Interim Report - 13 of 21

RNS Number : 3120X

HSBC Holdings PLC

14 August 2009

 



Liquidity and funding 

HSBC expects its operating entities to manage liquidity and funding risk on a stand alone basis employing a centrally imposed framework and limit structure which is adapted to changes in business mix and underlying markets. The Group emphasises the importance of customer deposits as a source of stable funding, using funding from professional markets only in selected circumstances and for non-banking subsidiaries like HSBC Finance.

HSBC adapts its liquidity and funding risk management framework in response to changes in the mix of business that it undertakes and the nature of the markets in which it operates. There have been no material changes to HSBC's objectives, policies or procedures for the management of liquidity and funding risks described in the Annual Report and Accounts 2008, the key features of which are repeated below. HSBC continuously monitors the effect of market events on the Group's liquidity positions and changes behavioural assumptions where justified; its liquidity and funding risk framework will continue to evolve accordingly.

The management of liquidity and funding is primarily undertaken locally in HSBC's operating entities in compliance with practices and limits set by the Risk Management Meeting ('RMM'). These limits vary according to the depth and liquidity of the markets in which the entities operate. HSBC's general policy is that each banking entity should be self-sufficient when funding its own operations.

Current accounts and savings deposits payable on demand or at short notice form a significant part of HSBC's funding, and the Group places considerable importance on maintaining their stability. For deposits, stability depends upon preserving depositor confidence in HSBC's capital strength and liquidity, and on competitive and transparent pricing.

HSBC also accesses professional markets in order to obtain funding for non-banking subsidiaries that do not accept deposits, to maintain a presence in local money markets and to optimise the funding of asset maturities not naturally matched by core deposit funding. In aggregate, HSBC's banking entities are liquidity providers to the inter-bank market, placing significantly more funds with other banks than they themselves borrow.

The main operating subsidiary that does not accept deposits is HSBC Finance, which principally funds itself by taking term funding in the professional markets and by securitising assets. At 30 June 2009, US$88 billion (30 June 2008: US$132 billion; 31 December 2008: US$111 billion) of HSBC Finance's liabilities were drawn from professional markets, utilising a range of products, maturities and currencies.

The management of liquidity risk

The Group uses a number of principal measures to manage liquidity risk, as described below.

Advances to deposits ratio

HSBC emphasises the importance of core current accounts and savings accounts as a source of funds to finance lending to customers, and discourages reliance on short-term professional funding. This is achieved by placing limits on banking entities which restrict their ability to increase loans and advances to customers without corresponding growth in current accounts, savings accounts or term deposits. This measure is referred to as the 'advances to deposits' ratio.

Advances to deposits ratio limits are set by the RMM and monitored by Group Finance. The ratio describes loans and advances to customers as a percentage of the total of core current and savings accounts and term funding with a remaining term to maturity in excess of one year. Excluded from the ratio are loans and advances to customers that are part of reverse repurchase arrangements under which HSBC receives securities that are deemed to be liquid, and current accounts and savings accounts deemed to be 'non-core' taking into consideration the anticipated behavioural characteristics of the customer's total deposit balances.

The three principal banking entities listed in the table overleaf represented 70 per cent of HSBC's total core deposits at 30 June 2009 (30 June 2008: 70 per cent; 31 December 2008: 70 per cent). The table shows that loans and advances to customers in these entities are in the main financed by reliable and stable sources of funding. HSBC would meet any unexpected net cash outflows by selling securities and accessing additional funding sources such as interbank or collateralised lending markets. The distinction between core and non-core deposits generally means that the Group's measure of advances to deposits is more restrictive than that which can be inferred from the published financial statements (by way of comparison to the table overleaf, the Group's consolidated advances to deposits measure at 30 June 2009 based only on published balance sheet information was 79.5 per cent (30 June 2008: 90.3 per cent; 31 December 2008: 83.6 per cent)).

Ratio of net liquid assets to customer liabilities

Net liquid assets are liquid assets less all funds maturing in the next 30 days from wholesale market sources and from customers who are deemed to be professional. For this purpose, HSBC defines liquid assets as cash balances, short-term interbank deposits and highly-rated debt securities available for immediate sale and for which a deep and liquid  171.

Limits for the ratio of net liquid assets to customer liabilities are set for each operating entity, except for HSBC Finance. As HSBC Finance does not accept customer deposits, it is not appropriate to manage its liquidity using standard liquidity ratios. The liquidity and funding risk management framework of HSBC Finance is discussed below.

HSBC's principal banking entities - the management of liquidity risk

	Advances to deposits ratio  during half-year to:						Ratio of net liquid assets  to customer liabilities  during half year to:						Net liquid assets  during half-year to:
	30     June    2009		30      June     2008		31     December     2008		30     June    2009		30      June     2008		31     December     2008		30     June    2009		30      June     2008		31     December     2008
	%		%		%		%		%		%		US$bn		US$bn		US$bn
HSBC Bank (UK operations)
Period-end	104.3		100.9		106.0		10.1		9.8		7.1		32.0		37.3		21.3
Maximum	107.7		101.0		106.7		11.8		14.1		10.2		37.4		52.5		37.3
Minimum	104.3		97.5		100.9		6.5		9.8		6.9		19.5		37.0		21.3
Average	106.4		99.4		103.5		8.9		11.5		8.5		27.4		42.2		29.6
The Hongkong and Shanghai Banking Corporation
Period-end	70.3		82.9		77.4		31.4		19.9		25.0		86.9		51.1		64.6
Maximum	77.4		82.9		82.9		35.0		22.7		25.0		97.8		57.7		64.6
Minimum	69.3		76.7		77.4		25.0		19.9		19.9		64.6		51.1		51.1
Average	73.1		80.5		81.0		29.7		21.5		22.0		80.5		54.9		57.4
HSBC Bank USA
Period-end	106.4		110.3		103.7		26.1		17.0		31.5		22.3		17.1		27.4
Maximum	110.3		115.9		117.3		31.5		20.4		31.5		27.4		21.7		27.4
Minimum	103.7		110.3		103.7		21.5		15.8		17.0		18.6		17.1		17.1
Average	106.9		113.1		110.3		25.3		18.6		25.7		22.3		19.6		22.9
Total of Group's  other principal banking entities1
Period-end	82.2		91.1		85.2		27.0		19.4		26.5		84.1		68.3		83.5
Maximum	85.2		92.3		91.1		27.0		22.1		26.5		84.1		74.4		83.5
Minimum	81.7		86.4		82.7		24.7		19.4		19.4		73.2		66.1		68.3
Average	83.0		89.4		86.7		26.1		21.1		23.5		79.9		70.2		76.8

1    This comprises the Group's other main banking subsidiaries and, as such, includes businesses spread across a range of locations, in many of which HSBC may require a higher ratio of net liquid assets to customer liabilities to reflect local market conditions. 

Projected cash flow scenario analysis

The Group uses a number of standard projected cash flow scenarios designed to model both Group-specific and market-wide liquidity crises in which, among other things, the rate and timing of deposit withdrawals and drawdowns on committed lending facilities are varied, and access to interbank funding and term debt markets and the ability to generate funds from asset portfolios are restricted. The scenarios are modelled by all Group banking entities and by HSBC Finance. The appropriateness of the assumptions underpinning the scenarios is regularly reviewed. In addition to the Group's standard projected cash flow scenarios, individual entities are required to design their own scenarios reflecting specific local market conditions, products and funding bases.

Limits for cumulative net cash flows under stress scenarios are set for each banking entity and for HSBC Finance, and reflect the local market place, the diversity of funding sources available and the concentration risk from large depositors. Compliance with entity level limits is monitored centrally by Group Finance and reported regularly to the RMM.

HSBC Finance

As HSBC Finance does not accept customer deposits, it accesses the professional markets and fellow Group subsidiaries for funding. HSBC Finance uses a range of measures to monitor funding risk, including projected cash flow scenario analysis and caps placed on the amount of unsecured term funding that can mature in any rolling three-month and rolling 12-month periods. HSBC Finance also maintains access to committed sources of secured funding and has in place committed backstop lines for short-term refinancing CP programmes.  

HSBC Finance - funding

	At      30 June      2009		At  30 June 2008	At  31December 2008
	US$bn		US$bn		US$bn
Maximum amounts of unsecured term funding maturing in any rolling:
3 month period	5.2		6.2		6.0
12 month period	13.5		17.7		17.4
Unused committed sources of secured funding1	-		2.9		2.4
Committed backstop lines from non-Group entities in support of CP programmes	5.3		6.3		7.3

1    For which eligible assets were held.

The reduction in unused committed sources of secured funding reflects the transfer of credit card portfolios, and therefore also the associated conduit credit facilities, from HSBC Finance to HSBC Bank USA, and also the expiration and reduction of other conduit credit facilities. The transfer of the credit card portfolios was conducted primarily to fund prime customer loans through core deposits more efficiently.

During the current period HSBC Finance successfully renewed US$1.8 billion of committed backstop lines.

Contingent liquidity risk

In the normal course of business, Group entities provide customers with committed facilities, including committed backstop lines to conduit vehicles sponsored by the Group and standby facilities to corporate customers. These facilities increase the funding requirements of the Group when customers raise drawdown levels above their normal utilisation rates. The liquidity risk consequences of increased levels of drawdown are analysed in the form of projected cash flows under different stress scenarios. The RMM also sets limits for non-cancellable contingent funding commitments by Group entity after due consideration of each entity's ability to fund them. The limits are split according to the borrower, the liquidity of any underlying assets, market sector and the size of the committed line.

In times of market stress, the Group may choose to provide non-contractual liquidity support to certain HSBC-sponsored vehicles or HSBC-promoted products. This support would only be provided after careful consideration of the potential funding requirement and the impact on the entity's overall liquidity. 

HSBC's contractual exposures monitored under the contingent liquidity risk limit structure

	HSBC Bank						HSBC Bank USA						HSBC Bank Canada						The Hongkong and Shanghai Banking Corporation
	At  30 Jun  2009		At  30 Jun  2008		At  31 Dec  2008		At  30 Jun  2009		At 30 Jun  2008		At 31 Dec  2008		At 30 Jun  2009		At   30 Jun 2008		At 31 Dec 2008		At  30 Jun 2009		At 30 Jun 2008		At 31 Dec 2008
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
Conduits
Client-originated assets1
- total lines	6.3		7.9		5.6		9.4		11.9		11.2		0.3		0.7		0.3		-		-		-
- largest individual lines	1.0		1.0		1.0		0.4		0.5		0.4		0.1		0.3		0.2		-		-		-
HSBC-managed  assets2	30.9		35.7		34.8		-		-		-		-		-		-		-		-		-
Other conduits3	-		0.2		-		1.2		1.4		1.1		-		-		-		-		-		-
Single-issuer  liquidity facilities
- five largest4	5.6		8.4		6.0		4.5		5.8		5.0		1.8		-		1.5		0.9		1.4		1.0
- largest market sector5	7.8		6.6		7.3		3.1		4.1		3.5		2.6		-		2.4		1.5		2.1		1.7

1    These exposures relate to consolidated multi-seller conduits (see page 129). These vehicles provide funding to Group customers by issuing debt secured by a diversified pool of customer-originated assets. 

2    These exposures relate to consolidated securities investment conduits, primarily Solitaire and Mazarin (see page 129). These vehicles issue debt secured by ABSs which are managed by HSBC. Of the total contingent liquidity risk under this category, US$21.9 billion (30 June 2008: US$20.4 billion; 31 December 2008: US$25.3 billion) was funded on-balance sheet at 30 June 2009, leaving a net contingent exposure of US$9.0 billion (30 June 2008: US$15.3 billion; 31 December 2008: US$9.5 billion).

3    These exposures relate to third-party sponsored conduits (see page 137).

4    These figures are the five largest committed liquidity facilities provided to customers other than facilities to conduits.

5    These figures are the total of all committed liquidity facilities provided to the largest market sector, other than facilities to conduits.

The impact of market turmoil on the Group's liquidity risk position 

HSBC's limited dependence on wholesale markets for funding has been a significant competitive advantage during the recent period of market turmoil. As a net provider of funds to the interbank market, HSBC has not been significantly affected by the scarcity of interbank funding.

The recent market turmoil continues to have adverse effects on the liquidity and funding risk profile of the banking system.

At a systemic level, these may be characterised as follows:

• interbank funding costs increased compared with those in the period prior to the market turmoil as banks became reluctant to lend to each other beyond the very short term. Although interbank funding costs have reduced slightly since their peaks in the latter part of 2008, they still remain above the pre-market turmoil levels; 

• many asset classes considered to be liquid before the start of the market turmoil remain illiquid;

• the ability of many market participants to issue either unsecured or secured debt continues to be restricted, although this has since been mitigated by the on-going support provided by some central bank and government programmes;

• many special purpose entities with investments linked to US sub-prime mortgages, or to ABSs where the underlying credit exposures were not fully transparent, continue to be restricted in their ability to raise wholesale funding.

HSBC's customer deposit base grew between 30 June 2007, the reporting date closest to the onset of the market turmoil, and 30 June 2009 by US$183 billion. This growth in US dollar equivalent terms was diluted by the strengthening of the US dollar against many other major currencies in the period, as growth in customer deposits on an underlying currency basis was even stronger. As a net provider of funds to the interbank market, the Group has not been significantly affected by the scarcity of interbank funding.

The deterioration of the US sub-prime credit market has reduced the availability of term financing to entities with exposures to the US sub-prime market. However, HSBC Finance, by virtue of its position within the Group, continued to enjoy committed financing facilities, albeit at a lower level, and access to Commercial Paper ('CP') markets at competitive interest rates. By reducing the size of its balance sheet, issuing cost effective retail debt, receiving capital infusions from the HSBC Group and utilising alternative sources of funding, including funding from other members of the HSBC Group, HSBC Finance eliminated the need to issue institutional term debt in 2008 and the first half of 2009. Funding plans are in place to enable HSBC Finance to deal with continued stress in the credit markets. As part of these plans, asset portfolios totalling US$15.3 billion were transferred from HSBC Finance to HSBC Bank USA in January 2009, resulting in US$8.0 billion of net funding benefit to HSBC Finance.

The scheme set up by US Federal Reserve in 2008 to provide support to US issuers in the CP market has been extended to 1 February 2010. Under this scheme, HSBC Finance is eligible to issue a maximum of US$12.0 billion. As at 30 June 2009, HSBC Finance does not have any outstanding CP under this programme (30 June 2008: nil; 31 December 2008: US$520 million).

HSBC Holdings' access to debt capital markets has continued at normal market pricing levels with a number of both senior and subordinated debt issues completed in the six months to 30 June 2009.

The Group regularly reviews the quality of assets to ensure that only those assets for which a deep and liquid market exists are classified as liquid within liquidity and funding risk measures.

Market risk 

There have been no material changes to HSBC's objectives for the management of market risk as described in the Annual Report and Accounts 2008. The key features are reported below.

Market risk is the risk that movements in market risk factors, including foreign exchange rates and commodity prices, interest rates, credit spreads and equity prices, will reduce HSBC's income or the value of its portfolios.

HSBC separates exposures to market risk into trading and non-trading portfolios. Trading portfolios include positions arising from market-making and proprietary position-taking and other marked-to-market positions so designated. 

Non-trading portfolios include positions that primarily arise from the interest rate management of HSBC's retail and commercial banking assets and liabilities, financial investments classified as available for sale and held to maturity, and exposures arising from HSBC's insurance operations.

Market risk arising in HSBC's insurance businesses is discussed in 'Risk management of insurance operations' on pages 182 to 186.

Monitoring and limiting market risk exposures

HSBC uses a range of tools to monitor and limit market risk exposures. These include sensitivity analysis, value at risk ('VAR') and stress testing. 

Sensitivity analysis

Sensitivity measures are used to monitor the market risk positions within each risk type, for example, present value of a basis point movement in interest rates for interest rate risk. Sensitivity limits are set for portfolios, products and risk types, with the depth of the market being one of the principal factors in determining the level of limits set.

Value at risk 

VAR is a technique that estimates the potential losses that could occur on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence. 

The VAR models used by HSBC are based predominantly on historical simulation. These models derive plausible future scenarios from past series of recorded market rates and prices, taking into account inter-relationships between different markets and rates such as interest rates and foreign exchange rates. The models also incorporate the effect of option features on underlying exposures.

The historical simulation models used by HSBC include the following elements:

• potential market movements are calculated with reference to data from the past two years;

• historical market rates and prices are calculated with reference to foreign exchange rates and commodity prices, interest rates, equity prices and the associated volatilities; and

• VAR is calculated to a 99 per cent confidence level and for a one-day holding period.

HSBC routinely validates the accuracy of its VAR models by back-testing the actual daily profit and loss results, adjusted to remove non-modelled items such as fees and commissions, against the corresponding VAR numbers. Statistically, HSBC would expect to see losses in excess of VAR only 1 per cent of the time over a one-year period. The actual number of excesses over this period can therefore be used to gauge how well the models are performing.

Although a valuable guide to risk, VAR should always be viewed in the context of its limitations. For example: 

• the use of historical data as a proxy for estimating future events may not encompass all potential events, particularly those which are extreme in nature;

• the use of a one-day holding period assumes that all positions can be liquidated or the risks offset in one day. This may not fully reflect the market risk arising at times of severe illiquidity, when a one-day holding period may be insufficient to liquidate or hedge all positions fully;

• the use of a 99 per cent confidence level, by definition, does not take into account losses that might occur beyond this level of confidence;

• VAR is calculated on the basis of exposures outstanding at the close of business and therefore does not necessarily reflect intra-day exposures; and

• VAR is unlikely to reflect loss potential on exposures that only arise under significant market moves.

Stress testing 

In recognition of its limitations, VAR is augmented with stress testing to evaluate the potential impact on portfolio values of more extreme, although plausible, events or movements in a set of financial variables.

The process is governed by the 'Stress Testing Review Group' forum. This coordinates the Group's stress testing scenarios in conjunction with regional risk managers, considering actual market risk exposures and market events in determining the scenarios to be applied to portfolios and HSBC's consolidated positions, as follows:

• sensitivity scenarios, which consider the impact of any single risk factor or set of factors that are unlikely to be captured within the VAR models, such as the break of a currency peg;

• technical scenarios, which consider the largest move in each risk factor without including any underlying market correlation;

• hypothetical scenarios, which consider potential macro economic events; and

• historical scenarios, which incorporate historical observations of market moves during previous periods of stress which would not be captured within VAR.

Stress testing results provide senior management with an assessment of the financial impact such events would have on HSBC's profit. The daily losses experienced in the first half of 2009 were within the stress loss scenarios reported to senior management.

The following table provides an overview of the reporting of risks within this section:

	Portfolio
	Trading	Non-trading
	Portfolio
	Trading	Non-trading
Risk type
Foreign exchange	VAR	VAR1
Interest rate	VAR	VAR2
Commodity	VAR	N/A
Equity	VAR	Sensitivity
Credit spread	Sensitivity	Sensitivity3

1    The structural foreign exchange risk is monitored using sensitivity analysis. See page 181.

2    The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included within the Group VAR. The management of this risk is described on page 178.

3    Credit spread VAR is reported for the credit derivatives transacted by Global Banking. See page 176.

The impact of market turmoil on market risk

High levels of market volatility across all asset classes continued into 2009 although the effect was limited by HSBC reducing its market risk exposures in trading portfolios.

The market turmoil that began in 2007 and accelerated through 2008 was characterised by extreme market volatility and, as a consequence, increased levels of VAR. High levels of market volatility across all asset classes continued into 2009 although the overall impact was limited as a result of further managing down the market risk exposures in trading portfolios in all asset classes during this period (see 'VAR by risk type for trading activities (excluding credit spread VAR)' on page 176).

During the second quarter of 2009, an improvement in credit spread levels was generally observed. This is discussed further in 'Credit spread risk' on page 176.

Value at risk of trading and non-trading portfolios

The data in the table and the graphs below comprise both trading and non-trading VAR for the Group. 

Value at risk

	Half-year to
	30 June      2009		30 June     2008	31 December    2008
	US$m		US$m		US$m
At period end	152.3		144.2		191.2
Average	166.2		135.5		181.2
Minimum	135.1		59.8		108.4
Maximum	194.6		230.5		287.1

Daily VAR (trading and non-trading) (US$m) 

The major contributor to the trading and non-trading VAR for the Group was Global Markets.

The histogram below illustrates the frequency of daily revenue arising from Global Markets' trading, balance sheet management and other trading activities.

Daily revenue

	Half-year to
	30 June      2009		30 June     2008	31 December    2008
	US$m		US$m		US$m
Average daily revenue	72.1		21.7		21.5
Standard deviation1	44.0		48.3		58.2

1     The standard deviation measures the variation of daily revenues about the mean value of those revenues.

An analysis of the frequency distribution of daily revenue shows that there were 7 days with negative revenue during the first half of 2009 compared with 33 days in each half of 2008. The most frequent result was a daily revenue of between US$70 million and US$80 million with 14 occurrences, compared with between US$40 million and US$50 million with 17 occurrences in the first half of 2008, and 14 occurrences arising in each of the intervals between US$10 million and US$40 million in the second half of 2008.

Daily distribution of Global Markets' trading, balance sheet management and other trading revenues1

Half-year to 30 June 2009

Number of days

Revenues (US$m)

 Profit and loss frequency

Half-year to 30 June 2008

Number of days

Revenues (US$m)

 Profit and loss frequency

Half-year to 31 December 2008

Number of days

Revenues (US$m)

 Profit and loss frequency

1    The effect of any month-end adjustments not attributable to a specific daily market move is spread evenly over the days in the month in question.

For a description of HSBC's fair value and price verification controls, see page 114.

Trading portfolios

HSBC's control of market risk is based on a policy of restricting individual operations to trading within a list of permissible instruments authorised for each site by Group Risk, of enforcing rigorous approval procedures for new products and of restricting trading in the more complex derivative products to offices with appropriate levels of product expertise and robust control systems.

Market making and proprietary position-taking is undertaken within Global Markets. The VAR for such trading activity at 30 June 2009 was US$65.7 million (30 June 2008: US$37.0 million; 31 December 2008: US$72.5 million). This is analysed below by risk type. 

VAR by risk type for trading activities (excluding credit spread VAR)

	Foreign     exchange and     commodity		Interest     rate		Equity		Total1
	US$m		US$m		US$m		US$m
At 30 June 2009	21.2		68.2		5.7		65.7
At 30 June 2008	16.6		34.5		9.6		37.0
At 31 December 2008	29.8		63.4		13.9		72.5
Average
First half of 2009	23.7		54.0		11.3		58.4
First half of 2008	14.2		39.6		16.8		44.2
Second half of 2008	23.7		61.4		13.6		61.6
Minimum
First half of 2009	16.3		35.6		4.9		35.6
First half of 2008	8.7		21.4		9.2		23.7
Second half of 2008	12.9		23.7		8.2		22.6
Maximum
First half of 2009	33.2		78.0		18.7		86.6
First half of 2008	21.9		67.9		37.9		87.2
Second half of 2008	54.9		147.4		39.0		104.4

1    The total VAR is non-additive across risk types due to diversification effects.

Credit spread risk

The risk associated with movements in credit spreads is primarily managed through sensitivity limits, stress testing and VAR for those portfolios on which it is calculated.

The Group is introducing credit spread as a separate risk type within its VAR models and, at 30 June 2009, credit spread VAR was calculated for the London and Hong Kong trading and New York credit derivatives portfolios (for 2008, calculated for London and New York only). At that date, the total VAR for the trading activities, including credit spread VAR for the above portfolios, was US$84.7 million (31 December 2008: US$106.4 million) compared with a total VAR of US$65.7 million (31 December 2008: US$72.5 million) reported within the 'VAR by risk type for trading activities' table above, which excludes the credit spread VAR for these two portfolios.

The sensitivity of trading income to the effect of movements in credit spreads on the total trading activities of the Group was US$334.7 million at 30 June 2009 (30 June 2008: US$188.1 million; 31 December 2008: US$590.9 million). This sensitivity captures the credit spread exposure arising from the positions taken throughout the Group, including the London and Hong Kong trading and the New York credit derivatives portfolios captured within credit spread VAR (see above). The sensitivity was calculated using simplified assumptions based on one-day movements in average market credit spreads over a two-year period at a confidence level of 99 per cent, and assumes a simultaneous movement in credit spreads across issuers. It should be noted that diversification effects within the portfolio and with other risk types are likely to reduce the impact on trading income.

The decrease in the sensitivity at 30 June 2009, compared with 31 December 2008, was due to the effect of the reduction in the level of credit spreads. Furthermore, the actual positions within the trading portfolios exposed to credit risk were lower on 30 June 2009 than on 31 December 2008.

In addition to the above measure, certain portfolios are also managed using default risk measures where appropriate.

The measurement of the credit spread impact on trading income as at 30 June 2009 and 31 December 2008 excludes the positions that were reclassified as non-trading during the second half of 2008 following the amendment to IFRSs. These positions are included within the 30 June 2008 comparative as the reclassification took effect from 1 July 2008.

Credit spread risk also arises on credit derivative transactions entered into by Global Banking in order to manage the risk concentrations within the corporate loan portfolio and so enhance capital efficiency. The mark-to-market of these transactions is taken through the income statement.

At 30 June 2009, the credit spread VAR on the credit derivatives transactions entered into by Global Banking was US$15.3 million (30 June 2008: US$33.7 million; 31 December 2008: US$23.0 million). 

Gap risk

For certain transactions which are structured so that the risk to HSBC is negligible under a wide range of market conditions or events, there exists a remote possibility that a significant gap event could lead to loss. A gap event could arise from a change in market price from one level to another with no accompanying trading opportunity, where the price change breaches the threshold beyond which the risk profile changes from having no open risk to having full exposure to the underlying structure. Such movements may occur, for example, when adverse news announcements turn the market for a specific investment illiquid, making hedging impossible.

Given the characteristics of these transactions, they will make little or no contribution to VAR or to traditional market risk sensitivity measures. HSBC captures the risks of such transactions within its stress testing scenarios and monitors gap risk arising on an ongoing basis. HSBC realised no gap losses arising from movements in the underlying market price on such transactions in the six months ended 30 June 2009. HSBC regularly considers the probability of gap loss and fair value adjustments are booked against this risk.

ABSs/MBSs positions

The ABSs/MBSs exposures within the trading portfolios are managed within sensitivity and VAR limits, as described on page 241 in the Annual Report and Accounts 2008, and are included within the stress testing scenarios described on page 174.

Non-trading portfolios

Interest rate risk in non-trading portfolios arises principally from mismatches between the future yield on assets and their funding cost, as a result of interest rate changes. Analysis of this risk is complicated by the need to make assumptions on embedded optionality within certain product areas, such as the incidence of mortgage prepayments, and from behavioural assumptions regarding the economic duration of liabilities which are contractually repayable on demand, such as current accounts. The prospective change in future net interest income from non-trading portfolios will be reflected in the current realisable value of these positions, should they be sold or closed prior to maturity. In order to manage this risk optimally, market risk in non-trading portfolios is transferred to Global Markets or to separate books managed under the supervision of the local Asset and Liability Committee ('ALCO').

Once market risk has been consolidated in Global Markets or ALCO-managed books, the net exposure is typically managed through the use of interest rate swaps within agreed limits. The VAR for these portfolios is included within the Group VAR (see 'Value at risk of trading and non-trading portfolios' above).

Credit spread risk

At 30 June 2009, the sensitivity of equity to the effect of movements in credit spreads on the Group's available-for-sale debt securities was US$764.5 million (30 June 2008: US$345.1 million; 31 December 2008: US$1,092 million). The sensitivity was calculated on the same basis as that applied to the trading portfolio. Including the gross exposure for the SICs consolidated within HSBC's balance sheet at 30 June 2009 increased the sensitivity to US$907.8 million (30 June 2008: US$393.1 million; 31 December 2008: US$1,145 million). This sensitivity was calculated, however, before taking account of any losses which would have been absorbed by the capital note holders. At 30 June 2009, they would have absorbed the first US$2.2 billion (31 December 2008: US$2.2 billion) of SIC losses prior to HSBC incurring any equity losses.

The decrease in this sensitivity at 30 June 2009, compared with 31 December 2008, was due to the effect of the reduction in the level of credit spreads observed during the first half of 2009. In addition, the overall credit spread positions were lower than at 31 December 2008.

Equity securities classified as available for sale

Market risk arises on equity securities held as available for sale. The fair value of these securities at 30 June 2009 was US$8.8 billion (30 June 2008: US$9.5 billion; 31 December 2008: US$7.2 billion), including private equity holdings of US$2.4 billion (30 June 2008: US$3.4 billion; 31 December 2008: US$2.5 billion). Investments in private equity are primarily made through managed funds that are subject to limits on the amount invested. Potential new commitments are subject to risk appraisal to ensure that industry and geographical concentrations remain within acceptable levels for the portfolio as a whole. Regular reviews are performed to substantiate the valuation of the investments within the portfolio. At 30 June 2009, funds typically invested for short-term cash management represented US$0.7 billion (30 June 2008: US$1.8 billion; 31 December 2008: US$0.9 billion), and investments held to facilitate ongoing business, such as holdings in government-sponsored enterprises and local stock exchanges, represented US$1.2 billion (30 June 2008: US$1.4 billion; 31 December 2008: US$1.0 billion). Other strategic investments represented US$4.5 billion at 30 June 2009 (30 June 2008: US$2.9 billion; 31 December 2008: US$2.8 billion). The fair value of the constituents of equity securities classified as available for sale can fluctuate considerably. A 10 per cent reduction in the value of the available-for-sale equities at 30 June 2009 would have reduced equity by US$0.9 billion (30 June 2008: US$0.9 billion; 31 December 2008: US$0.7 billion). HSBC's policy for assessing impairment on available-for-sale equity securities is described on page 350 of the Annual Report and Accounts 2008.

Additional market risk measures applicable only to the parent company

Interest rate repricing gap table

As described on page 174, the interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included within the Group VAR, but is managed on a repricing gap basis. The interest rate repricing gap table below analyses the full-term structure of interest rate mismatches within HSBC Holdings' balance sheet. An interest rate risk repricing gap table is a more suitable risk management measure for the longer term risk management strategy of a bank holding company balance sheet, compared to the VAR measures used for the Group's operating businesses.

The decrease in the negative net interest rate gap in the up to 1 year time bucket is mainly due to an increase in short-term interest bearing loans made to Group counterparties as HSBC Holdings placed the additional equity raised through the rights issue.

Repricing gap analysis of HSBC Holdings

	Up to      1 year		1-5 years		5-10 years		More than     10 years		Non-    interest     bearing		Total
	US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2009
Total assets	24,740		1,819		579		3,555		92,712		123,405
Total liabilities and equity	(10,263)		(9,050)		(9,076)		(15,725)		(79,291)		(123,405)
Off-balance sheet items sensitive to interest rate changes	(14,810)		6,571		5,772		4,114		(1,647)		-
Net interest rate risk gap	(333)		(660)		(2,725)		(8,056)		11,774		-
Cumulative interest rate gap	(333)		(993)		(3,718)		(11,774)		-		-
At 30 June 2008
Total assets	16,128		2,193		-		2,773		79,906		101,000
Total liabilities and equity	(3,653)		(11,652)		(9,813)		(14,052)		(61,830)		(101,000)
Off-balance sheet items sensitive to interest rate changes	(16,563)		9,356		6,338		4,510		(3,641)		-
Net interest rate risk gap	(4,088)		(103)		(3,475)		(6,769)		14,435		-
Cumulative interest rate gap	(4,088)		(4,191)		(7,666)		(14,435)		-		-
At 31 December 2008
Total assets	10,897		1,605		300		3,982		83,898		100,682
Total liabilities and equity	(9,099)		(6,597)		(8,252)		(14,250)		(62,484)		(100,682)
Off-balance sheet items sensitive to interest rate changes	(12,353)		4,410		5,046		3,760		(863)		-
Net interest rate risk gap	(10,555)		(582)		(2,906)		(6,508)		20,551		-
Cumulative interest rate gap	(10,555)		(11,137)		(14,043)		(20,551)		-		-

Foreign exchange risk

Total foreign exchange VAR arising within HSBC Holdings was as follows:

HSBC Holdings - value at risk

	Foreign exchange
	At  30 June  2009 US$m	At 30 June 2008 US$m	At 31 December 2008 US$m
At period end	63.4	41.8	55.2
Average in six  month period	80.7	34.6	44.6
Minimum in six  month period	55.2	29.1	37.5
Maximum in six  month period	190.8	41.8	56.1

The foreign exchange risk largely arises from loans to subsidiaries of a capital nature that are not denominated in the functional currency of either the provider or the recipient and which are accounted for as financial assets. Changes in the carrying amount of these loans due to foreign exchange rate differences are taken directly to HSBC Holdings' income statement. These loans, and the associated foreign exchange exposures, are eliminated on a Group consolidated basis.

The increased maximum VAR in the six months to 30 June 2009 compared to prior periods related to a portion of the proceeds of the Group's rights issue that were held in sterling.

Defined benefit pension scheme

Market risk also arises within HSBC's defined benefit pension schemes to the extent that the obligations of the schemes are not fully matched by assets with determinable cash flows. Pension scheme obligations fluctuate with changes in long-term interest rates, inflation, salary levels and the longevity of scheme members. Pension scheme assets include equities and debt securities, the cash flows of which change as equity prices and interest rates vary. There are risks that market movements in equity prices and interest rates could result in asset values which, taken together with regular ongoing contribution, are insufficient over time to cover the level of projected obligations and these, in turn, could increase with a rise in inflation and members living longer. Management, together with the trustees who act on behalf of the pension scheme beneficiaries, assess these risks using reports prepared by independent external actuaries and take action and, where appropriate, adjust investment strategies and contribution levels accordingly. 

HSBC's defined benefit pension schemes

	At 30      June      2009		At 30     June     2008		At 31     December    2008
	US$bn		US$bn		US$bn
Liabilities (present value)	28.3		32.3		24.0
	%		%		%
Assets:
Equity investments	19		21		20
Debt securities	66		64		68
Other (including property)	15		15		12
	100		100		100

Lower corporate bond yields in the UK in 2009 have resulted in a decrease of 100 basis points in the real discount rate (net of the increase in expected inflation) used to value the accrued benefits payable under the HSBC Bank (UK) Pension Scheme, the Group's largest plan. There has been an increase in the liabilities of the scheme as well as a reduction in the fair values of the plan assets of the scheme. As a consequence, the deficit on the HSBC Bank (UK) Pension Scheme has increased to US$3,881 million from US$392 million.

Sensitivity of net interest income

There have been no material changes since 31 December 2008 to HSBC's measurement and management of the sensitivity of net interest income to movements in interest rates.

A principal part of HSBC's management of market risk in non-trading portfolios is to monitor the sensitivity of projected net interest income under varying interest rate scenarios (simulation modelling). HSBC aims, through its management of market risk in non-trading portfolios, to mitigate the effect of prospective interest rate movements which could reduce future net interest income, while balancing the cost of such hedging activities on the current net revenue stream.

For simulation modelling, businesses use a combination of scenarios relevant to local entities and markets and standard scenarios which are required throughout HSBC. The standard scenarios are consolidated to illustrate the combined pro forma effect on HSBC's consolidated portfolio valuations and net interest income.

The table below sets out the effect on future net interest income of an incremental 25 basis points parallel rise or fall in all yield curves worldwide at the beginning of each quarter during the 12 months from 1 July 2009. Under the simplifying assumption of no management actions, a series of such rises would increase planned net interest income for the 12 months to 30 June 2010 by US$161 million (to 31 December 2009: US$463 million decrease), while a series of such falls would decrease planned net interest income by US$1,031 million (to 31 December 2009: US$284 million). These figures incorporate the effect of any option features in the underlying exposures.

Instead of assuming that all interest rates move together, HSBC groups its interest rate exposures into blocs of currencies whose rates are considered likely to move together. The sensitivity of projected net interest income, on this basis, is as follows:

Sensitivity of projected net interest income

	US dollar     bloc		Rest of     Americas     bloc		Hong Kong     dollar     bloc		Rest of     Asia     bloc		Sterling     bloc		Euro     bloc		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m
Change in July 2009 to June 2010 projected net interest income arising from a shift in yield curves at the beginning of each quarter of:
+ 25 basis points	(20)		76		(5)		107		368		(365)		161
- 25 basis points	(141)		(32)		(509)		(127)		(569)		347		(1,031)
Change in January 2009 to December 2009 projected net interest income arising from a shift in yield curves  at the beginning of each quarter of:
+ 25 basis points	(243)		42		(45)		100		28		(345)		(463)
- 25 basis points	41		(42)		(285)		(114)		(235)		351		(284)

The interest rate sensitivities set out in the table above are illustrative only and are based on simplified scenarios. 

The figures represent the effect of the pro forma movements in net interest income based on the projected yield curve scenarios and the Group's current interest rate risk profile. This effect, however, does not incorporate actions which would likely be taken by Global Markets or in the business units to mitigate interest rate risk. In reality, Global Markets seeks proactively to change the interest rate risk profile to minimise losses and optimise net revenues. The projections above also assume that interest rates of all maturities move by the same amount and, therefore, do not reflect the potential impact on net interest income of some rates changing while others remain unchanged. The projections make other simplifying assumptions too, including that all positions run to maturity. The projections take account of the effect on net interest income of anticipated differences in changes between interbank interest rates and interest rates linked to other bases (such as Central Bank rates or product rates over which the entity has discretion in terms of the timing and extent of rate changes). 

Projecting the movement in net interest income from prospective changes in interest rates is a complex interaction of structural and managed exposures. HSBC's exposure to the effect of movements in interest rates on its net interest income arises in two main areas: core deposit franchises and Global Markets. This is described more fully in the Annual Report and Accounts 2008.

The change in sensitivity of the Group's net interest income to the changes in interest rates tabulated above was mainly driven by:

•     decreases in interest rates, particularly in the US dollar, Hong Kong dollar and Sterling have restricted the Group's ability to pass on to depositors further rate reductions thereby increasing exposures to further rate falls; and

•     Global Markets reduced its net trading asset positions, particularly in Sterling and US dollars, decreasing net interest income sensitivity to both rising and falling rates. The funding of net trading assets is generally sourced from floating rate retail deposits and recorded in 'Net interest income' whereas the income from such assets is recorded in 'Net trading income'.

HSBC monitors the sensitivity of reported reserves to interest rate movements on a monthly basis by assessing the expected reduction in valuation of available-for-sale portfolios and cash flow hedges due to parallel movements of plus or minus 100 basis points in all yield curves. The table below describes the sensitivity of HSBC's reported reserves to these movements and the maximum and minimum month-end figures during the period:

Sensitivity of reported reserves to interest rate movements

			Impact in the preceding 6 months
	US$m		Maximum     US$m		Minimum     US$m
At 30 June 2009
+ 100 basis point parallel move in all yield curves	(2,918)		(3,085)		(2,715)
As a percentage of total shareholders' equity	(2.5%)		(2.6%)		(2.3%)
- 100 basis point parallel move in all yield curves	2,922		3,004		2,477
As a percentage of total shareholders' equity	2.5%		2.5%		2.1%
At 30 June 2008
+ 100 basis point parallel move in all yield curves	(2,179)		(2,519)		(1,737)
As a percentage of total shareholders' equity	(1.7%)		(2.0%)		(1.4%)
- 100 basis point parallel move in all yield curves	2,494		2,609		1,947
As a percentage of total shareholders' equity	2.0%		2.1%		1.5%
At 31 December 2008
+ 100 basis point parallel move in all yield curves	(2,740)		(2,740)		(2,052)
As a percentage of total shareholders' equity	(2.9%)		(2.9%)		(2.2%)
- 100 basis point parallel move in all yield curves	2,477		2,494		1,944
As a percentage of total shareholders' equity	2.6%		2.7%		2.1%

The sensitivities are illustrative only and are based on simplified scenarios. The table shows the potential sensitivity of reserves to valuation changes in available-for-sale portfolios and from cash flow hedges following the pro forma movements in interest rates. These particular exposures form only a part of the Group's overall interest rate exposures. The accounting treatment under IFRSs of the Group's remaining interest rate exposures, while economically largely offsetting the exposures shown in the above table, does not require revaluation movements to go to reserves.

Structural foreign exchange exposures

Structural foreign exchange exposures represent net investments in subsidiaries, branches or associates, the functional currencies of which are currencies other than the US dollar. HSBC's policies and procedures for managing these exposures are described on pages 248 and 249 in the Annual Report and Accounts 2008.

Operational risk

Operational risk is inherent to every aspect of the Group's business, and covers a wide spectrum of issues. The Group has adopted the Basel II definition of operational risk: 'the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, including legal risk.'

Losses arising from fraud, unauthorised activities, process or systems failure and natural disasters all fall within this definition.

The objective of HSBC's operational risk management is to manage and control operational risk in a cost effective manner within targeted levels consistent with the Group's risk appetite, as defined by the Group Management Board.

A formal governance structure provides oversight over the management of operational risk across the Group's geographical regions and its global businesses. The Global Operational Risk and Control Committee, which reports to the Risk Management Meeting, meets quarterly to discuss key risk issues and review the effective implementation of the Group's operational risk management framework.

In each of HSBC's subsidiaries, business managers are responsible for maintaining an acceptable level of internal control, commensurate with the scale and nature of operations. They are responsible for identifying and assessing risks, designing controls and monitoring the effectiveness of these controls.

HSBC has set out its operational risk management framework in a high level standard, supplemented by detailed policies. These policies include:

• the definition of a standard risk assessment methodology to identify, assess and report on operational risks faced by Group businesses; and

• setting out minimum standards for operational loss incident identification and reporting. To ensure that operational risk losses can be monitored at Group level, all Group companies are required to report individual losses when the net loss is expected to exceed US$10,000.

Further details of HSBC's approach to operational risk management can be found in the Annual Report and Accounts 2008, supplemented by the Capital and Risk Management Pillar 3 Disclosures as at 31 December 2008.

Legal risk 

Each operating company is required to implement procedures to manage legal risk that conform to HSBC standards. Legal risk falls within the definition of operational risk and includes contractual risk, dispute risk, legislative risk and non-contractual rights risk.

• Contractual risk is the risk that the rights and/or obligations of an HSBC company within a contractual relationship are defective.

• Dispute risk is the risk that an HSBC company is subject to when it is involved in or managing a potential or actual dispute.

• Legislative risk is the risk that an HSBC company fails to adhere to the laws of the jurisdictions in which it operates.

• Non-contractual rights risk is the risk that an HSBC company's assets are not properly owned or are infringed by others, or an HSBC company infringes another party's rights. 

HSBC has a global legal function to assist management in controlling legal risk. The function provides legal advice and support in managing claims against HSBC companies, as well as in respect of non-routine debt recoveries or other litigation against third parties. The Group Management Office ('GMO') legal department oversees the global legal function and is headed by a Group General Manager who reports to the Group Chairman. There are legal departments in 54 of the countries in which HSBC operates. There are also regional legal functions in each of Europe, North America, Latin America, the Middle East, and AsiaߛPacific.

Global security and fraud risk

Security and fraud risk issues are managed at Group level by Global Security and Fraud Risk. This unit, which has responsibility for physical fraud, information and contingency risk, security and business intelligence is fully integrated within the central GMO Risk function. The integration facilitates synergies between it and other risk functions, such as Global Retail Risk Management, in the selection, design and implementation of systems and processes to protect the Group against fraud by deterring fraudulent activity, detecting it where it occurs and mitigating its effects.

Reputational risk

The safeguarding of HSBC's reputation is of paramount importance to its continued prosperity and is the responsibility of every member of staff. Reputational risks can arise from a wide variety of causes, including social, ethical or environmental issues, or as a consequence of operational risk events. As a banking group, HSBC's good reputation depends upon the way in which it conducts its business, but it can also be affected by the way in which its clients conduct themselves.

A Group Reputational Risk Committee ('GRRC') has been established at which relevant Group functions with responsibilities for activities and functions which attract reputational risk are represented. The primary role of the GRRC is to consider areas and activities of policy presenting significant reputational risk and, where appropriate, make recommendations to the Risk Management Meeting and Group Management Board for policy or procedural changes to mitigate such risk. A wider description of HSBC's management of reputational risk is described on page 254 in the Annual Report and Accounts 2008.

Risk management of insurance operations

HSBC operates a bancassurance model which provides insurance products for customers with whom the Group has a banking relationship. Insurance products are sold to all customer groups, mainly utilising retail branches, the internet and phone centres. Personal Financial Services customers attract the majority of sales and comprise the majority of policyholders. HSBC offers its customers a wide range of insurance and investment products, many of which complement other bank and consumer finance products.

Many of these products are manufactured by HSBC subsidiaries but, where the Gr oup considers it operationally more effective, third parties are engaged to manufacture and provide insurance products for sale through HSBC's banking network.

Life insurance contracts inclue participating business (with discretionary participation features) such as endowments and pensions, credit life business in respect of income and payment 

 

END

 

 

MSCCKBKPCBKKFFD