Interim Report - 17 of 25

RNS Number : 6298J

HSBC Holdings PLC

10 August 2012

 



Liquidity and funding

Liquidity and funding in the first half of 2012 ......	162
Sources of funding ................................................	162
Management of funding and liquidity risk .............	163
Advances to core funding ratio .........................	163
Funding of HSBC Finance ...............................	164
Stressed coverage ratio .....................................	164
Liquid assets of HSBC's principal operating entities ..........................................................	165
Contingent liquidity risk ...................................	166
Encumbered assets ................................................	167
Liquidity regulation ..............................................	167

Liquidity risk is the risk that the Group does not have sufficient financial resources to meet its obligations as they fall due, or will have to do so at an excessive cost. The risk arises from mismatches in the timing of cash flows.

There have been no material changes to our policies and practices for the management of liquidity and funding risks as described in the Annual Report and Accounts 2011.

Our liquidity and funding risk management framework

The objective of our liquidity framework is to position our operating entities to withstand very severe liquidity stresses. It is designed to be adaptable to changing business models, markets and regulations.

Our liquidity and funding risk management framework requires:

·  liquidity to be managed by operating entities on a stand-alone basis with no implicit reliance on the Group or central banks;

·  all operating entities to comply with their limits for the advances to core funding ratio; and

·  all operating entities to maintain a positive stressed cash flow position out to three months under prescribed Group stress scenarios.

Further details of the metrics are provided in the Appendix to Risk on page 183.

A summary of our current policies and practices regarding liquidity and funding is provided in the Appendix to Risk on page 183.

Liquidity and funding in the first half of 2012

The liquidity and funding position of the Group remained strong in the first half of 2012, as demonstrated by the Group's key liquidity and funding metrics presented in the tables below and explained on the following pages.

During the first half of 2012, HSBC UK (see footnote 40) continued to fund the majority of growth in advances with growth in core deposits. The advances to core funding ratioincreased, reflecting certain wholesale term debt becoming due within one year and therefore no longer meeting the definition of core funding.

The Hongkong and Shanghai Banking Corporation, with an advances to core funding ratio of 74%, continued to be well positioned from a funding perspective to implement the Group's business strategy across Asia-Pacific.

The completion of the sale of the US card business and branch network during the first half of 2012 improved the liquidity and funding position of both HSBC Finance and HSBC USA (see footnote 42), the latter recording a decrease in the advances to core funding ratio to 68% from 86% at 31 December 2011.

As shown in the sources and uses table below, customer deposits (excluding repo and liabilities held for sale) increased by US$29bn reflecting the Group's continued ability to attract new customer deposits. The increase was driven by growth in Europe across all global businesses, and in Hong Kong across RBWM and CMB, reflecting the success of deposit gathering initiatives. These increases were partly offset by declines in Latin America due to a managed reduction in GB&M term deposits in Brazil, together with a reduction in North America as short-term customer placements at the end of 2011 returned to more normal levels in a competitive market.

We also continued to have good access to senior debt capital markets during the first half of 2012, with Group entities issuing US$8bn of term debt securities with maturities in excess of one year in the public capital markets.

Sources of funding

Our primary sources of funding are current accounts and savings deposits payable on demand or short notice, and we do not rely on securitisations, covered bond issuance programmes or repurchase agreements as important sources of funding. Repurchase agreements entered into are generally short-term in nature, maturing in 90 days or less. We carry out short-term lending using reverse repurchase agreements in various markets. The majority of the counterparts to these transactions are of high credit quality. For all transactions we ensure that the collateral is accepted with an appropriate haircut reflecting counterparty and collateral credit quality.

The funding sources and uses table, which provides a consolidated view of how our balance sheet is funded, should be read in the light of our risk management framework, which requires our operating entities to manage liquidity and funding risk on a stand-alone basis. The table analyses our consolidated balance sheet according to the assets that primarily arise from operating activities and the sources of funding primarily supporting these activities. The assets and liabilities that do not arise from operating activities are presented as a net balancing source or deployment of funds.

Funding sources and uses

	30 Jun      2012		30 Jun       2011		31 Dec       2011			30 Jun      2012		30 Jun       2011		31 Dec       2011
	US$m		US$m		US$m			US$m		US$m		US$m
Sources							Uses
Customer accounts .........	1,278,489		1,318,987		1,253,925		Loans and advances to customers ....................	974,985		1,037,888		940,429
- repos ...........................	26,426		64,192		30,785		- reverse repos ...............	49,320		74,123		41,419
- cash deposits ...............	1,252,063		1,254,795		1,223,140		- loans or other receivables	925,665		963,765		899,010
Deposits by banks ...........	123,553		125,479		112,822		Loans and advances to banks ...........................	182,191		226,043		180,987
- repos ...........................	17,054		18,329		17,617		- reverse repos ...............	42,429		68,247		41,909
- cash deposits ...............	106,499		107,150		95,205		- loans or other receivables .....................................	139,762		157,796		139,078
Debt securities issued ......	125,543		149,803		131,013		Assets held for sale .........	12,383		1,626		39,558
Liabilities of disposal groups							Trading assets .................	391,371		474,950		330,451
held for sale .................	12,599		41		22,200		- reverse repos ...............	104,335		111,373		79,848
							- stock borrowing ...........	16,509		19,826		9,459
Subordinated liabilities ....	29,696		32,753		30,606		- other trading assets ......	270,527		343,751		241,144
Financial liabilities designated at fair							Financial investments .....	393,736		416,857		400,044
value ............................	87,593		98,280		85,724
Liabilities under insurance							Cash and balances with
contracts .....................	62,861		64,451		61,259		central banks ..................	147,911		68,218		129,902
Trading liabilities ............	308,564		385,824		265,192		Net deployment in other
- repos ...........................	112,628		119,783		86,838		balance sheet assets and
- stock lending ...............	6,013		8,479		4,595		liabilities ......................	100,087		117,573		107,463
- other trading liabilities .	189,923		257,562		173,759
Total equity ...................	173,766		167,537		166,093
	2,202,664		2,343,155		2,128,834			2,202,664		2,343,155		2,128,834

Management of funding and liquidity risk

Our liquidity and funding risk framework employs two key measures to define, monitor and control the Group's liquidity and funding risk. For each operating entity, the advances to core funding ratio is used to monitor the structural long-term funding position and stressed coverage ratios incorporating Group defined stress scenarios are used to monitor the resilience to severe liquidity stresses.

Advances to core funding ratio

The three principal entities listed in the table below represented 61% of the total core deposits originated by operating entities at 30 June 2012 and overseen by the Risk Management Meeting (30 June 2011: 61%; 31 December 2011: 61%).

The table shows that loans and advances to customers in our principal banking entities were financed by reliable and stable sources of funding. We would meet any unexpected cash outflows primarily from our cash and balances at central banks, by selling or entering into repos with the securities assessed as liquid assets, and by running down interbank loans and reverse repos contractually. Additional sources of secured funding such as collateralised lending markets could also be accessed over the longer term.

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 could be inferred from the published financial statements.

Advances to core funding ratios³⁹

	Half-year to
	30 Jun    2012		30 Jun     2011		31 Dec     2011
	%		%		%
HSBC UK40
Period-end ...........	104		100		100
Maximum ............	104		103		102
Minimum .............	100		98		99
Average ...............	102		101		100
The Hongkong and Shanghai Banking Corporation41
Period-end ...........	74		79		75
Maximum ............	75		79		79
Minimum .............	71		70		75
Average ...............	73		75		77
HSBC USA42
Period-end ...........	68		81		86
Maximum ............	86		98		86
Minimum .............	68		80		81
Average ...............	80		86		82
Total of HSBC's other principal entities43
Period-end ...........	88		89		86
Maximum ............	88		90		90
Minimum .............	85		88		86
Average ...............	86		89		88

For footnotes, see page 180.

Funding of HSBC Finance

HSBC Finance historically raised term funding from the professional markets and, to a lesser extent, through securitising assets. At 30 June 2012, US$41bn (30 June 2011: US$59bn; 31 December 2011: US$51bn) of HSBC Finance's liabilities were drawn from professional markets, utilising a range of products, maturities and currencies.

HSBC Finance - funding

	At 30 Jun     2012		At   30 Jun     2011		At 31 Dec     2011
	US$bn		US$bn		US$bn
Maximum amounts of unsecured term funding maturing in any rolling:
3-month period ...............	3.6		5.1		5.1
12-month period .............	9.4		10.8		9.7
Unused committed sources of secured funding44 .............	-		0.5		0.5
Committed backstop lines from non-Group entities in support of CP programmes ..........	2.0		4.0		4.0

For footnote, see page 180.

HSBC Finance uses a range of measures to monitor funding risk, including stress 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 has in place committed backstop lines from non-Group entities for short-term refinancing commercial paper ('CP') programmes. A CP programme is a short-term, unsecured funding tool used to manage day to day cash flow needs. In agreement with the rating agencies, issuance under this programme will not exceed 100% of committed bank backstop lines. HSBC Finance plans to wind down its CP programme during 2012 and, to that end, did not renew a US$2bn credit facility that expired in April 2012.

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

We do not expect the professional markets to be a source of funding for HSBC Finance in the future in light of the sale of the Card and Retail Services business and the run-off of its remaining business. HSBC Finance will meet future funding needs by asset sales and affiliate funding. As a consequence, no new external third-party funding (including CP) is being originated by HSBC Finance.

Stressed coverage ratios

The stressed coverage ratios tabulated below express stressed cash inflows as a percentage of stressed cash outflows over a one month time horizon. Operating entities are required to maintain a ratio of 100% or greater out to three months.

At 30 June 2012, the one-month and three-month stressed coverage ratios for the three principal entities and the total of HSBC's other principal operating entities shown in the table below were in excess of the 100% target.

Inflows included in the numerator of the stressed coverage ratio are those that are assumed to be generated from the utilisation of liquid assets net of management assumed haircuts, and cash inflows related to assets contractually maturing within the stressed cash flow time period and not already reflected as a utilisation of a liquid asset.

In general, customer advances are assumed to be renewed and as a result are not assumed to generate a stressed cash inflow or represent a liquidity resource.

Stressed one-month coverage ratio³⁹

	Half-year to
	30 Jun    2012		30 Jun     2011		31 Dec     2011
	%		%		%
HSBC UK40
Period-end ..................	111		116		116
Maximum ...................	117		116		118
Minimum ....................	111		109		110
Average ......................	114		112		113
The Hongkong and Shanghai Banking Corporation41
Period-end ..................	124		117		123
Maximum ...................	134		145		123
Minimum ....................	123		117		116
Average ......................	130		128		119
HSBC USA42
Period-end ..................	134		117		118
Maximum ...................	137		128		123
Minimum ....................	115		108		109
Average ......................	125		122		116
Total of HSBC's other principal entities43
Period-end ..................	118		117		118
Maximum ...................	123		121		119
Minimum ....................	118		117		116
Average ......................	120		119		117

For footnotes, see page 180.

The total shown for other principal HSBC operating entities represents the combined position of all the other operating entities overseen directly by the Risk Management Meeting.

Liquid assets of HSBC's principal operating entities

The table below shows the estimated liquidity value (before haircuts) of assets categorised as liquid assets used for the purposes of calculating the three month stressed coverage ratio, as defined under the HSBC Group framework.

Any unencumbered asset held as a consequence of a reverse repo transaction with a residual contractual maturity within three months is not reflected in the liquid assets values presented as these assets are reflected as contractual cash inflows. Unsecured interbank loans maturing within three months are also not reflected in the liquid asset values presented as these assets are also reflected as contractual cash inflows.

The decrease of US$8bn in level 1 and level 2 liquid assets and US$12bn in total liquid assets reported for HSBC USA in the first half of 2012 was offset by an increase of US$14bn in the amount of cash deployed in reverse repo transactions maturing within three months (the majority maturing within one week) which are excluded from the liquid asset values presented for HSBC USA.

Liquid assets of HSBC's principal entities

	Estimated liquidity value45
	30 Jun               2012		30 Jun                2011		31 Dec                2011
	US$m		US$m		US$m
HSBC UK40
Level 1 and Level 2 ..................................................................................	121,165		82,425		114,940
Level 3 .....................................................................................................	9,320		-		-
Non-government assets ............................................................................	-		28,468		23,007
	130,485		110,893		137,947
The Hongkong and Shanghai Banking Corporation41
Level 1 and Level 2 ..................................................................................	110,872		94,401		107,056
Level 3 .....................................................................................................	4,889		-		-
Non-government assets ............................................................................	-		3,747		2,151
	115,761		98,149		109,208
HSBC USA42
Level 1 and Level 2 ..................................................................................	79,477		78,587		87,429
Level 3 .....................................................................................................	8,405		-		-
Other ........................................................................................................	6,238		-		-
Non-government assets ............................................................................	-		19,526		19,093
	94,120		98,113		106,522
Total of HSBC's other principal entities43
Level 1 and Level 2 ..................................................................................	155,329		153,281		140,911
Level 3 .....................................................................................................	11,205		-		-
Other ........................................................................................................	-		-		-
Non-government assets ............................................................................	-		37,155		23,584
	166,534		190,436		164,495

For footnotes, see page 180.

The Group's liquid asset policy was refined as at 1 January 2012 to apply a more granular definition of liquid assets, as set out in the Appendix to Risk on page 183. Under the previous framework, liquid assets were classified into two categories: central government, central bank and US agency MBS exposures; and all other non-government exposures. Central government, central bank and US agency MBS exposures qualify as Level 1 or Level 2 under the new policy and are shown as such in the comparatives. All other non-governmental liquid assets are separately presented in the comparatives. All assets within the liquid asset portfolio are unencumbered.

Contingent liquidity risk

Contingent liquidity risk is the risk associated with the need to provide additional funds to clients. The client-originated exposure relates to multi-seller conduits, which were established to enable clients to access a flexible market-based source of finance (see page 256). HSBC-managed asset exposures are differentiated in that they relate to consolidated SICs which issue debt secured by ABSs (see page 255). Other conduit exposures relate to third-party sponsored conduits (see page 257). Single issuer liquidity facilities are provided directly to clients rather than via any form of conduit. Single issuer liquidity facilities provided in the table below represent the aggregate of the five largest facilities, and the largest market sector.

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

	HSBC UK						HSBC USA						HSBC Canada						The Hongkong and Shanghai Banking Corporation
	At 30 Jun    2012		At 30 Jun    2011		At 31 Dec    2011		At 30 Jun    2012		At 30 Jun    2011		At 31 Dec    2011		At 30 Jun    2012		At 30 Jun    2011		At 31 Dec    2011		At 30 Jun   2012		At 30 Jun    2011		At 31 Dec    2011
	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 assets
- total lines .........	10.0		7.5		11.4		1.7		1.2		0.9		0.9		0.7		0.7		-		-		-
- largest individual lines ..............	0.6		0.4		0.7		0.5		0.4		0.3		0.8		0.5		0.5		-		-		-
HSBC-managed assets46 - total lines .........	20.0		23.6		22.1		-		-		-		-		-		-		-		-		-
Other conduits47 - total lines .........	-		-		-		1.0		1.1		1.4		-		-		-		-		-		-
Single-issuer liquidity facilities
- five largest48 .....	4.0		4.2		3.4		5.9		6.6		5.7		1.7		2.2		1.8		1.6		1.9		1.9
- largest market sector49 .........	8.4		9.8		7.5		7.1		5.1		6.5		4.2		4.3		3.8		2.5		2.6		2.5

For footnotes, see page 180.

Comparatives for HSBC UK have been adjusted to reflect the reassessment of contingent liquidity risk exposures for certain entities.

Encumbered assets

Encumbered assets are assets which have been pledged or used as collateral or which legally we may not be able to use to secure funding. It remains a strength that only a small percentage of our assets are encumbered and that the majority of our assets are available as security for all our creditors. The majority of the encumbrance arises due to our repo activity within Europe and the US in GB&M, which is largely self-funding.

Our encumbered assets on an IFRSs basis are disclosed in Note 19 on the Financial Statements. Assets not included in Note 19 but which would generally not be used to secure funding include assets backing insurance and investment contracts (see 'Balance sheet of insurance manufacturing' on page 178) and Hong Kong Government certificates of indebtedness which secure Hong Kong currency notes in circulation, which are included on the face of the consolidated balance sheet. Additionally, properties with net book values of US$38m (30 June 2011: US$61m; 31 December 2011: US$33m) are considered encumbered.

Liquidity regulation

In December 2010, the Basel Committee on Banking Supervision ('Basel Committee') published the 'International framework for liquidity risk measurement, standards and monitoring'. The framework comprises two liquidity metrics: the liquidity coverage ratio ('LCR') and the net stable funding ratio ('NSFR'). The ratios are subject to an observation period that began in 2011, and are expected to become established standards by 2015 and 2018, respectively. During the observation period, the standards are under review by the Basel Committee with any revisions to the LCR expected by mid-2013 and to the NSFR by mid-2016.

Currently, the Basel Committee and the European Commission are debating the final calibration of the LCR and the NSFR. A significant level of interpretation is required in determining how to apply the definitions as currently drafted, in particular, the definition of operational deposits. It is therefore likely that the ratios will be subject to further change as exact requirements are finalised.

Market risk

Market risk in the first half of 2012 ......................	168
Trading and non-trading portfolios ........................	168
Structural foreign exchange exposures ...................	171
Sensitivity of net interest income ..........................	171
Balance Sheet Management ...................................	172
Defined benefit pension schemes ...........................	172
Additional market risk measures applicable only to the parent company ..........................................	173

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 our income or the value of our portfolios.

There have been no material changes to our policies and practices for the management of market risk as described in the Annual Report and Accounts 2011.

Exposure to market risk

Exposure to market risk is separated into two portfolios:

·      Trading portfolios include positions arising from market-making and position-taking and others designated as marked to market.

·      Non-trading portfolios including Balance Sheet Management, include positions that primarily arise from the interest rate management of our retail and commercial banking assets and liabilities, financial investments designated as available for sale and held to maturity, and exposures arising from our insurance operations (see page 176).

Monitoring and limiting market risk exposures

Our objective is to manage and control market risk exposures in order to optimise return on risk while maintaining a market profile consistent with our status as one of the world's largest banking and financial services organisations.

We use a range of tools to monitor and limit market risk exposures, including:

·      sensitivity measures are used to monitor the market risk positions within each risk type;

·      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; and

·      in recognition of VAR's limitations we augment VAR with stress testing to evaluate the potential impact on portfolio values of more extreme, though plausible, events or movements in a set of financial variables. Examples of scenarios reflecting current market concerns are the mainland China slowdown and the potential effects of a sovereign debt default, including its wider contagion effects.

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

A summary of our current policies and practices regarding market risk is provided in the Appendix to Risk on page 183.

Market risk in the first half of 2012

The first quarter of the year began with a positive trend in the markets. This was reflected in a stock market rally, a sharp decrease in major volatility indices, credit spreads tightening and funding spreads improving across the board. The issuance of new debt and secondary trading activity benefited from the strong rally in credit. However, in the second quarter, the slowdown in global growth combined with the persistent challenges in the eurozone to re‑introduce risk aversion, resulting in credit markets retracting, global stock markets retreating and the US dollar appreciating against the euro, sterling and emerging market currencies.

The eurozone sovereign debt crisis remained the centre of attention throughout the first half of the year. The difficulties in implementing the prescribed austerity measures and fiscal discipline, the possibility of counties exiting the eurozone, the escalating fears around high debt to GDP ratios and the need for aid to recapitalise banks weighed down on market sentiment. Against this backdrop, our response was to continue to manage down and, where possible, hedge our exposure to eurozone countries.

Trading and non-trading portfolios

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	VAR50
Interest rate .................	VAR	VAR51
Equity ..........................	VAR	Sensitivity
Credit spread ................	VAR	VAR

For footnotes, see page 180.

Value at risk of the trading and non-trading portfolios

Our Group VAR, both trading and non-trading, was as tabulated overleaf.

During the first half of 2012, the reduction in VAR mainly came from credit portfolios as a result of a reduction in the volatility of the historical market data in our VAR model.

Value at risk

	Half-year to
	30 June          2012		30 June         2011	31 December          2011
	US$m		US$m		US$m
At period-end ......	258.6		249.7		367.0
Average ..............	292.4		289.5		313.2
Minimum ............	229.0		241.1		231.5
Maximum ...........	383.9		403.2		404.3

 

We routinely validate the accuracy of our 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, we would expect to see losses in excess of VAR only 1% 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. In the first half of 2012, there were no loss exceptions at Group level. This was consistent with what is statistically expected from the model.

Daily distribution of Global Markets' trading, Balance Sheet Management and other trading revenues52,53
	Half-year to							Half-year to 30 June 2012
		30 Jun		30 Jun		31 Dec		Number of days
		2012		2011		2011
		US$m		US$m		US$m
Average daily revenue ..		55.5		50.7		34.2
Standard deviation54 .....		29.7		25.8		40.5
Ranges of most frequent daily revenues ...........		40 - 50		30 - 40		30 - 40
		days		days		days
- daily occurrences ....		23		25		17
Days of negative revenue		-		2		21
								Revenues (US$m)
								< Profit and loss frequency
Half-year to 30 June 2011								Half-year to 31 December 2011
Number of days								Number of days
Revenues (US$m)								Revenues (US$m)
< Profit and loss frequency								< Profit and loss frequency

For footnotes, see page 180.

Our Group daily VAR, both trading and non-trading, was as follows. For a description of HSBC's fair value and price verification controls, see page 230.

Daily VAR (trading and non-trading)

(US$m)

Trading portfolios

VAR by risk type for trading intent activities⁵⁵

	Foreign exchange and     commodity		Interest                 rate		Equity		Credit             spread		Portfolio diversification56		Total57
	US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2012 .........	28.8		42.9		13.8		26.4		(42.7)		69.2
At 30 June 2011 ...........	10.3		67.0		4.1		38.7		(28.5)		91.6
At 31 December 2011 ...	18.6		49.4		7.4		75.2		(32.3)		118.3
Average
First half of 2012 ....	30.0		45.0		5.9		37.4		(29.7)		88.7
First half of 2011 ......	15.0		52.0		9.2		46.2		(28.8)		93.6
Second half of 2011 ..	18.6		56.3		6.7		67.9		(39.9)		109.7
Minimum
First half of 2012 ....	14.4		33.3		2.7		22.4		-		62.0
First half of 2011 ......	7.6		30.1		3.6		34.7		-		62.2
Second half of 2011 ..	9.2		44.4		2.5		34.8		-		77.9
Maximum
First half of 2012 ....	46.0		60.0		13.8		77.9		-		130.9
First half of 2011 ......	26.8		80.2		17.2		56.2		-		143.9
Second half of 2011 ..	31.9		78.2		14.9		103.2		-		138.4

For footnotes, see page 180.

The VAR for trading intent activity within Global Markets at 30 June 2012 (US$69.2m) was lower than at 31 December 2011 (US$118.3m) due to a reduction in positions, lower volatility of the historical market data in our VAR model, and an increase in portfolio diversification.

Credit spread risk

Credit spread risk arises on credit derivative transactions entered into by Global Banking in order to manage the risk concentrations within our corporate loan portfolio and enhance capital efficiency.

At 30 June 2012, the credit VAR on these transactions was US$5.5m (30 June 2011: US$3.7m; 31 December 2011: US$6.6m). The mark-to-market of these transactions is reflected in the income statement.

Gap risk

We did not incur any significant gap risk loss in the half-year to 30 June 2012.

Non-trading portfolios

Available-for-sale debt securities

At 30 June 2012, the sensitivity of equity capital to the effect of movements in credit spreads on our available-for-sale debt securities, including the gross exposure for the SICs consolidated within our balance sheet, based on credit spread VAR, was US$212m (30 June 2011: US$220m; 31 December 2011: US$389m). This sensitivity is calculated before taking into account losses which would have been absorbed by the capital note holders.

At 30 June 2012, the capital note holders would absorb the first US$2.2bn (30 June 2011: US$2.2bn; 31 December 2011: US$2.3bn) of any losses incurred by the SICs before we incur any equity losses.

Equity securities classified as available for sale

Fair values of equity securities

	At   30 Jun      2012		At    30 Jun      2011		At  31 Dec      2011
	US$bn		US$bn		US$bn
Private equity holdings58	3.0		2.9		3.0
Funds invested for short- term cash management ....................................	0.1		0.6		0.2
Investment to facilitate ongoing business59 .......	1.1		1.1		1.1
Other strategic investments ....................................	2.5		3.6		2.9
Total ..............................	6.7		8.2		7.2

For footnotes, see page 180.

Potential new commitments are subject to risk appraisal to ensure that industry and geographical concentrations remain within acceptable levels for the portfolio. Regular reviews are performed to substantiate the valuation of the investments within the portfolio and investments held to facilitate ongoing business, such as holdings in government-sponsored enterprises and local stock exchanges.

The fair value of the constituents of equity securities classified as available for sale can fluctuate considerably. A 10% reduction in the value of the available-for-sale equities at 30 June 2012 would have reduced equity by US$0.7bn (30 June 2011: US$0.8bn; 31 December 2011: US$0.7bn). Our policy for assessing impairment on available-for-sale equity securities is described on page 301 of the Annual Report and Accounts 2011.

Structural foreign exchange exposures

Our policies and procedures for managing structural foreign exchange exposures are described on page 201 in the Annual Report and Accounts 2011.

Sensitivity of 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 2012. Assuming no management actions, a sequence of such rises would increase planned net interest income for the 12 months to 30 June 2013 by US$1,586m (to 31 December 2012: US$1,571m), while a sequence of such falls would decrease planned net interest income by US$1,685m (to 31 December 2012: US$1,909m). These figures incorporate the effect of any option features in the underlying exposures.

Sensitivity of projected net interest income⁶⁰

	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 2012 to June 2013 projected net interest income arising from a shift in yield curves at the beginning of each quarter of:
+  25 basis points ........................	242		81		225		199		779		60		1,586
-  25 basis points ........................	(394)		(69)		(325)		(142)		(719)		(36)		(1,685)
Change in January 2012 to December 2012 projected net interest income arising from a shift in yield curves at the beginning of each quarter of:
+  25 basis points ........................	209		62		263		232		729		76		1,571
-  25 basis points ........................	(465)		(59)		(443)		(166)		(708)		(68)		(1,909)

For footnote, see page 180.

The interest rate sensitivities set out in the table above are illustrative only and are based on simplified scenarios. The limitations of this analysis are discussed in the Appendix to Risk on page 183.

The main driver of the changes between December 2011 and June 2012 in the sensitivity of the Group's net interest income to the change in rates shown in the table above were lower implied yield curves, resulting in reduced margin compression risk in a falling rate scenario.

We monitor the sensitivity of reported reserves before any tax adjustments to interest rate movements on a monthly basis. This is done by assessing the expected pre-tax 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 movements⁶⁰

			Impact in the preceding 6 months
	US$m		Maximum              US$m		Minimum              US$m
At 30 June 2012
+ 100 basis point parallel move in all yield curves ......................................	(5,199)		(5,748)		(5,199)
As a percentage of total shareholders' equity .............................................	(3.1%)		(3.4%)		(3.1%)
- 100 basis point parallel move in all yield curves ......................................	4,879		5,418		4,879
As a percentage of total shareholders' equity .............................................	2.9%		3.3%		2.9%
At 30 June 2011
+ 100 basis point parallel move in all yield curves ......................................	(5,889)		(6,178)		(5,889)
As a percentage of total shareholders' equity .............................................	(3.7%)		(3.9%)		(3.7%)
- 100 basis point parallel move in all yield curves ......................................	6,081		6,329		6,081
As a percentage of total shareholders' equity .............................................	3.8%		4.0%		3.8%
At 31 December 2011
+ 100 basis point parallel move in all yield curves ......................................	(5,594)		(6,178)		(5,594)
As a percentage of total shareholders' equity .............................................	3.5%		(3.9%)		(3.5%)
- 100 basis point parallel move in all yield curves ......................................	5,397		6,411		5,397
As a percentage of total shareholders' equity .............................................	3.4%		4.0%		3.4%

For footnote, see page 180.

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

The year-on-year decrease in sensitivity of reserves was due to a decrease in government bonds held in Balance Sheet Management, which are accounted for on an available-for-sale basis.

Balance Sheet Management

In each Group entity, Balance Sheet Management ('BSM') is responsible for managing liquidity and funding under the supervision of the local Asset and Liability Management Committee ('ALCO'). It also manages the structural interest rate position of the entity within a Global Markets limit structure.

BSM reinvests excess liquidity into highly rated liquid assets. The majority of the liquidity is invested in central bank deposits, and government, supranational and agency securities with most of the remainder short-term interbank and central bank loans.

Central bank deposits are accounted for as cash balances. Interbank loans and loans to central banks

are accounted for as loans and advances to banks. BSM's holdings of securities are accounted for as available-for-sale assets.

BSM is permitted to use derivatives as part of its mandate to manage interest rate risk. Derivative activity is predominantly through the use of vanilla interest rate swaps which are part of cash flow hedging relationships.

Credit risk in BSM is predominantly limited to short-term bank exposure created by interbank lending and exposure to central banks as well as high quality sovereigns, supranationals or agencies which constitute the majority of BSM's liquidity portfolio. BSM does not and is not mandated to manage the structural credit risk of any Group balance sheets. BSM only manages interest rate risk.

BSM is permitted to enter into single name and index credit derivatives activity, but it does so to manage credit risk on the exposure specific to its securities portfolio in limited circumstances only. The risk limits are extremely limited and closely monitored. BSM currently has no open credit derivative index risk.

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.

HSBC's defined benefit pension schemes

	At    30 Jun       2012		At     30 Jun       2011		At    31 Dec      2011
	US$bn		US$bn		US$bn
Liabilities (present value).................................	35.9		33.7		35.0
	%		%		%
Assets:
Equity investments .....	17		20		15
Debt securities ............	72		69		73
Other (including property) ................	11		11		12
	100		100		100

For details of the latest actuarial valuation of the HSBC Bank (UK) Pension Scheme ('the Scheme') funded defined benefit plan ('the principal plan'), see Note 7 on the Financial Statements in the Annual Report and Accounts 2011.

Additional market risk measures applicable only to the parent company

The principal tools used in the management of market risk are VAR for foreign exchange rate risk, and the projected sensitivity of HSBC Holdings' net interest income to future changes in yield curves and interest rate gap repricing for interest rate risk.

Foreign exchange risk

Total foreign exchange VAR arising within HSBC Holdings in the first half of 2012 was as follows:

HSBC Holdings - foreign exchange VAR

	Half-year to
	30 Jun       2012		30 Jun       2011		31 Dec       2011
	US$m		US$m		US$m
At period end ..............	39.4		43.4		47.7
Average.......................	48.2		40.7		43.3
Minimum ....................	39.4		38.2		38.2
Maximum ...................	54.2		43.4		48.3

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.

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 change in the interest rate gap profile between 30 June 2011 and 30 June 2012 is primarily driven by part of the subordinated and tier 1 debt approaching maturity.

Repricing gap analysis of HSBC Holdings

	Total		Up to         1 year		1-5 years		5-10 years		More than     10 years		Non-      interest      bearing
	US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2012
Total assets .................................................	125,392		26,223		1,450		1,010		612		96,097
Total liabilities and equity ...........................	(125,392)		(7,333)		(7,051)		(11,052)		(14,005)		(85,951)
Off-balance sheet items attracting interest rate sensitivity .........................................	-		(18,331)		4,632		8,575		4,200		924
Net interest rate risk gap .............................	-		559		(969)		(1,467)		(9,193)		11,070
Cumulative interest rate gap ........................	-		559		(410)		(1,877)		(11,070)		-
At 30 June 2011
Total assets .................................................	123,004		27,224		1,175		1,021		624		92,960
Total liabilities and equity ...........................	(123,004)		(3,886)		(12,468)		(16,243)		(13,373)		(77,034)
Off-balance sheet items attracting interest rate sensitivity .........................................	-		(18,990)		10,033		6,315		3,535		(893)
Net interest rate risk gap .............................	-		4,348		(1,260)		(8,907)		(9,214)		15,033
Cumulative interest rate gap ........................	-		4,348		3,088		(5,819)		(15,033)		-
At 31 December 2011
Total assets .................................................	123,862		25,885		2,350		1,010		603		94,014
Total liabilities and equity ...........................	(123,862)		(5,730)		(8,814)		(8,227)		(14,833)		(86,258)
Off-balance sheet items attracting interest rate sensitivity .........................................	-		(17,945)		6,405		5,749		5,048		743
	-
Net interest rate risk gap .............................	-		2,210		(59)		(1,468)		(9,182)		8,499
	-
Cumulative interest rate gap ........................	-		2,210		2,151		683		(8,499)		-

Operational risk

Operational risk is relevant to every aspect of our business, and covers a wide spectrum of issues, in particular legal, compliance, security and fraud. Losses arising from breaches of regulation and law, unauthorised activities, error, omission, inefficiency, fraud, systems failure or external events all fall within the definition of operational risk.

There were continuing enhancements to our operational risk management framework policies and procedures in the first half of 2012. This included the implementation of a Top Risk analysis process to enhance the quantification and management of material risks through scenario analysis. This provides a top down, forward-looking view to help determine whether the risks are being effectively managed within our risk appetite or whether further management action is required.  

A summary of our current policies and practices regarding operational risk is provided in the Appendix to Risk on page 183.

Operational risk in the first half of 2012

During the first half of 2012, our top and emerging risk profile was dominated by compliance and legal risks. Other featured operational risks include:

·     challenges to achieving our strategy in a downturn: businesses and geographical regions have prioritised strategy and annual operating plans to reflect current economic conditions. Performance against plan is monitored through a number of means including the use of balanced scorecards and performance reporting at all relevant management committees;

·     internet crime and fraud: increased monitoring and additional controls including internet banking controls have been implemented to enhance our defences against external attack and reduce the level of losses in these areas;

·     social media risk: compensating controls have been implemented by several Group companies in an attempt to reduce our exposure to these risks, including:

-      an HSBC presence in several of the larger social media networks; and

-      increased monitoring;

·     level of change creating operational complexity: risk functions are engaged with business management in business transformation

initiatives to ensure robust internal controls are maintained, including through participation in all relevant management committees; and

·     information security: significant investment has already been made in enhancing controls, including increased training to raise staff awareness of the requirements, enhanced controls around data access and heightened monitoring of information flows. This area will continue to be a focus of ongoing initiatives to strengthen the control environment.

Other operational risks are also monitored and managed through the use of the operational risk management framework, including investments made to further improve the resilience of our payments infrastructure.

Legal risks are discussed on page 194 and further details regarding compliance risk are set out below.

Compliance risk

All Group companies are required to observe the letter and spirit of all relevant laws, codes, rules, regulations and standards of good market practice. In 2012, we continued to experience increasing levels of compliance risk as regulators and other agencies pursued investigations into historic activities and as we continued to work with them in relation to already identified issues. These included:

·     the mis-selling of interest rate derivative products to SMEs in the UK and the settlement of claims by HSBC Bank to provide appropriate redress;

·     investigations related to certain past submissions made by panel banks in connection with the setting of LIBOR, EURIBOR and other interest rates. As certain HSBC entities are members of such panels, HSBC Holdings and certain of its subsidiaries have been the subject of regulatory demands for information;

·     appearance before the US Senate Permanent Subcommittee on Investigations ('PSI') about our compliance with US regulations including anti-money laundering laws, the BSA and OFAC sanctions. We have previously disclosed these matters and have co‑operated with relevant US authorities since 2010; and

·     ongoing investigations by US regulatory and law enforcement authorities into our compliance with anti-money laundering laws, the BSA and OFAC sanctions.

It is clear from both our own and wider industry experience that there is a significantly increased level of activity from regulators and law enforcement agencies in pursuing investigations in relation to possible breaches of regulation. Coupled with a substantial increase in the volume of new regulation, much of which has some level of extra-territorial effect, and the geographical spread of our businesses, we believe that the level of inherent compliance risk that we face will continue to remain high for the foreseeable future. Many of the steps described in the reputational risk section below are intended to adapt to and address that ongoing increased compliance risk. 

Reputational risk

The safeguarding of our reputation is paramount. It is the responsibility of all members of staff, who are supported by a global risk management structure underpinned by relevant policies and practices, readily available guidance, and regular training.

As noted in the compliance risk section above, we have acknowledged, in the context of the recent PSI hearing, that it was not enough to fix the specific issues that the PSI focused on and outlined additionally our implementation of a global strategy to tackle the root causes of these identified deficiencies.

With a new senior leadership team and a new strategy in place since 2011, HSBC has already taken concrete steps to augment the framework to address these issues including making significant changes to strengthen compliance, risk management and culture. These steps, which should also serve, over time, to enhance our reputational risk management, include the following:

·     the creation of a new global structure, which will make HSBC easier to manage and control, by reorganising HSBC into four global businesses and ten global functions, including Compliance and Risk, allowing a coordinated and consistent approach;

·     simplifying our business through the ongoing implementation of our organisational effectiveness programme and our five economic filters strategy and developing a sixth global risk filter which should help to standardise our approach to doing business in higher risk countries;

·     a substantial increase in resources, doubling of global expenditure and significant strengthening of compliance as a control (and not only as an advisory) function;

·     continuing to roll out an HSBC Values programme that seeks to define the way everyone in the Group should act. This makes all managers and senior executives accountable for ensuring that business decisions and activities are aligned to our Values and business principles and includes reviewing all products, services, policies and practices to ensure that the Values are embedded into our 'business as usual' operations;

·     the appointment of a new Chief Legal Officer, with particular expertise and experience in US law and regulation;

·     designing and implementing new global standards by which we conduct our businesses. As a key principle in doing this, we will adopt and enforce a single standard globally that is determined by the highest regulatory standard we must apply anywhere. We will also maximise information sharing for risk management purposes across HSBC to the extent permitted by law and apply a globally consistent approach to knowing and retaining our customers; and

·     enforcing a consistent global sanctions policy.

Success in detecting and preventing illicit actors' access to the global financial system calls for constant vigilance and HSBC will continue to work in close cooperation with all governments to achieve this. This is integral to the execution of HSBC's strategy, to our core values and to preserving and enhancing our reputation.

 

END

 

 

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