Annual Financial Report - 24 of 44

RNS Number : 1487A
HSBC Holdings PLC
27 March 2012
 



Liquidity and funding

(Audited)

Liquidity and funding in 2011 ................................

157

Contractual maturity of financial liabilities ............

158

The management of liquidity risk ..........................

159

Encumbered assets .................................................

160

Diversity of funding sources ..................................

161

Contingent liquidity risk ........................................

161

HSBC Holdings ......................................................

162

 

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.

 

Our liquidity and funding risk management framework

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

We expect our operating entities to manage liquidity and funding risk on a standalone basis employing a centrally imposed framework and limit structure which is adapted to variations in business mix and underlying markets. Our operating entities are required to maintain strong liquidity positions and to manage the liquidity profiles of their assets, liabilities and commitments with the objective of ensuring that their cash flows are balanced under various severe stress scenarios and that all their anticipated obligations can be met when due.

 

There were no material changes to our policies and practices for the management of liquidity and funding risks in 2011.

 


A summary of our current policies and practices regarding liquidity and funding is provided in the Appendix to Risk on page 188.


Liquidity and funding in 2011

(Audited)

The liquidity position of the Group strengthened in 2011, and we continued to enjoy strong inflows of customer deposits and maintained good access to wholesale markets. During 2011, customer accounts grew by 2% while customer advances fell by 2%, leading to a decrease in our advances-to-deposits ratio to 75%. Despite a highly competitive environment in Asia, our customer accounts grew by 8% due to growth in deposits in Hong Kong dollars and offshore renminbi.

Market conditions

2011 was another challenging year for banks in the wholesale funding markets. Despite a strong first quarter, the total volume of term debt issued by banks in 2011 was low by recent historical standards, with a particularly marked slowdown in the second half of the year.

Developments in the eurozone sovereign debt crisis continued to dominate the markets. In May 2011, Portugal became the third eurozone country to seek financial support from the ECB and the IMF. Conditions deteriorated markedly over the summer with sharp increases in CDS premia for eurozone peripheral countries. This prompted European authorities to propose a package of measures in October including a near doubling of the capacity of the European Financial Stability Facility.

In December, with the crisis reaching systemic levels, the ECB injected liquidity into the European banking sector via an unprecedented €489bn (US$632bn) 3-year Long-Term Refinancing Operation ('LTRO'), and committed to conduct a similar operation in February 2012. This intervention by the ECB had a positive effect on bank CDS levels, as well as on general funding conditions. We support the ECB in its efforts to stabilise the capital markets. Given the lack of stigma in participating and the attractive pricing, and with the outlook for capital markets remaining uncertain, we considered it prudent for our Continental Europe operations to anticipate future funding requirements by participating in the LTRO, receiving €5.2bn (US$6.7bn) in total, mainly in France.


Effect on HSBC's liquidity and funding position

We issue wholesale securities to supplement our customer deposits and change the currency mix, maturity profile or location of our liabilities. We continued to have good access to debt capital markets during 2011, with Group entities issuing US$22bn of term debt securities in the public capital markets at competitive prices in a range of currencies, maturities, obligations and markets. Of this amount, over 90% was unsecured funding. Our ability to access capital markets even in very challenging conditions was best demonstrated by the successful issuance of US$1.65bn of 10 and 30 year unsecured senior bonds by HSBC Holdings in November 2011. In general, the prices of our debt securities have not been unduly affected by the market turmoil.

Our European subsidiaries continued to maintain a liquidity profile within our risk appetite despite the ongoing eurozone crisis.


Contractual maturity of financial liabilities

(Audited)

The balances in the table below will not agree directly with those in our consolidated balance sheet as the table incorporates, on an undiscounted basis, all cash flows relating to principal and future coupon payments (except for trading liabilities and trading derivatives). In addition, loan and other credit-related commitments and financial guarantees and similar contracts are generally not recognised on our balance sheet. Trading liabilities and trading derivatives are included in the 'On demand' time bucket, and not by contractual maturity, because trading liabilities are typically held for short periods of time. We classify the undiscounted cash flows payable under hedging derivative liabilities according to their contractual maturities. The undiscounted cash flows potentially payable under financial guarantees and similar contracts are classified on the basis of the earliest date they can be called.


Cash flows payable by HSBC under financial liabilities by remaining contractual maturities

(Audited)


               On

       demand
          US$m


              Due

      within 3         months           US$m


              Due

      between

      3 and 12         months

          US$m


              Due

      between

        1 and 5            years

          US$m


              Due

         after 5            years

          US$m











At 31 December 2011










Deposits by banks ................................................

47,659


59,096


3,578


11,048


997

Customer accounts ...............................................

914,762


252,226


72,993


20,508


1,094

Trading liabilities .................................................

265,192


-


-


-


-

Financial liabilities designated at fair value ...........

7,066


930


9,789


39,915


57,295

Derivatives ..........................................................

340,394


394


497


2,858


1,007

Debt securities in issue ..........................................

117


48,465


27,520


57,507


7,019

Subordinated liabilities ..........................................

6


528


1,834


9,616


47,715

Liabilities of disposal groups held for sale43 ..........

3,108


1,721


1,045


211


150

Other financial liabilities ......................................

25,452


28,137


5,845


2,023


1,377












1,603,756


391,497


123,101


143,686


116,654

Loan and other credit-related commitments .........

355,366


65,245


94,120


111,061


29,113

Financial guarantees and similar contracts ............

12,460


7,585


12,107


5,899


1,273












1,971,582


464,327


229,328


260,646


147,040











At 31 December 2010










Deposits by banks ................................................

42,481


70,072


8,393


7,949


1,346

Customer accounts ...............................................

881,575


244,501


89,557


23,209


3,483

Trading liabilities .................................................

300,703


-


-


-


-

Financial liabilities designated at fair value ...........

7,421


3,786


7,825


35,583


61,575

Derivatives ..........................................................

255,046


531


1,143


2,065


942

Debt securities in issue ..........................................

1,320


48,062


41,939


62,148


16,255

Subordinated liabilities ..........................................

34


1,491


1,863


10,001


51,293

Other financial liabilities ......................................

24,834


24,378


7,944


2,184


824












1,513,414


392,821


158,664


143,139


135,718

Loan and other credit-related commitments .........

524,394


51,732


14,023


11,964


400

Financial guarantees and similar contracts ............

18,491


9,233


12,231


7,082


2,399












2,056,299


453,786


184,918


162,185


138,517

For footnote, see page 185.


Cash flows payable in respect of customer accounts are primarily contractually repayable on demand or at short notice. However, in practice, short-term deposit balances remain stable as inflows and outflows broadly match and a significant portion of loan commitments expire without being drawn upon. We therefore manage our balance sheet on both contractual and behaviouralised bases. Each operating entity determines the behaviouralisation of its products within the guidelines set out in our liquidity framework and as approved by its ALCO.

Although on a contractual basis 86% of our liabilities are due within one year, only approximately half of our behaviouralised liabilities are expected to fall due within this one-year period.

The management of liquidity risk

(Audited)

Advances to core funding ratio

The three principal banking entities listed in the table below represented 61% of our total core deposits at 31 December 2011 (2010: 62%). The distinction between core and non-core deposits generally means that our measure of advances to core funding is more restrictive than that which can be inferred from the published financial statements. Loans and advances to customers in these principal banking entities were overwhelmingly financed by reliable and stable sources of funding. We would meet any unexpected net cash outflows by using our cash and balances at central banks, selling or entering into repos of the securities within our liquid asset buffers or accessing additional funding sources such as the interbank market. Collateralised lending markets could also be accessed over the longer term.

Of particular note was the strong funding position of The Hongkong and Shanghai Banking Corporation, as reflected in the advances to core funding ratio in the table below, which allowed us to take advantage of loan growth opportunities in Asia while still maintaining ratios well below the Group's average.


HSBC's principal banking entities - the management of liquidity risk44

(Audited)


Advances to core funding
ratio during:


Stressed one month coverage
ratio during:


                2011


               2010


                2011


               2010


                    %


                    %


                    %


                    %

HSBC Bank plc45








Year-end .......................................................................

                99.8


              103.0


               116.2


              111.1

Maximum .....................................................................

              103.4


              109.7


               118.1


              111.3

Minimum ......................................................................

                98.4


              102.6


              109.4


              103.2

Average .........................................................................

              100.8


              106.0


               112.5


              108.2









The Hongkong and Shanghai Banking Corporation45








Year-end .......................................................................

                75.0


                70.3


              122.9


              144.6

Maximum .....................................................................

                78.9


                70.3


              144.6


              165.4

Minimum ......................................................................

                70.3


                55.5


               116.4


              132.6

Average .........................................................................

                75.9


                63.6


              124.0


              148.8









HSBC Bank USA46








Year-end .......................................................................

                85.7


                98.3


               117.7


              108.5

Maximum .....................................................................

                89.5


              104.3


              128.3


              118.5

Minimum ......................................................................

                79.8


                94.2


              108.5


              105.3

Average .........................................................................

                84.6


                98.0


               118.9


              112.3









Total of HSBC's other principal banking entities47








Year-end .......................................................................

                86.4


                89.1


               117.6


              119.6

Maximum .....................................................................

                90.2


                89.1


              120.4


              126.5

Minimum ......................................................................

                86.4


                85.7


               116.2


              118.1

Average .........................................................................

                88.9


                87.0


               117.9


              122.2

For footnotes, see page 185.



Stressed one month coverage ratio

The stressed one month coverage ratios tabulated above are derived from projected cash flow scenario analyses described in the Appendix to Risk on page 188, 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% or more.

HSBC Finance

As HSBC Finance is unable to accept standard retail customer deposits, it takes funding from the professional markets. At 31 December 2011, US$51bn (2010: US$65bn) of HSBC Finance's liabilities were drawn from professional markets and affiliates, utilising a range of products, maturities and currencies. HSBC Finance uses a number 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 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.

The need for HSBC Finance to refinance maturing term funding is largely mitigated by the continued run-down of its balance sheet and the proposed sale of the Card and Retail Services business, which should complete in the second quarter of 2012 and is expected to generate additional funding of approximately US$12bn. During 2011, the shelf registration statement under which HSBC Finance has historically issued long-term debt expired and we chose not to renew it.


HSBC Finance - funding

(Audited)


At 31 December


       2011


      2010


   US$bn


    US$bn

Maximum amounts of unsecured
term funding maturing in any rolling:




-  3 month period .....................

         5.1


         5.1

-  12 month period ...................

         9.7


       10.8

Unused committed sources of
secured funding48 .......................

         0.5


         0.5

Committed backstop lines from
non-Group entities in support
of CP programmes ....................

         4.0


         4.3

For footnote, see page 185.

Encumbered assets

(Audited)

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 37 on the Financial Statements. Assets not included in Note 37 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 173) 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$33m (2010: US$31m) are considered encumbered.


Diversity of funding sources

(Audited)

Our primary sources of funding are current accounts and savings deposits payable on demand or short notice. As part of our liquidity and funding risk management, we do not rely on securitisations, covered bond issuance programmes or repurchase agreements as an important source of funding. Repurchase agreements entered into are generally short-term in nature maturing in 90 days or less. We are a net cash provider to the repo market.

Our sources and uses of funding, which provide a consolidated view of how our balance sheet is funded, should be read with consideration of our risk management framework which requires our operating entities to manage liquidity and funding risk on a standalone basis. Notwithstanding the above, the material difference between funding sources and uses is an illustration of the strength of our liquidity position.

Funding sources

 


At 31 December


2011


2010


US$bn


US$bn





Customer accounts ..............

1,253.9


1,227.7

Deposits by banks ................

112.8


110.6

Debt securities .....................

131.0


145.4

Financial liabilities
designated at fair value .....

85.7


88.1

Equity .................................

166.1


154.9






1,749.5


1,726.7

Funding usage

 


At 31 December


2011


2010


US$bn


US$bn





Loans and advances to customers ........................

940.4


958.4

Loans and advances to banks ..

181.0


208.3

Financial investments held to maturity ..........................

21.2


19.5






1,142.6


1,186.2

Contingent liquidity risk

(Audited)

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 404). HSBC-managed asset exposures are differentiated in that they relate to consolidated SICs which issue debt secured by ABSs (see page 403). Other conduit exposures relate to third-party sponsored conduits (see page 405). Single issuer liquidity facilities are provided directly to clients rather than via any form of conduit. These facilities are split by the addition of the five largest specific facilities and the single largest market sector.

 

 

 


The Group's contractual exposures at 31 December monitored under the contingent liquidity risk limit structure

(Audited)


HSBC Bank


HSBC Bank USA


HSBC Bank Canada


The Hongkong and Shanghai Banking Corporation


        2011


       2010


       2011


       2010


       2011


       2010


       2011


        2010


    US$bn


     US$bn


    US$bn


     US$bn


    US$bn


     US$bn


    US$bn


      US$bn

Conduits
















Client-originated assets49
















-  total lines ......................

         12.8


          8.4


          0.9


          3.9


          0.7


          0.2


             -

              

              -

-  largest individual lines ...

           0.7


          0.7


          0.3


          0.4


          0.5


          0.1


             -

              

              -

HSBC-managed assets50  
- total lines........................

         22.1


        25.6


             -


             -

              

             -


             -


             -


              -

Other conduits51
- total lines........................

              -


             -


          1.4


          1.4


             -


             -


             -


              -

















Single-issuer liquidity facilities
















-  five largest52 .................

           3.4


          4.2


          5.7


          5.3


          1.8


          2.0

              

          1.9

              

           1.4

-  largest market sector53 ..

           7.5


          8.4


          6.5


          4.9


          3.8


          3.8

              

          2.5


           2.4

For footnotes, see page 185.



HSBC Holdings

(Audited)

During 2011, HSBC Holdings continued to have full access to debt capital markets at market rates and issued US$5.3bn of senior debt (2010: nil). The eligibility requirements for non-equity instruments under Basel III rules have not been clearly defined in the UK, so HSBC Holdings issued no capital instruments in 2011 (2010: US$5.0bn).

The balances in the following table do not agree directly with those in the balance sheet of HSBC Holdings as the table incorporates, on an undiscounted basis, all cash flows relating to principal and future coupon payments (except for trading derivatives).

In addition, loan and other credit-related commitments and financial guarantees and similar contracts are generally not recognised on the balance sheet. Trading derivatives are included in the 'On demand' time bucket, and not by contractual maturity, because trading derivatives are typically held for short periods of time. The undiscounted cash flows potentially payable under financial guarantees and similar contracts are classified on the basis of the earliest date they can be called.


Cash flows payable by HSBC Holdings under financial liabilities by remaining contractual maturities

(Audited)


               On
       demand


              Due

      within 3        months


              Due

      between

      3 and 12         months


              Due

      between

        1 and 5            years


              Due

         after 5            years

US$m


US$m


US$m


US$m


US$m

At 31 December 2011










Amounts owed to HSBC undertakings ..............

-


1,174


17


1,428


-

Financial liabilities designated at fair value ......

-


281


3,530


4,987


28,988

Derivatives .....................................................

1,067


-


-


-


-

Debt securities in issue .....................................

-


35


104


1,975


1,490

Subordinated liabilities .....................................

-


216


649


3,461


27,558

Other financial liabilities .................................

-


1,460


-


-


-












1,067


3,166


4,300


11,851


58,036











Loan commitments .........................................

1,810


-


-


-


-

Financial guarantees and similar contracts .......

49,402


-


-


-


-












52,279


3,166


4,300


11,851


58,036











At 31 December 2010










Amounts owed to HSBC undertakings ..............

-


163


1,332


1,453


-

Financial liabilities designated at fair value ......

-


219


658


5,810


24,215

Derivatives .....................................................

827


-


-


-


-

Debt securities in issue .....................................

-


35


106


2,110


1,559

Subordinated liabilities .....................................

-


219


657


3,504


28,670

Other financial liabilities .................................

-


1,782


-


-


-












827


2,418


2,753


12,877


54,444

Loan commitments .........................................

2,720


-


-


-


-

Financial guarantees and similar contracts .......

46,988


-


-


-


-












50,535


2,418


2,753


12,877


54,444

 


Market risk

(Audited)

Market risk in 2011 ..............................................

163

Trading and non-trading portfolios ........................

163

Structural foreign exchange exposures ...................

166

Sensitivity of net interest income ..........................

166

Defined benefit pension schemes ...........................

167

Additional market risk measures applicable only to
the parent company ..........................................

167

 

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.

 

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 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 165).

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 US treasuries downgrade 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. Market risk arising in our insurance business is discussed in 'Risk management of insurance operations' on page 171.

 

There were no material changes to our policies and practices for the management of market risk in 2011.

 


A summary of our current policies and practices regarding market risk is provided in the Appendix to Risk on page 188.

Market risk in 2011

(Audited)

Market risk in 2011 was managed against a backdrop of global economic slowdown, the fiscal deficit of the US and concerns over European sovereign debt and its contagion effects. Funding and capital concerns relating to financial institutions also dominated in Europe. All these factors triggered high levels of volatility in the financial markets. In addition, the transition to CRD III at the end of 2011, with its increased capital requirements for certain market risk exposures, also affected the environment in which market risk appetite was managed over the year. In response to these challenges, we managed down our market risk exposures within the eurozone and in our securitisation books. We proactively tested contingency plans intended to respond to potential adverse scenarios.

In 2011, our European Credit and Rates business reported significantly lower trading revenue as turmoil in eurozone sovereign debt markets escalated, particularly in the second half of the year. Increased risk aversion and limited client activity, led to a significant widening of credit spreads on certain eurozone sovereign and corporate bonds, resulting in trading losses and an increase in days of negative revenue.

Trading and non-trading portfolios

(Audited)

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


            VAR54

Interest rate .....................

             VAR


            VAR55

Equity ..............................

             VAR


    Sensitivity

Credit spread ....................

             VAR


            VAR56

For footnotes, see page 185.


Value at risk of the trading and non-trading portfolios

Our Group VAR, both trading and non-trading, was as follows:

Value at risk

(Audited)


2011


201057


US$m


US$m

At 31 December ..............

            367.0


           371.6

Average ...........................

            301.6


           357.5

Minimum .........................

            231.5


           205.3

Maximum ........................

            404.3


           556.3

For footnote, see page 185.

Group total VAR was lower at the end of 2011 than at the end of 2010 despite an increase in volatility in the historical scenarios used in the VAR calculation. This was mainly driven by the reduction in sovereign, agency and bank eurozone
exposures. Further details are given in 'Exposures to countries in the eurozone' on page 113.

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 2011, there was one loss exception at a Group level. This is consistent with what is statistically expected from the model.

The major contributor to Group trading and non-trading VAR was GB&M. Our Group daily VAR, both trading and non-trading, was as follows:


 

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


Daily revenue

(Unaudited)


(Unaudited)




2011


2010


US$m


US$m

Average daily revenue ..............

              42.4


              49.3

Standard deviation58 .................

              35.1


              37.8

Ranges of most frequent
daily revenues .......................

       30 to 40


       30 to 40






             days


              days

-  daily occurrences ..............

                 42


                 41

Days of negative revenue .........

                 23


                   9









Daily distribution of Global Markets' trading, Balance Sheet Management and other trading revenues59

(Unaudited)

2011


2010

Number of days


Number of days




Revenues (US$m)


Revenues (US$m)

< Profit and loss frequency


< Profit and loss frequency

For footnotes, see page 185.


Trading portfolios

(Audited)


VAR by risk type for trading intent activities60

(Audited)


          Foreign exchange and

    commodity


          Interest
                rate


            Equity


            Credit

            spread


       Portfolio

diversification61


              Total62


             US$m


             US$m


             US$m


             US$m


            US$m


            US$m













At 31 December 2011 .

                18.6


                49.4


                  7.4


                75.2


               (32.3)


              118.3

At 31 December 2010 ...

                24.9


                49.5


                13.0


                39.1


               (45.6)


                80.8

Average












2011 .........................

                16.8


                54.2


                  8.0


                57.3


               (34.4)


              101.8

2010 .........................

                27.2


                51.6


                  9.2


                62.0


               (36.5)


              113.4

Minimum












2011 .........................

                  7.6


                30.1


                  2.5


                34.7


                     -


                62.2

2010 .........................

                  8.0


                34.7


                  2.9


                33.7


                     -


                55.0

Maximum












2011 .........................

                31.9


                80.2


                17.2


              103.2


                     -


              143.9

2010 .........................

                62.9


                88.9


                21.6


              102.5


                     -


              212.2

For footnotes, see page 185.


The VAR for trading intent activity within Global Markets at 31 December 2011 was US$118.3m (2010: US$80.8m). The increase was mainly driven by the credit spread asset class, due to a rise in the volatilities in the historical scenarios used in the VAR calculation.

Credit spread risk

(Audited)

Credit spread risk also arises on credit derivative transactions entered into by Global Banking in order to manage the risk concentrations within our corporate loan portfolio and so enhance capital efficiency. At 31 December 2011, the credit VAR on these transactions was US$6.6m (2010: US$12.3m). The mark-to-market of these transactions is reflected in the income statement.

Gap risk

During 2011 gap risk continued to be managed down. We did not incur any material gap loss in 2011.

Non-trading portfolios

(Audited)

Available-for-sale debt securities

At 31 December 2011, 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$389m (2010: US$299m). This sensitivity is calculated before taking into account losses which would have been absorbed by the capital note holders. Excluding the gross exposure for SICs consolidated in our balance sheet this exposure reduced to US$325m (2010: US$264m). (Credit spread VAR for available-for-sale debt securities is included in the Group total VAR.)

At 31 December 2011, the capital note holders would absorb the first US$2.3bn (2010: US$2.2bn) of any losses incurred by the SICs before we incur any equity losses.

Equity securities classified as available for sale

Fair value of equity securities

(Audited)


2011


2010


US$bn


US$bn





Private equity holdings63 ........

            3.0


            2.8

Funds invested for short-term
cash management ...............

            0.2


            0.5

Investment to facilitate
ongoing business64 ..............

            1.1


            1.0

Other strategic investments ...

            2.9


            3.7






            7.2


            8.0

For footnotes, see page 185.

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 their value at 31 December 2011 would have reduced our equity by US$0.7bn (2010: US$0.8bn). For details of the impairment incurred on available-for-sale equity securities, see 'Securitisation exposures and other structured products' on page 149.

Structural foreign exchange exposures

(Unaudited)

Our policies and procedures for managing structural foreign exchange exposures are described on page 201.

For details of structural foreign exchange exposures see Note 36 on the Financial Statements.

Sensitivity of net interest income

(Unaudited)

The table below sets out the effect on our 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 January 2012. Assuming no management actions, a sequence of such rises would increase planned net interest income for 2012 by US$1,571m (2011: US$882m), while a sequence of such falls would decrease planned net interest income by US$1,909m (2011: US$1,525m). These figures incorporate the effect of any option features in the underlying exposures.


 

Sensitivity of projected net interest income65

(Unaudited)


  US dollar

           bloc

        US$m


      Rest of

  Americas

           bloc

        US$m


Hong Kong

        dollar

           bloc

        US$m


      Rest of

           Asia

           bloc

        US$m


    Sterling

           bloc

        US$m


          Euro

           bloc

        US$m


          Total

        US$m

Change in 2012 projected net interest income arising from
a shift in yield curves of:




























+25 basis points at the
beginning of each quarter ..

209


62


263


232


729


76


1,571

-25 basis points at the
beginning of each quarter ..

(465)


(59)


(443)


(166)


(708)


(68)


(1,909)















Change in 2011 projected net interest income arising from
a shift in yield curves of:




























+25 basis points at the
beginning of each quarter ..

164


72


191


245


292


(82)


882

-25 basis points at the
beginning of each quarter ..

(550)


(68)


(280)


(143)


(546)


62


(1,525)

For footnote, see page 185.


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 188.

The main drivers of the year-on-year changes 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, the potential for wider margins in a rising interest rate scenario, and a reduction in the funding requirement of the HSBC Bank plc trading book. Net interest income and its associated sensitivity as reflected in the table above
include the expense of internally funding trading assets, while related revenue is reported in 'Net trading income'.

We monitor 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 our reported reserves to these movements and the maximum and minimum month-end figures during the year:


Sensitivity of reported reserves to interest rate movements

(Unaudited)


US$m


Maximum

impact
US$m


Minimum

impact

US$m

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%







At 31 December 2010






+ 100 basis point parallel move in all yield curves ........................................

(6,162)


(6,162)


(3,096)

As a percentage of total shareholders' equity ................................................

(4.2%)


(4.2%)


(2.1%)







- 100 basis point parallel move in all yield curves ........................................

6,174


6,174


3,108

As a percentage of total shareholders' equity ................................................

4.2%


4.2%


2.1%

 


The sensitivities above 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 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 is due to a decrease in government bonds held in Balance Sheet Management, which are accounted for on an available-for-sale basis.

Defined benefit pension schemes

(Audited)

Market risk arises within our 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

(Audited)


          2011


          2010


       US$bn


        US$bn





Liabilities (present value) ....

           35.0


           32.6






               %


               %

Assets:




Equities ...............................

              15


              20

Debt securities .....................

              73


              66

Other (including property) ..

              12


              14






            100


            100

For details of our defined benefit schemes, see Note 7 on the Financial Statements, and for pension risk management, see page 184.

Additional market risk measures applicable only to the parent company

(Audited)

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 re-pricing tables for interest rate risk.

Foreign exchange risk

Total foreign exchange VAR arising within HSBC Holdings in 2011 was as follows:

HSBC Holdings - foreign exchange VAR

(Audited)



Foreign exchange



        2011

     US$m


        2010

      US$m





At 31 December ........................

         47.7


         40.4

Average .....................................

         43.3


         56.6

Minimum ...................................

         38.2


         40.2

Maximum ..................................

         48.3


         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.


Sensitivity of net interest income

(Audited)

HSBC Holdings monitors net interest income sensitivity over a 5-year time horizon reflecting the longer-term perspective on interest rate risk management appropriate to a financial services holding company. The table below sets out the effect on HSBC Holdings' future net interest income over a 5-year time horizon of incremental 25 basis point parallel falls or rises in all yield curves worldwide at


the beginning of each quarter during the 12 months from 1 January 2012.

Assuming no management actions, a sequence of such rises would decrease planned net interest income for the next five years by US$269m (2011: increase of US$155m), while a sequence of such falls would increase planned net interest income by US$248m (2011: decrease of US$155m). These figures incorporate the effect of any option features in the underlying exposures.


 

Sensitivity of HSBC Holdings' net interest income to interest rate movements65

(Audited)


US dollar

bloc


Sterling

bloc


Euro

bloc


         Total

US$m


US$m


US$m


US$m

Change in projected net interest income as at 31 December  arising from a shift in yield curves
















2011








of + 25 basis points at the beginning of each quarter








0-1 year .............................................................

(13)


11


4


2

2-3 years ...........................................................

(161)


33


33


(95)

4-5 years ...........................................................

(244)


21


47


(176)









of - 25 basis points at the beginning of each quarter








0-1 year .............................................................

14


(11)


(4)


(1)

2-3 years ...........................................................

127


(27)


(27)


73

4-5 years ...........................................................

244


(21)


(47)


176









2010








of + 25 basis points at the beginning of each quarter








0-1 year .............................................................

(6)


19


11


24

2-3 years ...........................................................

(56)


75


62


81

4-5 years ...........................................................

(79)


71


58


50









of - 25 basis points at the beginning of each quarter








0-1 year .............................................................

6


(19)


(11)


(24)

2-3 years ...........................................................

56


(75)


(62)


(81)

4-5 years ...........................................................

79


(71)


(58)


(50)


For footnote, see page 185.


The interest rate sensitivities tabulated above are illustrative only and are based on simplified scenarios. The figures represent hypothetical movements in net interest income based on our projected yield curve scenarios, HSBC Holdings' current interest rate risk profile and assumed changes to that profile during the next five years. The main driver of the change in the US dollar projected net interest income sensitivity was a change in the assumptions for projected capital funding. Changes to assumptions concerning the risk profile over the next five years can have a significant impact on the net


interest income sensitivity for that period. However, the figures do not take into account the effect of actions that could be taken to mitigate this interest rate risk.

Interest rate 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.  


Repricing gap analysis of HSBC Holdings

(Audited)


          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 31 December 2011












Cash at bank and in hand:












- balances with HSBC undertakings ..........

316


280


-


-


-


36

Derivatives ..................................................

3,568


-


-


-


-


3,568

Loans and advances to HSBC undertakings ..

28,048


25,373


1,175


279


603


618

Financial investments ..................................

1,078


-


300


731


-


47

Investments in subsidiaries ...........................

90,621


232


875


-


-


89,514

Other assets .................................................

231


-


-


-


-


231













Total assets .................................................

123,862


25,885


2,350


1,010


603


94,014













Amounts owed to HSBC undertakings ..........

(2,479)


(2,260)


-


-


-


(219)

Financial liabilities designated at fair values .

(21,151)


(2,694)


(6,423)


(6,157)


(5,156)


(721)

Derivatives ..................................................

(1,067)


-


-


-


-


(1,067)

Debt securities in issue .................................

(2,613)


-


(1,617)


-


(1,006)


10

Other liabilities ............................................

(911)


-


-


-


-


(911)

Subordinated liabilities .................................

(12,450)


(776)


(774)


(2,070)


(8,671)


(159)

Total equity .................................................

(82,183)


-


-


-


-


(82,183)

Other non-interest bearing liabilities ............

(1,008)


-


-


-


-


(1,008)










-



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)


-













At 31 December 2010












Cash at bank and in hand:












- balances with HSBC undertakings ..........

459


339


-


-


-


120

Derivatives ..................................................

2,327


-


-


-


-


2,327

Loans and advances to HSBC undertakings ..

21,238


19,351


-


290


605


992

Financial investments ..................................

2,025


-


300


900


731


94

Investments in subsidiaries ...........................

92,899


1,785


875


1,164


-


89,075

Other assets .................................................

393


-


-


-


-


393













Total assets .................................................

119,341


21,475


1,175


2,354


1,336


93,001













Amounts owed to HSBC undertakings ..........

(2,932)


(2,266)


-


-


-


(666)

Financial liabilities designated at fair values .

(16,288)


-


(7,184)


(4,740)


(3,509)


(855)

Derivatives ..................................................

(827)


-


-


-


-


(827)

Debt securities in issue .................................

(2,668)


-


(1,664)


-


(1,004)


-

Other liabilities ............................................

(1,232)


-


-


-


-


(1,232)

Subordinated liabilities .................................

(13,313)


(750)


(1,579)


(2,140)


(8,680)


(164)

Total equity .................................................

(81,331)


-


-


(7,450)


-


(73,881)

Other non-interest bearing liabilities ............

(750)


-


-


-


-


(750)













Total liabilities and equity ............................

(119,341)


(3,016)


(10,427)


(14,330)


(13,193)


(78,375)













Off-balance sheet items attracting interest rate sensitivity .........................................

-


(15,302)


7,221


4,403


3,409


269













Net interest rate risk gap .............................

-


3,157


(2,031)


(7,573)


(8,448)


14,895













Cumulative interest rate gap ........................

-


3,157


1,126


(6,447)


(14,895)


-

 


Operational risk

(Unaudited)

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 unauthorised activities, error, omission, inefficiency, fraud, systems failure or external events all fall within the definition of operational risk.

HSBC has continued to enhance its operational risk management framework including the use of the risk and control assessment process that provides business areas and functions with a forward-looking view of operational risks and an assessment of the effectiveness of controls, and a tracking mechanism for action plans so that they can proactively manage operational risks within acceptable levels.

There were no material changes to our policies and procedures for the management of operational risk in 2011.


A summary of our current policies and practices regarding operational risk is provided in the Appendix to Risk on page 188.

 

Operational risk in 2011

During 2011, our top and emerging risk analysis included a number of risks which were of an operational nature:

·     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 by 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 to reduce the level of losses in these areas;

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

-      an HSBC presence has been created in several of the larger social media networks in order to provide an official point of contact for HSBC customers and stakeholders; and

-      monitoring has been implemented in some entities to protect our brand identity and pro-active communication has been implemented in some geographies targeted at broadcasting to customers and media organisations;

·     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 use of the operational risk management framework including investments made to further improve the resilience of our payments infrastructure.

There were no material losses relating to fraud and security during the year.

Further information on the nature of these risks is provided in 'Top and emerging risks' on page 99.


This information is provided by RNS
The company news service from the London Stock Exchange
 
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