HSBC has established securitisation programmes where term-funded SPEs are used to securitise third party originated mortgages, mainly sub-prime and Alt-A residential mortgages. The majority of these SPEs are not consolidated by HSBC as it is not exposed to the majority of the risk and rewards of ownership in the SPEs. No liquidity facility has been provided by HSBC.

3 Local investment management funds.

Third party sponsored SPEs

HSBC has, through standby liquidity facility commitments, exposure to third party sponsored SIVs, conduits and securitisations, under normal banking arrangements on standard market terms. These exposures are quantified below:

HSBC's commitments under liquidity facilities to third party SIVs, conduits and securitisations

	Commit- ments	Drawn
	US$bn	US$bn
At 30 June 2008
Third party SIVs	0.1	-
Third party conduits	1.6	-
Third party securitisations	0.7	-

	2.4	-
At 31 December 2007
Third party SIVs	0.3	-
Third party conduits	4.4	0.4
Third party securitisations	0.5	-

	5.2	0.4

Other exposures to third party SIVs, conduits and securitisations where a liquidity facility has been provided

	At 30 June 2008	At 31 December 2007
	US$bn	US$bn

Derivative assets	-	0.2

Other off-balance sheet arrangements and commitments

Financial guarantees, letters of credit and similar undertakings

Note 17 on the Financial Statements describes various types of guarantees and discloses the maximum potential future payments under such arrangements. Credit risk associated with all forms of guarantees is assessed in the same manner as for on-balance sheet credit advances and, where necessary, provisions for assessed impairment are included in 'Other provisions'.

Commitments to lend

Undrawn credit lines are disclosed in Note 17 on the Financial Statements. The majority by value of undrawn credit lines arise from 'open to buy' lines on personal credit cards, advised overdraft limits and other pre-approved loan products, and mortgage offers awaiting customer acceptance. HSBC generally has the right to change or terminate any conditions of a personal customer's overdraft, credit card or other credit line upon notification to the customer. In respect of corporate commitments to lend, in most cases HSBC's position will be protected through restrictions on access to funding in the event of material adverse change.

Leveraged finance transactions

Loan commitments in respect of leveraged finance transactions are accounted for as derivatives where it is HSBC's intention to sell the loan after origination. Further information is provided on page 127.

This information is provided by RNS

The company news service from the London Stock Exchange

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