Interim Report - 13 of 21

RNS Number : 9201Q

HSBC Holdings PLC

13 August 2010

 



markets and by securitising assets. At 30 June 2010, US$73 billion (30 June 2009: US$88 billion; 31 December 2009: US$82 billion) of HSBC Finance's liabilities were drawn from professional markets, utilising a range of products, maturities and currencies. As the loan portfolios within HSBC Finance are in run-off it has not accessed the term debt markets for more than two years.

The management of liquidity risk

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

Advances to core funding ratio

HSBC emphasises the importance of core customer deposits 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 core customer deposits or long term debt funding. This measure is referred to as the 'advances to core funding' ratio (previously referred to in the Annual Report and Accounts 2009 as the 'advances to deposits' ratio).

Advances to core funding ratio limits are set by the RMM and monitored by Group Finance. The ratio describes current loans and advances to customers as a percentage of the total of core customer deposits and term funding with a remaining term to maturity in excess of one year. Loans and advances to customers which are part of reverse repurchase arrangements, and where HSBC receives securities which are deemed to be liquid, are excluded from the advances to core funding ratio.

The three principal banking entities listed in the table below represented 62 per cent of HSBC's total core deposits at 30 June 2010 (30 June 2009: 64 per cent; 31 December 2009: 63 per cent). The table shows that loans and advances to customers in HSBC's principal banking entities are overwhelmingly 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 core funding is more restrictive than that which can be inferred from the published financial statements.

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

	Advances to core funding ratio during half-year to:						Stressed one month coverage ratio during half-year to:
	30        June       2010		30          June        2009		31 December         2009		30        June       2010		30          June        2009		31 December         2009
	%		%		%		%		%		%
HSBC Bank plc30
Period-end ......................................................	107.3		113.0		105.0		107.4		102.5		103.2
Maximum .......................................................	110.0		114.6		116.0		111.3		106.5		108.1
Minimum ........................................................	105.0		108.9		105.0		103.2		101.3		101.7
Average ..........................................................	107.6		111.6		109.9		106.7		103.2		104.4
The Hongkong and Shanghai Banking Corporation30
Period-end ......................................................	64.8		58.7		55.5		137.3		138.2		153.2
Maximum .......................................................	64.8		62.0		58.7		154.3		150.7		153.2
Minimum ........................................................	55.5		55.9		55.5		137.3		134.3		138.2
Average ..........................................................	59.7		58.9		56.3		146.5		140.3		148.4
HSBC Bank USA
Period-end ......................................................	95.7		106.4		101.0		110.7		121.9		105.3
Maximum .......................................................	104.0		124.8		106.6		112.9		128.0		121.9
Minimum ........................................................	95.7		106.4		97.0		105.3		121.9		105.3
Average ..........................................................	100.4		113.7		102.1		110.1		124.6		113.2
Total of HSBC's other principal banking entities31
Period-end ......................................................	85.7		87.7		85.9		123.7		119.7		124.8
Maximum .......................................................	87.2		89.2		87.7		126.5		121.7		124.8
Minimum ........................................................	85.7		81.2		85.9		120.9		116.3		118.6
Average ..........................................................	86.6		85.5		86.6		123.7		119.4		121.5

For footnotes, see page 196.

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 the rate and timing of deposit withdrawals and drawdowns on committed lending facilities are varied, and the ability to access interbank funding and term debt markets and to generate funds from asset portfolios are restricted. The Group applies conservative criteria to those securities that can be deemed 'liquid' and are therefore assumed to be a source of funding under stress scenarios. The scenarios are modelled by all Group banking entities and by HSBC Finance. The appropriateness of the assumptions under each scenario is regularly reviewed. In addition to the Group's standard projected cash flow scenarios, individual entities are required to design their own scenarios to reflect specific local market conditions, products and funding bases.

Stressed one month coverage ratio

The stressed one month coverage ratios tabulated above are derived from these scenario analyses, and express the stressed cash inflows as a percentage of stressed cash outflows over a one month time horizon. Group sites are required to target a ratio of 100 per cent or greater.

HSBC Finance

As HSBC Finance is unable to accept standard retail deposits, it takes funding from the professional markets. 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       2010		At    30 June       2009	At 31 December          2009
	US$bn		US$bn		US$bn
Maximum amounts of unsecured term funding maturing in any rolling:
3-month period ......	5.2		5.2		5.2
12-month period ....	12.3		13.5		12.3
Unused committed sources of secured funding32 ................	0.5		-		0.4
Committed backstop lines from non-Group entities in support of CP programmes ...........	4.3		5.3		5.3

For footnote, see page 196.

The need for HSBC Finance to refinance maturing term funding is mitigated by the continued run-down of its balance sheet.

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 HSBC and standby facilities to corporate customers. These facilities increase the funding requirements of the Group when customers choose to 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 the underlying assets 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    2010		At 30 Jun    2009		At 31 Dec    2009		At 30 Jun    2010		At 30 Jun    2009		At 31 Dec    2009		At 30 Jun    2010		At 30 Jun    2009		At 31 Dec    2009		At 30 Jun   2010		At 30 Jun    2009		At 31 Dec    2009
	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 assets33
- total lines ..........	7.3		6.3		7.4		5.1		9.4		6.4		0.1		0.3		0.3		0.2		-		0.3
- largest individual lines ...................	0.8		1.0		0.8		0.5		0.4		0.4		0.1		0.1		0.1		0.2		-		0.3
HSBC-managed assets34 .................	26.9		30.9		29.1		-		-		-		-		-		-		-		-		-
Other conduits35 .....	-		-		-		1.3		1.2		1.3		-		-		-		-		-		-
Single-issuer liquidity facilities
- five largest36 ......	4.1		5.6		4.3		5.7		4.5		6.1		2.0		1.8		2.0		2.8		0.9		1.2
- largest market sector37 ..............	6.8		7.8		7.9		4.4		3.1		4.7		3.5		2.6		2.9		2.9		1.5		1.5

For footnotes, see page 196.

The impact of market turmoil on liquidity risk

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.

Market turmoil continued to have adverse effects on the liquidity and funding risk profile of the banking system in 2010:

·     the markets continued to react cautiously to uncertainties arising from some economic and political developments and from potential regulatory changes;

·     wholesale funding markets, both secured and unsecured, continued to be challenging; and

·     many asset classes continued to suffer from reduced liquidity.

Despite these challenges, the Group has continued to have good access to debt capital markets with a number of issues completed in the six months to 30 June 2010.

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 2009. The key features are reported below.

Market risk is the risk that movements in market 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, 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 designated 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 185 to 189.

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, for interest rate risk, the present value of a basis point movement in interest rates. 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 account of 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 the 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, credit spreads 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 the limitations of VAR, HSBC augments it 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 at portfolio and consolidated levels, 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 consideration of any underlying market correlation;

·     hypothetical scenarios, which consider potential macro economic events, for example, a global flu pandemic; and

·     historical scenarios, which incorporate historical observations of market movements 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 following table provides an overview of the reporting of risks within this section:

	Portfolio
	Trading	Non-trading
Risk type
Foreign exchange and commodity .................	VAR	VAR38
Interest rate ...................	VAR	VAR39
Equity ............................	VAR	Sensitivity
Credit spread ..................	VAR	VAR40

For footnotes, see page 196.

The impact of market turmoil on market risk

High levels of market volatility across all asset classes continued into 2010 although the effect was limited by HSBC reducing its market risk exposures in non-trading portfolios.

Uncertainty over the robustness of the economic recovery, high levels of government borrowing in major economies and concerns over sovereign debt in the eurozone area have led to increased levels of market volatility across all asset classes during the first half of 2010.

The overall impact on VAR was limited as a result of continuing to manage down the market risk exposures in non-trading portfolios.

Value at risk of the trading and non-trading portfolios

The VAR, both trading and non-trading, for the Group was as follows:

Value at risk (excluding credit spread VAR)

	Half-year to
	30 June          2010		30 June          2009	31 December          2009
	US$m		US$m		US$m
At period end .......	182.6		152.3		204.5
Average ................	201.2		166.2		146.4
Minimum .............	156.2		135.1		105.7
Maximum .............	275.8		194.6		204.5

During the first half of 2010, continued market volatility, a reduction in portfolio diversification benefits and an increase in client-led transactions resulted in frequent periods of higher VAR utilisation, as reflected in the VAR summary in the above table. A significant amount of the underlying exposure driving the higher utilisation matured in the second quarter of 2010.

The daily VAR, both trading and non-trading, for the Group was as follows:

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       2010		30 June       2009	31 December          2009
	US$m		US$m		US$m
Average daily revenue	60.0		72.1		48.3
Standard deviation41 ... .................................	46.6		44.0		27.5

For footnote, see page 196.

An analysis of the frequency distribution of daily revenues shows that there were 5 days with negative revenue during the first half of 2010 compared with 7 days in the first half of 2009 and 4 days in the second half of 2009. The most frequent result was a daily revenue of between US$60 million and US$70 million with 21 occurrences, compared with between US$70 million and US$80 million with 14 occurrences in the first half of 2009, and 22 occurrences between US$30 million and US$40 million in the second half of 2009.

On 9 May 2010, the International Monetary Fund and the 16 member states of the euro area announced stabilisation measures for the eurozone. The period prior to this announcement was volatile, leading to a number of negative revenue days. The maximum daily revenue of US$450 million arose on 10 May 2010 which in large part reflected a recovery of these negative revenues days.

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.

Daily distribution of Global Markets' trading, Balance Sheet Management and other trading revenues⁴²

Half-year to 30 June 2010

Number of days

Revenues (US$m)

< Profit and loss frequency

Half-year to 30 June 2009

Number of days

Revenues (US$m)

<Profit and loss frequency

Half-year to 31 December 2009

Number of days

Revenues (US$m)

<Profit and loss frequency

For footnote, see page 196.

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 new product approval procedures, and of restricting trading in the more complex derivative products only to offices with appropriate levels of product expertise and robust control systems.

Market-making and position-taking is undertaken within Global Markets. The VAR for such trading activity at 30 June 2010 was US$62.5 million (30 June 2009: US$65.7 million; 31 December 2009: US$45.3 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		Total43
	US$m		US$m		US$m		US$m
At 30 June 2010 ...........................................................	21.7		43.3		3.8		62.5
At 30 June 2009 .............................................................	21.2		68.2		5.7		65.7
At 31 December 2009 ....................................................	19.5		42.6		17.5		45.3
Average
First half of 2010 .....................................................	31.4		56.1		11.6		81.5
First half of 2009 .......................................................	23.7		54.0		11.3		58.4
Second half of 2009 ....................................................	18.7		48.7		11.3		49.3
Minimum
First half of 2010 .....................................................	13.2		43.3		2.9		55.9
First half of 2009 .......................................................	16.3		35.6		4.9		35.6
Second half of 2009 ....................................................	11.1		37.8		5.6		38.3
.....................................................................................
Maximum
First half of 2010 .....................................................	62.9		88.9		21.6		122.2
First half of 2009 .......................................................	33.2		78.0		18.7		86.6
Second half of 2009 ....................................................	46.7		62.4		18.6		74.8

For footnote, see page 196.

The VAR for overall trading activity at 30 June 2010 was higher than at 31 December 2009 due to a reduction in the portfolio diversification benefit across asset classes. However, VAR remained consistent with the level as at 30 June 2009.

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 has introduced credit spread as a separate risk type within its VAR models on a global basis. The VAR shows the effect on trading income from a one-day movement in credit spreads over a two-year period, calculated to a 99 per cent confidence level.

At 30 June 2010, the credit VAR for trading activities was US$91.7 million (30 June 2009: US$109.8 million; 31 December 2009: US$72.7 million, calculated on a comparable basis). The increase in the credit VAR in the first half of 2010 was due to a modest increase in the sensitivity within the trading portfolios exposed to credit spread risk compared with 31 December 2009, as well as a slight increase in the volatility in the credit spreads observed during this period.

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 reflected in the income statement.

At 30 June 2010, the credit VAR on the credit derivatives transactions entered into by Global Banking was US$11.6 million (30 June 2009: US$15.3 million; 31 December 2009: US$13.8 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 there are adverse news announcements and the market for a

specific investment becomes 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 regularly considers the probability of gap loss and fair value adjustments are booked against this risk. HSBC has not incurred any significant gap loss in respect of such transactions in the half-year to 30 June 2010.

ABS/MBS positions

The ABS/MBS exposures within the trading portfolios are managed within sensitivity and VAR limits, as described on page 251 in the Annual Report and Accounts 2009, and are included within the stress testing scenarios described on page 176.

Non-trading portfolios

The principal objective of market risk management of non-trading portfolios is to optimise net interest income.

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 purchase of fixed income securities or 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 the trading and non-trading portfolios' above).

Credit spread risk

At 30 June 2010, the sensitivity of equity to the effect of movements in credit spreads, based on credit spread VAR, on the Group's available-for-sale debt securities was US$375 million (30 June 2009: US$533 million; 31 December 2009: US$535 million). The sensitivity was calculated on the same basis as applied to the trading portfolio. Including the gross exposure for the SICs consolidated within HSBC's balance sheet at 30 June 2010, the sensitivity increased to US$491 million (30 June 2009: US$749 million; 31 December 2009: US$549 million). This sensitivity is struck, however, before taking account of any losses which would be absorbed by the capital note holders. At 30 June 2010, the capital note holders would have absorbed the first US$2.2 billion (30 June 2009: US$2.2 billion; 31 December 2009: US$2.2 billion) of actual losses incurred by the SICs prior to HSBC incurring any equity losses.

The decrease in the credit spread VAR at 30 June 2010, compared with 31 December 2009, was due to the decrease in sensitivity within the available-for-sale portfolios.

Equity securities classified as available for sale

Market risk arises on equity securities classified as available for sale. The fair value of these securities at 30 June 2010 was US$8.8 billion (30 June 2009: US$8.8 billion; 31 December 2009: US$9.1 billion), and included private equity holdings of US$4.2 billion (30 June 2009: US$2.4 billion; 31 December 2009: US$4.0 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 2010, funds typically invested for short-term cash management represented US$0.5 billion (30 June 2009: US$0.7 billion; 31 December 2009: US$0.8 billion), and investments held to facilitate ongoing business, such as holdings in government-sponsored enterprises and local stock exchanges, represented US$1 billion (30 June 2009: US$1.2 billion; 31 December 2009: US$1.2 billion). Other strategic investments represented US$3.1 billion at 30 June 2010 (30 June 2009: US$4.5 billion; 31 December 2009: US$3.1 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 2010 would have reduced equity by US$0.9 billion (30 June 2009: US$0.9 billion; 31 December 2009: US$0.9 billion). HSBC's policy for assessing impairment on available-for-sale equity securities is described on page 375 of the Annual Report and Accounts 2009.

Sensitivity of net interest income

There have been no material changes since 31 December 2009 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, entities use a combination of scenarios relevant to their local businesses and markets and standard scenarios which are required throughout HSBC. The latter 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 2010. Assuming no management actions, a sequence of such rises would increase planned net interest income for the 12 months to 30 June 2011 by US$796 million (to 31 December 2010: US$695 million), while a sequence of such falls would decrease planned net interest income by US$1,495 million (to 31 December 2010: US$1,563 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 currency blocs 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 2010 to June 2011 projected net interest income arising from a shift in yield curves at the beginning of each quarter of:
+  25 basis points ...........................	346		81		131		123		282		(167)		796
-  25 basis points ...........................	(581)		(101)		(342)		(83)		(520)		132		(1,495)
Change in January 2010 to December 2010 projected net interest income arising from a shift in yield curves at the beginning of each quarter of:
+  25 basis points ...........................	13		92		416		112		363		(301)		695
-  25 basis points ...........................	(382)		(46)		(507)		(133)		(689)		194		(1,563)

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 the effect of 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 (although rates are not assumed to become negative in the falling rates scenario) and, therefore, do not reflect the potential impact on net interest income of some rates changing while others remain unchanged. In addition, 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). The projections make other simplifying assumptions, including that all positions run to maturity.

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 2009.

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 2010
+ 100 basis point parallel move in all yield curves ..............................	(4,714)		(4,714)		(3,096)
As a percentage of total shareholders' equity ......................................	(3.5%)		(3.5%)		(2.3%)
- 100 basis point parallel move in all yield curves ..............................	4,690		4,690		3,108
As a percentage of total shareholders' equity ......................................	3.5%		3.5%		2.3%
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%

Sensitivity of reported reserves to interest rate movements (continued)

			Impact in the preceding 6 months
	US$m		Maximum               US$m		Minimum               US$m
At 31 December 2009
+ 100 basis point parallel move in all yield curves ..............................	(3,096)		(3,438)		(2,918)
As a percentage of total shareholders' equity ......................................	(2.4%)		(2.7%)		(2.3%)
- 100 basis point parallel move in all yield curves ..............................	3,108		3,380		2,922
As a percentage of total shareholders' equity ......................................	2.4%		2.6%		2.3%

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 and 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 257 and 258 in the Annual Report and Accounts 2009.

Defined benefit pension schemes

Market risk 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 is a risk that market movements in equity prices and interest rates could result in asset values which, taken together with regular ongoing contributions, 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, take action and, where appropriate, adjust investment strategies and contribution levels accordingly.

HSBC's defined benefit pension schemes

	At 30       June       2010		At 30         June       2009		At 31 December      2009
	US$bn		US$bn		US$bn
Liabilities (present value).................................	30.0		28.3		30.6
	%		%		%
Assets:
Equity investments .....	20		19		21
Debt securities ............	67		66		67
Other (including property)	13		15		12
	100		100		100

Lower corporate bond yields in the UK in 2010 have resulted in a decrease of 10 basis points in the real discount rate (net of the decrease in expected inflation) used to value the accrued benefits payable under the HSBC Bank (UK) Pension Scheme, the Group's largest plan. The effect of the discount rate change and other market movements in the first half of the year on the HSBC Bank (UK) Pension Scheme is set out in Note 5 on the Financial Statements.

In June 2010, HSBC Bank agreed with the Trustee of the HSBC Bank (UK) Pension Scheme, the Group's largest plan, to accelerate the reduction of the plan deficit with a special contribution of £1,760 million (US$2,638 million). The reduction in the HSBC Bank (UK) Pension Scheme deficit from US$3,822 million to US$495 million is mainly a consequence of this contribution, which was used to acquire debt securities from HSBC Bank. This contribution also led to a revision in the plan's payment schedule, as disclosed in Note 5 on the Financial Statements.

For details of the latest actuarial valuation of the HSBC Bank (UK) Pension Scheme, see Note 8 on the Financial Statements in the Annual Report and Accounts 2009.

Additional market risk measures applicable only to the parent company

Interest repricing gap table

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.

The increase in the negative net interest rate gap since December 2009 is mainly due to fixed rate capital securities issued by HSBC Holdings in the half‑year period to 30 June 2010.

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 2010
Total assets .........................................................	18,701		1,648		300		3,733		93,456		117,838
Total liabilities and equity ...................................	(3,290)		(9,844)		(6,376)		(20,455)		(77,873)		(117,838)
Off-balance sheet items sensitive to interest rate changes ...........................................................	(15,302)		6,724		3,899		3,794		885		-
Net interest rate risk gap .....................................	109		(1,472)		(2,177)		(12,928)		16,468		-
Cumulative interest rate gap ................................	109		(1,363)		(3,540)		(16,468)		-		-
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 31 December 2009
Total assets .........................................................	19,070		4,301		300	4	4,381		87,741		115,793
Total liabilities and equity ...................................	(5,748)		(8,757)		(8,134)		(17,102)		(76,052)		(115,793)
Off-balance sheet items sensitive to interest rate changes ...........................................................	(15,302)		6,275		6,306		4,051		(1,330)		-
Net interest rate risk gap .....................................	(1,980)		1,819		(1,528)		(8,670)		10,359		-
Cumulative interest rate gap ................................	(1,980)		(161)		(1,689)		(10,359)		-		-

Foreign exchange risk

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

HSBC Holdings - foreign exchange VAR

	Half-year to
	30 June          2010        US$m		30 June          2009         US$m	31 December           2009          US$m
At period end ........	55.3		63.4		83.2
Average..................	62.8		80.7		70.6
Minimum ..............	52.7		55.2		63.4
Maximum ..............	83.2		190.8		83.2

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.

Operational risk

Operational risk is relevant to every aspect of the Group's business, and covers a wide spectrum of issues. Losses arising through fraud, unauthorised activities, error, omission, systems failure or from external events all fall within the definition of operational risk.

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.

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.

A formal governance structure provides oversight over the management of operational risk. A Global Operational Risk and Control Committee, which reports to the RMM, meets quarterly to discuss key risk issues and review the effective implementation of the Group's operational risk management framework.

HSBC has set out its operational risk management framework in a high level standard, supplemented by detailed policies which establish requirements for:

·     assigning responsibility for the management of operational risk and the maintenance of an appropriate internal control environment, under the oversight of a formal governance structure;

·     reporting top risks and control issues;

·     operational risk identification and reporting; and

·     provision of assurance over the design and operation of key controls through monitoring activities.

Further details of HSBC's approach to operational risk management can be found in the Annual Report and Accounts 2009, supplemented by the Capital and Risk Management Pillar 3 Disclosures as at 31 December 2009.

Legal risk

Each operating company is required to have processes and procedures in place to manage legal risk that conform to HSBC standards. Legal risk falls within the definition of operational risk and includes:

·     contractual risk, which is the risk that the rights and/or obligations of an HSBC company within a contractual relationship are defective;

·     dispute risk, which is made up of the risks that an HSBC company is subject to when it is involved in or managing a potential or actual dispute;

·     legislative risk, which is the risk that an HSBC company fails to adhere to the laws of the jurisdictions in which it operates; and

·     non-contractual rights risk, which 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, which assists the business in managing legal risk and provides legal advice and support. The GMO Legal department oversees the global legal function and is headed by a Group General Manager. There are legal departments in 58 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 Asia‑Pacific.

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 risk, fraud, information and contingency risk, and security and business intelligence is fully integrated within the central GMO Risk function. This enables the Group to identify and mitigate the permutations of these and other non-financial risks to its business lines across the jurisdictions in which it operates.

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, fiscal, 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 in such areas.

A Group Reputational Risk Committee ('GRRC') has been established to bring focus to activities that could attract reputational risk. The primary role of the GRRC is to consider both existing and emerging areas and activities presenting significant reputational risk and, where appropriate, to make recommendations to the RMM and Group Management Board for policy or procedural changes to mitigate such risk. Reputational Risk Committees have also been established in each of the Group's regions. These committees ensure that reputational risks are considered at a regional as well as Group level. Minutes from the regional committees are tabled at GRRC. A wider description of HSBC's management of reputational risk is provided on pages 263 and 264 in the Annual Report and Accounts 2009.

Compliance risk

Compliance risk has become increasingly significant since 31 December 2009, and there continues to be considerable activity by regulatory and law enforcement agencies, particularly in the UK and US. In the UK, the FSA has made numerous public policy statements to the effect that it intends to increase its use of its enforcement powers, to apply substantially increased penalties and focus on the conduct of individuals occupying senior management roles. In the US, the activities of law enforcement and supervisory agencies have included a focus on tax evasion, sanctions compliance and anti-money laundering controls. As an international banking group, HSBC is therefore operating in a more complex regulatory and compliance environment with a higher risk of regulatory sanction.

HSBC USA Inc. and HSBC Bank USA are currently the subject of ongoing examinations by the Office of the Comptroller of the Currency and the Federal Reserve Bank of Chicago, and they have received inquiries, including grand jury subpoenas and other requests for information, from US government agencies, including the U.S. Attorney's Office and the U.S. Department of Justice. These examinations and inquiries relate to, among other matters, HSBC Bank USA's Global Banknotes business and its foreign correspondent banking business, and its compliance with the Bank Secrecy Act, Anti-Money Laundering and Office of Foreign Assets Control requirements. HSBC USA Inc. and HSBC Bank USA are cooperating fully and are actively engaged in efforts to resolve these matters. While it is likely that there will be some form of formal enforcement action in some of these matters, HSBC is unable at this time to determine the terms on which it might be brought, the timing of any possible regulatory resolution or enforcement action or the amount of fines or penalties, if any, that may be imposed by the regulators or agencies.

HSBC is committed to the highest Compliance standards globally, especially due to the increasing scale and complexity of the regulatory environment. At the suggestion of HSBC's regulators and consistent with the Group's organisational model, in the second quarter of 2010 the Compliance and Legal functions in North America were separated into two functions. The Compliance function will continue to report to the HSBC Head of Group Compliance as well as functionally to the CEO of HSBC North America. The HSBC Head of Group Compliance has been appointed as the Acting Head of Compliance, North America Region until such time as a permanent appointment is made. Additional steps have been taken to enhance the Group's compliance risk management approach, including the strengthening of the Anti-Money Laundering ('AML') Office with responsibility for the guidance and oversight of AML risk management activities in HSBC North America and its subsidiaries, including HSBC Bank USA. Efforts to strengthen the Compliance function will continue.

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 insurance products are manufactured by HSBC subsidiaries. The Group underwrites the insurance risk and retains the risks and rewards associated with writing insurance contracts, retaining both the underwriting profit and the commission paid by the manufacturer to the bank distribution channel within the Group. When the Group chooses to manage its exposure to insurance risk through the use of third-party reinsurers, the associated revenue and manufacturing profit is ceded to them.

Where the Group considers it operationally more effective, third parties are engaged to manufacture insurance products for sale through HSBC's banking network. The Group works with a limited number of market-leading partners to provide the products. These arrangements earn HSBC a commission.

Life insurance contracts include participating business with discretionary participation features ('DPF') such as endowments and pensions, credit life business in respect of income and payment protection, annuities, term assurance and critical illness cover and linked contracts.

Non-life insurance contracts include motor, fire and other damage to property, accident and health, repayment protection and commercial insurance. In December 2007, the group decided to cease selling payment protection insurance ('PPI') products in the UK and a phased withdrawal was completed across the HSBC, first direct and M&S Money brands during 2008. HFC ceased selling single premium PPI in 2008 and sales of regular premium PPI will reduce as HFC exits its remaining retail relationships. HSBC continues to distribute its UK short-term income protection ('STIP') product. In January 2009, the Competition Commission ('CC') published its report into the PPI market in which it stipulated that STIP products will also be subject to their remedies when sold in conjunction with or as a

 

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