Interim Report - 19 of 28

RNS Number : 9069L

HSBC Holdings PLC

16 August 2013

 



Liquidity and funding

	Page		Tables	Page
Liquidity and funding in the first half of 2013 ...	156
Wholesale funding markets .........................................	156
Liquidity regulation ....................................................	157
Management of liquidity and funding risk .........	157
Advances to core funding ratio ...................................	157		Advances to core funding ratios ...................................	157
Stressed coverage ratios ..............................................	157		Stressed one-month and three-month coverage ratios ..	158
Liquid assets of HSBC's principal operating entities ....	158		Liquid assets of HSBC's principal entities .....................	158
Net contractual cash flows ..........................................	159		Net cash flows for inter-bank and intra-Group deposits and reverse repo, repo and short positions ......................	159
Contingent liquidity risk arising from committed lending facilities .................................................	160		The Group's contractual undrawn exposures monitored under the contingent liquidity risk limit structure ......	160
Sources of funding ..................................................	160		Funding sources and uses ............................................	161
Wholesale term debt maturity profile .................	161		Wholesale funding principal cash flows payable by HSBC under financial liabilities by remaining contractual maturities .................................................................	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.

There were no material changes to our policies and practices for the management of liquidity and funding risks in the first half of 2013.

A summary of our current policies and practices regarding liquidity and funding is provided in the Appendix to Risk on page 261 of the Annual Report and Accounts 2012.

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.

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 261 of the Annual Report and Accounts 2012.

Liquidity and funding in the first half of 2013

The liquidity position of the Group remained strong in the first half of 2013, as demonstrated by the Group's key liquidity and funding metrics presented below. During the first half of 2013, customer accounts decreased by 1.8% (US$24bn) while loans and advances to customers decreased by 2.8% (US$28bn), leading to a small reduction in our advances to deposits ratio to 73.7% (30 June 2012: 76.3%; 31 December 2012: 74.4%). The decrease in customer accounts in the first half of 2013 was primarily due to the reclassification of customer account balances of around US$14bn relating to non-strategic businesses, notably in Europe and Latin America, to 'Liabilities of disposal groups held for sale'.

Wholesale funding markets

Wholesale funding conditions were generally positive in the first half of 2013, although there was volatility in June as a result of uncertainty surrounding a reduction in economic stimulus and therefore the interest rate outlook. The volume of term debt issued by banks remained low, primarily reflecting reduced wholesale funding requirements compared with recent years.

HSBC continued to have good access to debt capital markets throughout the first half of 2013 with Group entities issuing US$8.5bn of public transactions of which US$6.8bn was in the form of senior unsecured debt.

Liquidity regulation

The European adoption of the Basel Committee framework, via legislative texts known as CRR/CRD IV, which were published on 27 June 2013, requires the reporting of the liquidity coverage ratio ('LCR') and the net stable funding ratio ('NSFR') from January 2014, with the regulatory LCR standard being implemented from January 2015, initially set at 60%, increasing to 100% by January 2018. There is currently a significant level of interpretation required to calculate the LCR as defined in the CRR text; in particular the definitions of operational deposits and several of the outflow assumptions. We expect more clarity on many of these points by 31 December 2013, as technical standards with regard to these are consulted upon and finalised by the European Banking Authority ('EBA'), as mandated by the CRR text. The European adoption of the Basel Committee framework diverges from the Basel recommendations with respect to the outflow assumption to be applied to undrawn committed liquidity facilities, where the CRR requires a 100% outflow to be used, compared with the 30-40% outflow recommended by Basel.

Regarding the finalisation of the NSFR standard, the Basel Committee is expected to issue a consultation on a revised framework in the coming months.

Management of liquidity and funding risk

Our liquidity and funding risk management framework ('LFRF') employs two key measures to define, monitor and control the liquidity and funding risk of each of our operating entities. The advances to core funding ratio is used to monitor the structural long-term funding position, and the stressed coverage ratio, incorporating Group-defined stress scenarios, is used to monitor the resilience to severe liquidity stresses.

The three principal entities listed in the tables below represented 63% (30 June 2012: 61%; 31 December 2012: 62%) of the Group's customer accounts (excluding repos); including other principal entities, 95% (30 June 2012: 97%; 31 December 2012: 94%) was represented.

Advances to core funding ratio

The table below shows the extent to which loans and advances to customers in our principal banking entities (see footnotes 39 to 41 on page 179), were financed by reliable and stable sources of funding.

There were no material movements in the first half of 2013 and all principal banking entities remained within their advances to core funding limit.

Advances to core funding limits set for principal operating entities at 30 June 2013 ranged between 80% and 115%.

Advances to core funding ratios³⁸

	Half-year to
	30 Jun     2013		30 Jun     2012		31 Dec     2012
	%		%		%
HSBC UK39
Period-end ......................	104		104		106
Maximum .......................	107		104		106
Minimum .......................	103		100		103
Average ..........................	105		102		105
The Hongkong and Shanghai Banking Corporation40
Period-end ......................	77		74		73
Maximum .......................	77		75		74
Minimum .......................	73		71		73
Average ..........................	74		73		73
HSBC USA41
Period-end ......................	84		68		78
Maximum .......................	84		86		78
Minimum .......................	78		68		68
Average ..........................	80		80		74
Total of HSBC's other principal entities42
Period-end ......................	92		88		91
Maximum .......................	92		88		92
Minimum .......................	89		85		88
Average ..........................	91		86		91

For footnotes, see page 178.

Stressed coverage ratios

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

Inflows included in the numerator of the stressed coverage ratio are those that are assumed to be generated from liquid assets net of assumed haircuts, and cash inflows related to assets contractually maturing within the time period.

In general, customer advances are assumed to be renewed and as a result do not generate a cash inflow.

Stressed one-month and three-month coverage ratios³⁸

	Stressed one-month coverage ratios for the half-year to						Stressed three-month coverage ratios for the half-year to
	30 Jun		30 Jun		31 Dec		30 Jun		30 Jun		31 Dec
	2013		2012		2012		2013		2012		2012
	%		%		%		%		%		%
HSBC UK39
Period-end ..............................................................	105		111		114		104		102		103
Maximum ...............................................................	114		117		114		104		103		103
Minimum ................................................................	103		111		108		101		101		101
Average ..................................................................	108		114		111		102		102		102
The Hongkong and Shanghai Banking Corporation40
Period-end ..............................................................	113		124		129		109		123		126
Maximum ...............................................................	131		134		130		126		125		126
Minimum ................................................................	113		123		124		109		118		122
Average ..................................................................	120		130		128		114		123		124
HSBC USA41
Period-end ..............................................................	111		134		126		110		130		119
Maximum ...............................................................	126		137		136		119		130		130
Minimum ................................................................	111		115		126		109		113		119
Average ..................................................................	117		125		131		113		123		125
Total of HSBC's other principal entities42
Period-end ..............................................................	114		118		127		109		110		117
Maximum ...............................................................	129		123		127		119		113		117
Minimum ................................................................	114		118		119		109		108		109
Average ..................................................................	122		120		122		114		110		112

For footnotes, see page 178.

Liquid assets of HSBC's principal operating entities

The table below shows the estimated liquidity value (before assumed haircuts) of assets categorised as liquid used for the purposes of calculating the three-month stressed coverage ratios, as defined under the LFRF.

Liquid assets of HSBC's principal entities

	Estimated liquidity value43
	30 Jun                2013		30 Jun                2012		31 Dec                2012
	US$m		US$m		US$m
HSBC UK39
Level 1 .....................................................................................................	142,005		120,690		138,812
Level 2 .....................................................................................................	933		475		374
Level 3 .....................................................................................................	44,866		9,320		27,656
	187,804		130,485		166,842
The Hongkong and Shanghai Banking Corporation40
Level 1 .....................................................................................................	91,742		104,944		112,167
Level 2 .....................................................................................................	5,131		5,928		5,740
Level 3 .....................................................................................................	3,861		4,889		3,968
	100,734		115,761		121,875
HSBC USA41
Level 1 .....................................................................................................	49,715		62,966		60,981
Level 2 .....................................................................................................	12,233		16,511		15,609
Level 3 .....................................................................................................	5,359		8,405		5,350
Other ........................................................................................................	5,842		6,238		6,521
	73,149		94,120		88,461
Total of HSBC's other principal entities42
Level 1 .....................................................................................................	140,529		118,616		154,445
Level 2 .....................................................................................................	12,984		36,713		18,048
Level 3 .....................................................................................................	12,693		11,205		6,468
Other ........................................................................................................	-		-		2,447
	166,206		166,534		181,408

For footnotes, see page 178.

Any unencumbered asset held as a consequence of a reverse repo transaction with a residual contractual maturity within the stressed coverage ratio time period and unsecured interbank loans maturing within three months are not included in liquid assets, as these assets are reflected as contractual cash inflows.

Liquid assets are held and managed on a standalone operating entity basis. Most of the liquid assets shown are held directly by each operating entity's Balance Sheet Management function, primarily for the purpose of managing liquidity risk, in line with the LFRF.

Liquid assets also include any unencumbered liquid assets held outside Balance Sheet Management for any other purpose. The LFRF gives ultimate control of all unencumbered assets and sources of liquidity to Balance Sheet Management.

All assets held within the liquid asset portfolio are unencumbered. Liquid assets held by HSBC UK increased predominantly as a result of higher deposits, some of which have been deployed in Level 3 securities. In addition there has been a reclassification of some securities as Level 3 liquid assets (previously illiquid) as they meet the criteria of liquid assets in accordance with the LFRF.

Liquid assets held by The Hongkong and Shanghai Banking Corporation and HSBC USA decreased predominantly as surplus liquidity, as measured by the LFRF, was deployed into alternative asset classes or deployed into loans and advances to customers, as demonstrated by the increase in the respective advances to core funding ratio and/or the decrease in the respective stressed coverage ratios.

Net contractual cash flows

The following table quantifies the contractual cash flows from interbank and intra-Group loans and deposits, and reverse repo, repo (including intra- Group transactions) and short positions for the principal entities shown. These contractual cash inflows and outflows are reflected gross in the numerator and denominator, respectively, of the one-month and three-month stressed coverage ratios and should be considered alongside the level of liquid assets.

Outflows included in the denominator of the stressed coverage ratios include the principal outflows associated with the contractual maturity of wholesale debt securities reported in the table headed 'Wholesale funding principal cash flows payable by HSBC under financial liabilities by remaining contractual maturities' on page 162.

Net cash inflows/(outflows) for interbank and intra-Group loans and deposits and reverse repo, repo and short positions

	Cash flows				Cash flows				Cash flows
	at 30 June 2013				at 30 June 2012				at 31 December 2012
	within          one     month		from      one to       three    months		within           one      month		from       one to         three     months		within           one      month		from       one to         three     months
	US$m		US$m		US$m		US$m		US$m		US$m
Interbank and intra-Group loans and deposits
HSBC UK39 ................................................................	(17,173)		(3,696)		(13,569)		(1,206)		(16,464)		(1,429)
The Hongkong and Shanghai Banking Corporation40 ..	(4,368)		8,638		4,089		8,147		4,402		9,685
HSBC USA41 ...............................................................	(23,320)		2,629		(30,186)		1,060		(30,269)		(473)
Total of HSBC's other principal entities42 ..................	4,500		10,894		3,898		12,972		5,419		10,511
Reverse repo, repo, stock borrowing, stock lending and outright short positions (including intra-Group)
HSBC UK39 ................................................................	(11,569)		(8,080)		(7,687)		(2,498)		(4,184)		(13,776)
The Hongkong and Shanghai Banking Corporation40 ..	7,746		2,354		5,314		708		13,672		2,501
HSBC USA41 ...............................................................	(10,818)		(219)		7,289		(786)		(4,003)		62
Total of HSBC's other principal entities42..................	(42,359)		8,114		(38,184)		8,281		(31,951)		(231)

For footnotes, see page 178.

Net cash flow arising from interbank and intra-Group loans and deposits

Under the LFRF, a net cash inflow within three months arising from interbank and intra-Group loans and deposits will give rise to a lower liquid asset
requirement. Conversely, a net cash outflow within three months arising from interbank and intra-Group loans and deposits will give rise to a higher liquid assets requirement.

Net cash flow arising from reverse repo, repo, stock borrowing, stock lending and outright short positions (including intra-Group)

A net cash inflow represents additional liquid resources, in addition to liquid assets, because any unencumbered asset held as a consequence of a reverse repo transaction with a residual contractual maturity within the stressed coverage ratio time period is not reflected as a liquid asset.

The impact of net cash outflow depends on whether the underlying collateral encumbered as a result will qualify as a liquid asset when released at the maturity of the repo. The majority of the Group's repo transactions are collateralised by liquid assets and, as such, any net cash outflow shown is offset by the return of liquid assets, which are excluded from the liquid asset table above.

Contingent liquidity risk arising from committed lending facilities

The Group's operating entities provide commitments to various counterparties. In terms of liquidity risk, the most significant risk relates to committed lending facilities which, whilst undrawn, give rise to contingent liquidity risk, as these could be drawn during a period of liquidity stress. Commitments are given to customers and committed lending facilities are provided to consolidated multi-seller conduits, established to enable clients to access a flexible market-based source of finance, consolidated SICs and third‑party sponsored conduits.

The consolidated SICs primarily represent Solitaire and Mazarin (see page 147). These conduits issue asset-backed commercial paper secured against the portfolio of securities held by these conduits. At 30 June 2013, HSBC UK had undrawn committed lending facilities to these conduits of US$16bn (30 June 2012: US$20bn; 31 December 2012: US$18bn), of which Solitaire represented US$12bn (30 June 2012: US$14bn; 31 December 2012: US$13bn) and the remaining US$4bn (30 June 2012: US$6bn; 31 December 2012: US$5bn) pertained to Mazarin. At 30 June 2013, the commercial paper issued by Solitaire and Mazarin was entirely held by HSBC UK. Since HSBC controls the size of the portfolio of securities held by these conduits, no contingent liquidity risk exposure arises as a result of these undrawn committed lending facilities.

The table below shows the level of undrawn commitments to customers outstanding for the five largest single facilities and the largest market sector, and the extent to which they are undrawn.

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

	HSBC UK39						HSBC USA41						HSBC Canada						The Hongkong and Shanghai Banking Corporation40
	At 30 Jun    2013		At 30 Jun    2012		At 31 Dec    2012		At 30 Jun    2013		At 30 Jun    2012		At 31 Dec    2012		At 30 Jun    2013		At 30 Jun    2012		At 31 Dec    2012		At 30 Jun   2013		At 30 Jun    2012		At 31 Dec    2012
	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 .........	7.9		10.0		7.8		3.1		1.7		2.3		0.9		0.9		1.0		-		-		-
- largest individual lines ..............	0.7		0.6		0.7		0.5		0.5		0.5		0.7		0.8		0.8		-		-		-
HSBC-managed assets - total lines .........	16.1		20.0		18.1		-		-		-		-		-		-		-		-		-
Other conduits - total lines .........	-		-		-		0.8		1.0		0.8		-		-		-		-		-		-
Single-issuer liquidity facilities
- five largest44 .....	6.6		4.0		6.0		6.2		5.9		6.0		1.4		1.7		1.7		2.8		1.6		2.1
- largest market sector45 .........	11.7		8.4		11.0		7.2		7.1		7.5		3.7		4.2		4.5		2.2		2.5		2.4

For footnotes, see page 178.

Sources of funding

Our primary sources of funding are customer current accounts and customer savings deposits payable on demand or at short notice. We issue wholesale securities (secured and unsecured) to supplement
our customer deposits and change the currency mix, maturity profile or location of our liabilities.

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 the

LFRF, which requires operating entities to manage liquidity and funding risk on a stand-alone basis.

The table below 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.

The level of customer accounts continued to exceed the level of loans and advances to customers.
Excluding the effect of repos from customer accounts and reverse repos from loans and advances to customers, the adjusted advances to deposits ratio at 30 June 2013 was 74.1% (30 June 2012; 73.9%; 31 December 2012: 73.4%). The positive funding gap was predominantly deployed into liquid assets; cash and balances with central banks and financial investments, as required by the LFRF.

Loans and other receivables due from banks continued to exceed deposits taken from banks. The Group remained a net unsecured lender to the banking sector.

Funding sources and uses

	At		At		At
	30 Jun		30 Jun		31 Dec
	2013		2012		2012
	US$m		US$m		US$m
Sources
Customer accounts .......	1,316,182		1,278,489		1,340,014
- repos ...........	49,277		26,426		28,618
- cash deposits	1,266,905		1,252,063		1,311,396
Deposits by banks ...........	110,023		123,553		107,429
- repos ...........	17,314		17,054		11,949
- cash deposits	92,709		106,499		95,480
Debt securities issued ...........	109,389		125,543		119,461
Liabilities of disposal groups held for sale ..............	19,519		12,599		5,018
Subordinated liabilities ......	28,821		29,696		29,479
Financial liabilities designated at fair value ......	84,254		87,593		87,720
Liabilities under insurance contracts ......	69,771		62,861		68,195
Trading liabilities ......	342,432		308,564		304,563
- repos ...........	134,506		112,628		130,223
- stock lending .....................	10,097		6,013		6,818
- settlement accounts .......	41,092		35,162		17,108
- other trading liabilities ......	156,737		154,761		150,414
Total equity ....	182,361		173,766		183,129
	2,262,752		2,202,664		2,245,008

	At		At		At
	30 Jun		30 Jun		31 Dec
	2013		2012		2012
	US$m		US$m		US$m
Uses
Loans and advances to customers .	969,382		974,985		997,623
- reverse repos	31,088		49,320		34,651
- loans or other receivables ....	938,294		925,665		962,972
Loans and advances to banks .......	185,122		182,191		152,546
- reverse repos	57,312		42,429		35,461
- loans or other receivables ....	127,810		139,762		117,085
Assets held for sale ...............	20,377		12,383		19,269
Trading assets .	432,601		391,371		408,811
- reverse repos	104,273		104,335		118,681
- stock borrowing .....	17,372		16,509		16,071
- settlement accounts .......	53,749		32,547		14,510
- other trading assets ............	257,207		237,980		259,549
Financial investments ..	404,214		393,736		421,101
Cash and balances with
central banks	148,285		147,911		141,532
Net deployment in other balance sheet assets and liabilities	102,771		100,087		104,126
	2,262,752		2,202,664		2,245,008

Wholesale term debt maturity profile

The maturity profile of the Group's wholesale term debt obligations is set out below in the table headed 'Wholesale funding principal cash flows payable by HSBC under financial liabilities by remaining contractual maturities'.

The balances in the table will not agree directly with those in our consolidated balance sheet as the table presents gross cash flows relating to principal payments and not the balance sheet carrying value,
which includes debt securities and subordinated liabilities measured at fair value.

The basis of preparation of this table has changed from that presented in the Annual Report and Accounts 2012, which included future coupon payments in addition to the principal amounts. The inclusion of principal amounts only is more consistent with how the Group manages the associated liquidity and funding risk.

Wholesale funding principal cash flows payable by HSBC under financial liabilities by remaining contractual maturities

	Due within 1 month		Due between 1 and 3 months		Due between 3 and 6 months		Due between 6 and 9 months		Due between 9 months and 1 year		Due between 1 and 2 years		Due between 2 and 5 years		Due after 5 years		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2013
Debt securities issued .............................................	25,197		16,162		18,123		14,894		9,158		30,335		44,591		27,194		185,654
-  unsecured CDs and CP ....................................	9,228		9,146		9,505		3,578		3,664		2,584		2,326		-		40,031
-  unsecured senior medium-term notes ('MTN's) ...........................................................................	2,636		3,570		6,947		8,745		3,607		19,219		31,828		18,708		95,260
-  unsecured senior structured notes ...................	435		705		646		1,164		1,344		2,936		4,868		6,059		18,157
-  secured covered bonds ....................................	-		397		667		939		287		3,179		3,459		425		9,353
-  secured asset-backed commercial paper ('ABCP') .......................................................	12,725		2,159		-		-		-		-		-		495		15,379
-  secured ABS ...................................................	70		142		315		461		181		1,384		1,517		92		4,162
-  others ............................................................	103		43		43		7		75		1,033		593		1,415		3,312
Subordinated liabilities ...........................................	-		10		-		26		1,170		336		4,349		39,084		44,975
-  subordinated debt securities ............................	-		10		-		26		1,170		336		3,349		32,560		37,451
-  preferred securities .........................................	-		-		-		-		-		-		1,000		6,524		7,524
	25,197		16,172		18,123		14,920		10,328		30,671		48,940		66,278		230,629
At 30 June 2012
Debt securities issued .............................................	16,541		25,847		16,662		8,738		16,658		31,681		59,260		28,484		203,871
-  unsecured CDs and CP ....................................	10,280		9,086		7,138		2,367		3,795		3,752		2,813		-		39,231
-  unsecured senior MTNs ..................................	2,216		4,856		6,052		4,557		9,718		21,180		41,041		18,985		108,605
-  unsecured senior structured notes ...................	472		897		2,045		1,291		1,549		1,773		4,126		6,640		18,793
-  secured covered bonds ....................................	-		-		1,027		-		1,105		2,527		6,671		793		12,123
-  secured ABCP ................................................	2,985		10,477		-		-		-		-		-		278		13,740
-  secured ABS ...................................................	85		168		226		377		486		1,262		2,610		611		5,825
-  others ............................................................	503		363		174		146		5		1,187		1,999		1,177		5,554
			-
Subordinated liabilities ...........................................	306		-		2,881		43		-		1,150		2,425		41,148		47,953
-  subordinated debt securities ............................	306		-		2,881		43		-		1,150		1,425		33,386		39,191
-  preferred securities .........................................	-		-		-		-		-		-		1,000		7,762		8,762
	16,847		25,847		19,543		8,781		16,658		32,831		61,685		69,632		251,824

	Due within 1 month		Due between 1 and 3 months		Due between 3 and 6 months		Due between 6 and 9 months		Due between 9 months and 1 year		Due between 1 and 2 years		Due between 2 and 5 years		Due after 5 years		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2012
Debt securities issued .............................................	19,280		20,724		22,479		10,269		14,934		27,716		56,543		25,970		197,915
-  unsecured CDs and CP ....................................	3,736		12,176		6,707		1,632		1,709		3,502		763		-		30,225
-  unsecured senior MTNs ..................................	201		5,360		12,655		6,772		10,411		15,318		41,381		17,299		109,397
-  unsecured senior structured notes ...................	487		1,112		1,694		1,075		897		2,584		5,779		6,208		19,836
-  secured covered bonds ....................................	-		-		1,133		422		758		3,578		4,557		826		11,274
-  secured ABCP ................................................	14,583		1,891		-		-		-		-		-		-		16,474
-  secured ABS ...................................................	104		175		211		339		633		1,677		2,072		525		5,736
-  others ............................................................	169		10		79		29		526		1,057		1,991		1,112		4,973
Subordinated liabilities ...........................................	7		44		-		-		10		1,296		2,550		43,949		47,856
-  subordinated debt securities ............................	7		44		-		-		10		1,296		1,550		36,005		38,912
-  preferred securities .........................................	-		-		-		-		-		-		1,000		7,944		8,944
	19,287		20,768		22,479		10,269		14,944		29,012		59,093		69,919		245,771

Market risk

	Page		Tables	Page
Market risk in the first half of 2013 .....................	165
Trading and non-trading portfolios .......................	165		Types of risk by global business ....................................	165
Market risk reporting measures ..................................	165		Overview of risk reporting ............................................	165
Market risk linkages to the accounting balance sheet ..	165
Trading portfolios ....................................................	165
Value at risk of the trading portfolios .........................	165		Trading value at risk ....................................................	165
			Daily VAR (trading portfolios) .....................................	165
			Daily revenues and daily distribution of Global Markets' trading and other trading revenues ..........................	166
			VAR by risk type for trading activities ...........................	167
Stressed value at risk of the trading portfolio ..............	167		Stressed value at risk (1-day equivalent) ......................	167
Non-trading portfolios ............................................	167
Value at risk of the non-trading portfolios ..................	167		Non-trading value at risk .............................................	167
			Daily VAR (non-trading portfolios) ..............................	167
Credit spread risk for available-for-sale debt securities	168
Equity securities classified as available for sale .	168		Fair value of equity securities ......................................	168
Structural foreign exchange exposures ...............	168
Non-trading interest rate risk ...............................	168
Balance Sheet Management ..................................	169		Analysis of third-party assets in Balance Sheet Management ............................................................	169
Sensitivity of net interest income ........................	170		Sensitivity of projected net interest income ...................	170
			Sensitivity of reported reserves to interest rate movements .................................................................................	171
Defined benefit pension schemes .........................	171		HSBC's defined benefit pension schemes ......................	171
Additional market risk measures applicable only to the parent company ............................................	171
Foreign exchange risk .................................................	171		HSBC Holdings - foreign exchange VAR .....................	171
Interest rate repricing gap table ..................................	172		Repricing gap analysis of HSBC Holdings ...................	172

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 2012.

Exposure to market risk

Exposure to market risk is separated into two portfolios:

·  Trading portfolios comprise positions arising from the market-making and warehousing of customer-derived positions.

·  Non-trading portfolioscomprise 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 175).

Monitoring and limiting market risk exposures

Our objective is to manage and control market risk exposures while maintaining a market profile consistent with our risk appetite.

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

·  sensitivity measures include sensitivity of net interest income and sensitivity for structural foreign exchange, which 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 slowdown in mainland China and the potential effects of a sovereign debt default, including its wider contagion effects.

A summary of our current policies and practices regarding market risk is provided in the Appendix to Risk on page 265 of the Annual Report and Accounts 2012.

Market risk in the first half of 2013

Following a pattern observed recently, 2013 started with generally positive market sentiment despite concerns around the US fiscal cliff, the bailout of Cyprus and slowing economic growth in Europe and major emerging markets. The accommodative policies followed by leading central banks provided the backdrop for major equity markets reaching recent highs, while credit spreads narrowed further and long-term interest rates fell. Generally low returns led investors to continue to search for yield, which resulted in strong levels of demand for high yielding debt.

The second quarter was characterised by increased turbulence in currency markets triggered by expansionary monetary policy in Japan and the US Federal Reserve discussing tapering off its asset purchase programme. The latter led to US longer term interest rates climbing rapidly, driving up yield curves in most developed and emerging markets. This led to volatilities increasing across most asset classes.

Against the backdrop of rising volatility in global financial markets, the equity business maintained a defensive risk profile and foreign exchange exposures remained low, leading to lower trading VAR. Non-trading VAR increased during the period as a result of rising levels of interest rate volatility, together with the extension of the asset profile in the non-trading book.

Trading and non-trading portfolios

The following tables provide an overview of the types of risks within the different global businesses.

Types of risk by global business

Risk types	Global businesses
Trading risk	GB&M including Balance
-  Foreign exchange	Sheet Management ('BSM')
and commodities
-  Interest rate
-  Equities
-  Credit spread
Non-trading risk	GB&M including BSM,
-  Foreign exchange (structural)	RBWM, CMB and GPB
-  Interest rate
-  Credit spread

Market risk reporting measures

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

Overview of risk reporting

	Portfolio
	Trading	Non-trading
Risk type
Foreign exchange and commodity ....................	VAR	VAR
Interest rate ......................	VAR	VAR/   Sensitivity
Equity ...............................	VAR	Sensitivity
Credit spread .....................	VAR	VAR
Structural foreign exchange .......................................	n/a	Sensitivity

The reporting of commodity risk is consolidated with foreign exchange risk. There is no commodity risk in the non-trading portfolios. The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included in the Group VAR. The management of this risk is described on page 172.

Market risk linkages to the accounting balance sheet

The market risk linkages to the accounting balance sheet are described on page 219 in the Annual Report and Accounts 2012.

For a description of the parameters used in calculating VAR, see the Appendix to Risk on page 266 of the Annual Report and Accounts 2012.

Trading portfolios

Value at risk of the trading portfolios

Trading value at risk

	Half-year to
	30 June          2013		30 June         2012	31 December          2012
	US$m		US$m		US$m
At period-end ......	52.9		69.2		78.8
Average ..............	50.1		88.7		60.1
Minimum ............	41.4		62.0		47.3
Maximum ...........	71.5		130.9		79.1

The daily levels of trading VAR over the course of 2012 and the first half of 2013 are set out in the graph below.

Daily VAR (trading portfolios)

Almost all trading VAR resides within Global Markets. The VAR for trading activity at 30 June 2013 was lower than at 31 December 2012 due primarily to the benefit of the defensive contribution from the equity business and reduced positions in the foreign exchange business. These contributions and higher diversification benefit across asset classes led to VAR trending lower during the period, even though financial markets became more volatile.

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. We would expect on average to see two to three losses in excess of VAR at the 99% confidence level, over a one-year period. The actual number of losses in excess of VAR over this period can therefore be used to gauge how well the models are performing. In the first half of 2013, there were no exceptions at the Group level.

Daily revenues and daily distribution of Global Markets' trading and other trading revenues46,47
	Half-year to							Half-year to 30 June 2013
		30 Jun		30 Jun		31 Dec		Number of days
		2013		2012		2012
		US$m		US$m		US$m
Average daily revenue ..		36.4		36.4		27.2
Standard deviation48 .....		23.6		27.6		15.3
Ranges of most frequent daily revenues ....................		30-40		20 - 30 30 - 40 40 - 50		20 - 30
		days		days		days
- daily occurrences ....		24		22		38
Days of negative revenue ..................................		6		3		5
								Revenues (US$m)
								< Profit and loss frequency
Half-year to 30 June 2012								Half-year to 31 December 2012
Number of days								Number of days
Revenues (US$m)								Revenues (US$m)
< Profit and loss frequency								< Profit and loss frequency

For footnotes, see page 178.

VAR by risk type for trading activities⁴⁹

	Foreign exchange and     commodity		Interest                 rate		Equity		Credit             spread		Portfolio diversification50		Total51
	US$m		US$m		US$m		US$m		US$m		US$m
First half of 2013 ........	14.9		35.5		4.2		18.1		(19.7)		52.9
Average ........................	15.2		33.0		5.1		17.6		(20.9)		50.1
Minimum ......................	8.8		22.8		2.2		11.9		-		41.4
Maximum .....................	25.8		52.3		14.1		25.5		-		71.5
First half of 2012 ..........	28.8		42.9		13.8		26.4		(42.7)		69.2
Average ........................	30.0		45.0		5.9		37.4		(29.7)		88.7
Minimum ......................	14.4		33.3		2.7		22.4		-		62.0
Maximum .....................	46.0		60.0		13.8		77.9		-		130.9
Second half of 2012 ......	20.5		37.5		17.7		16.1		(12.9)		78.8
Average ........................	17.3		40.3		12.5		16.5		(26.4)		60.1
Minimum ......................	6.9		29.5		6.0		12.2		-		47.3
Maximum .....................	29.6		54.9		24.9		29.1		-		79.1

For footnotes, see page 178.

Stressed value at risk of the trading portfolios

Stressed VAR is primarily used for regulatory capital purposes but is integrated into the risk management process to facilitate efficient capital management and to highlight potentially risky positions based on previous market volatility. Stressed VAR complements other risk measures by providing the potential losses arising from market turmoil.Calculations are based on a continuous one-year period of stress for the trading portfolio, based on the assessment at the Group level of the most volatile period in recent history.

Stressed value at risk (1-day equivalent)

	At		At
	30 Jun		31 Dec
	2013		2012
	US$m		US$m
At period-end .............	74.7		172.4

Stressed VAR significantly reduced during the first quarter of 2013 following the defensive positions taken by the Equity and Foreign Exchange businesses. As a consequence, the overall risk profile minimised the losses from highly volatile periods and led to a relatively low stressed VAR when compared with trading VAR. The risk profile was unchanged during the second quarter and the stressed VAR remained stable.

Non-trading portfolios

Value at risk of the non-trading portfolios

Non-trading value at risk

	At		At		At
	30 Jun		30 Jun		31 Dec
	2013		2012		2012
	US$m		US$m		US$m
At period-end .........	194.9		204.6		119.2
Average ..................	141.4		237.3		159.7
Minimum ................	114.7		181.9		118.1
Maximum ...............	212.7		322.5		206.4

The daily levels of non-trading VAR over the course of 2012 and the first half of 2013 are set out in the graph below.

Daily VAR (non-trading portfolios)

Most of the Group non-trading VAR relates to Balance Sheet Management or local treasury management functions. Contributions to Group non-trading VAR are driven by interest rates and credit spread risks arising from all global businesses.

The increase of non-trading VAR during the first half of 2013 was due mainly to the effect of higher levels of volatility in interest rates utilised in the VAR calculations, together with the extension of the asset profile in the non-trading book.

Non-trading VAR includes the interest rate risk of non-trading financial instruments held by the global businesses and transferred into portfolios managed by Global Markets or local treasury functions. In measuring, monitoring and managing risk in our non-trading portfolios, VAR is just one of the tools used. The management of interest rate risk in the banking book is described further in 'Non-trading interest rate risk' below, including the role of Balance Sheet Management.

Non-trading VAR excludes equity risk on available-for-sale securities, structural foreign exchange risk and interest rate risk on fixed rate securities issued by HSBC Holdings, the management of which is described in the relevant sections below. These sections together describe the scope of HSBC's management of market risks in non-trading books.

Credit spread risk for available-for-sale debt securities

Credit spread VAR for available-for-sale debt securities, excluding those held in insurance operations, is included in the Group non‑trading VAR. However, SICs are not included.

At 30 June 2013, 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$126m (30 June 2012: US$212m; 31 December 2012: US$150m). This sensitivity was 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$109m (30 June 2012: US$165m; 31 December 2012: US$119m).

The decrease in this sensitivity at 30 June 2013 compared with 31 December 2012 was due mainly to the effect of the lower credit spread baselines and volatilities utilised in the VAR calculation during 2013.

At 30 June 2013, the capital note holders would absorb the first US$2.2bn (30 June 2012: US$2.2bn; 31 December 2012: 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      2013		At    30 Jun      2012		At  31 Dec      2012
	US$bn		US$bn		US$bn
Private equity holdings52 .............	2.9		3.0		2.9
Funds invested for short- term cash management .........	0.1		0.1		0.2
Investment to facilitate ongoing business53	1.1		1.1		1.1
Other strategic investments ..........	5.3		2.5		1.6
Total .......................	9.4		6.7		5.8

For footnotes, see page 178.

The fair value of the constituents of equity securities classified as available for sale can fluctuate considerably. The table above sets out the maximum possible loss on shareholders' equity from available- for-sale equity securities. The increase in other strategic investments is largely due to the reclassification of our investment in Industrial Bank.

Structural foreign exchange exposures

Our policies and procedures for managing structural foreign exchange exposures are described on page 268 in the Annual Report and Accounts 2012. For details of structural foreign exchange exposures see page 493 in the Annual Report and Accounts 2012.

Non-trading interest rate risk

The Asset, Liability and Capital Management department is responsible for measuring and controlling non-trading interest rate risk under the supervision of the Risk Management Meeting of the GMB. Its primary responsibilities are:

·     to define the rules governing the transfer of interest rate risk from the global businesses to BSM;

·     to ensure that all market interest rate risk that can be hedged is transferred from the global businesses to BSM; and

·     to define the rules and metrics for monitoring the residual interest rate risk in the global businesses.

The different types of non-trading interest rate risk and the controls which we use to quantify and limit exposure to these risks can be categorised as follows:

·     risk which is transferred to BSM and managed by BSM within a defined risk mandate (see below);

·     risk which remains outside BSM because it cannot be hedged or which arises due to our behaviouralised transfer pricing assumptions. This risk is captured by our net interest income or Economic Value of Equity ('EVE') sensitivity, and corresponding limits are part of our global and regional risk appetite statements for non-trading interest rate risk. A typical example would be margin compression created by unusually low rates in key currencies;

·     basis risk which is transferred to BSM when it can be hedged. Any residual basis risk remaining in the global businesses is reported to the Asset and Liability Management Committee ('ALCO'). A typical example would be a managed rate savings product transfer-priced using a Libor-based interest rate curve; and

·     model risks which cannot be captured by net interest income or EVE sensitivity, but are controlled by our stress testing framework. A typical example would be prepayment risk on residential mortgages or pipeline risk.

Balance Sheet Management

Effective governance across BSM is supported by the dual reporting lines it has to the CEO of GB&M and to the Group Treasurer. In each operating entity, BSM is responsible for managing liquidity and funding under the supervision of the local 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 held in short-term interbank and central bank loans.

Analysis of third-party assets in Balance Sheet Management

	At      30 Jun          2013		At       31 Dec          2012
	US$m		US$m
Cash and balances at central banks ..................................	118,139		93,946
Trading assets ........................	7,830		8,724
Financial assets designated at fair value ............................	73		74
Loans and advances:
- to banks ..........................	75,195		72,771
- to customers ....................	23,805		22,052
Financial investments ............	279,051		293,421
Other .....................................	3,284		2,948
	507,377		493,936

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 or, to a lesser extent, held-to- maturity 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 and fair value hedging relationships.

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

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. At 30 June 2013 and 31 December 2012 BSM had no open credit derivative index risk.

VAR is calculated on both trading and non-trading positions held in BSM. It is calculated by applying the same methodology used for the Global Markets business and is utilised as a tool for market risk control purposes.

BSM holds trading portfolio instruments in only very limited circumstances. Positions and the associated VAR were not significant during the first half of 2013.

Sensitivity of net interest income

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 July 2013. Assuming no management response, a sequence of such rises would increase planned net interest income for the 12 months to 30 June 2014 by US$1,155m (to 31 December 2013: US$1,403m), while a sequence of such falls would decrease planned net interest income by US$1,544m (31 December 2013: US$1,550m). These figures incorporate the effect of any option features in the underlying exposures.

Sensitivity of projected net interest income⁵⁴

	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 2013 to June 2014 projected net interest income arising from a shift in yield curves at the beginning of each quarter of:
+  25 basis points ..........................	112		56		283		152		593		(41)		1,155
-  25 basis points ..........................	(351)		(65)		(399)		(181)		(524)		(24)		(1,544)
Change in January 2013 to December 2013 projected net interest income arising from a shift in yield curves at the beginning of each quarter of:
+  25 basis points ..........................	133		64		246		237		679		44		1,403
-  25 basis points ..........................	(366)		(52)		(305)		(168)		(602)		(57)		(1,550)

For footnote, see page 178.

The interest rate sensitivities set out in the table above are indicative and based on simplified scenarios. The limitations of this analysis are discussed in the Appendix to Risk on page 269 of the Annual Report and Accounts 2012.

The change in the sensitivity of the Group's net interest income to the change in rates shown in the table above is largely driven by changes in BSM exposure, in balance sheet composition and in yield curves. 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 100bps 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 period.

Sensitivity of reported reserves to interest rate movements⁵⁴

			Impact in the preceding 6 months
	US$m		Maximum              US$m		Minimum              US$m
At 30 June 2013
+ 100 basis point parallel move in all yield curves ........................................	(5,991)		(5,991)		(5,507)
As a percentage of total shareholders' equity ................................................	(3.4%)		(3.4%)		(3.2%)
- 100 basis point parallel move in all yield curves ........................................	5,752		5,752		4,910
As a percentage of total shareholders' equity ................................................	3.3%		3.3%		2.8%
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 31 December 2012
+ 100 basis point parallel move in all yield curves ........................................	(5,602)		(5,748)		(5,166)
As a percentage of total shareholders' equity ................................................	(3.2%)		(3.3%)		(2.9%)
- 100 basis point parallel move in all yield curves ........................................	4,996		5,418		4,734
As a percentage of total shareholders' equity ................................................	2.9%		3.1%		2.7%

For footnote, see page 178.

The sensitivities above are indicative and based on simplified scenarios. The table shows the potential sensitivity of reported 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 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.

Defined benefit pension schemes

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

	At    30 Jun       2013		At     30 Jun       2012		At    31 Dec      2012
	US$bn		US$bn		US$bn
Liabilities (present value).................................	37.1		35.9		38.1
	%		%		%
Assets:
Equity investments .....	19		17		18
Debt securities ............	71		72		71
Other (including property) ................	10		11		11
	100		100		100

For details of the latest actuarial valuation of the HSBC Bank (UK) Pension Scheme and other defined benefit plans, see page 415 in the Annual Report and Accounts 2012.

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 2013 was as follows:

HSBC Holdings - foreign exchange VAR

	Half-year to
	30 Jun       2013		30 Jun       2012		31 Dec       2012
	US$m		US$m		US$m
At period end ..............	46.9		39.4		69.9
Average.......................	52.6		48.2		52.2
Minimum ....................	46.6		39.4		39.2
Maximum ...................	64.1		54.2		69.9

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 most of 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.

Repricing gap analysis of HSBC Holdings

	Total		Up to         1 year		1 to       5 years		5 to     10 years		More than     10 years		Non-      interest      bearing
	US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2013
Total assets .................................................	142,080		43,355		310		2,183		594		95,638
Total liabilities and equity ...........................	(142,080)		(11,716)		(7,215)		(7,681)		(13,838)		(101,630)
Off-balance sheet items attracting interest rate sensitivity .........................................	-		(16,799)		3,977		7,681		4,079		1,062
Net interest rate risk gap .............................	-		14,840		(2,928)		2,183		(9,165)		(4,930)
Cumulative interest rate gap ........................	-		14,840		11,912		14,095		4,930		-
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 31 December 2012
Total assets .................................................	139,484		38,785		300		2,208		630		97,561
Total liabilities and equity ...........................	(139,484)		(13,913)		(8,790)		(9,818)		(14,180)		(92,783)
Off-balance sheet items attracting interest rate sensitivity .........................................	-		(18,583)		6,348		7,341		4,325		569
Net interest rate risk gap .............................	-		6,289		(2,142)		(269)		9,225		5,347
Cumulative interest rate gap ........................	-		6,289		4,147		3,878		(5,347)		-

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.

Activity to embed our operational risk management framework policies and procedures continued in the first half of 2013.

A summary of our current policies and practices regarding operational risk is provided in the Appendix to Risk on page 270 of the Annual Report and Accounts 2012.

Operational risk in the first half of 2013

During the first half of 2013, our operational top and emerging risk profile continued to be dominated by compliance and legal risks. Additional losses, at a level lower than seen in 2012, were realised in the first half of 2013 relating to the possible mis-selling of PPI policies in the UK in previous years. In relation to the DPAs, the Group has committed to take, or continue to adhere to, a number of remedial measures. Breach of the DPAs at any time during their terms may allow the DoJ or the New York County District Attorney's Office to prosecute HSBC in relation to the matters which are the subject of DPAs. Various regulators and competition authorities around the world are also investigating and reviewing certain past submissions made by panel banks and the process for making submissions in connection with the setting of Libor, Euribor, and other benchmark

interest and foreign exchange rates. In response, we have undertaken a number of initiatives by which we seek to address the issues identified, including creating a new global management structure, enhancing our governance and oversight, increasing our Compliance function resource, emphasising HSBC Values and designing and implementing new Global Standards.

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;

·     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. The Global Transactions Team has developed an enhanced risk management framework to be applied to the management of disposal risks; and

·     information security: in common with other banks and multinational organisations, we face a growing threat of cyber attacks. Significant investment has already been made in improving 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 proceedings are discussed in Note 24 on the Financial Statements and further details regarding compliance risk are set out below.

Compliance risk

Compliance risk is the risk that we fail to observe the letter and spirit of all relevant laws, codes, rules, regulations and standards of good market practice, and incur fines and penalties and suffer damage to our business as a consequence.

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 line with our ambition to be the world's leading international bank, we have committed to adopt and enforce industry leading compliance standards across the Group. One of the ways to achieve this is to ensure that we put in place a robust compliance risk management infrastructure.

We had already made progress on this during 2012 with the appointment of a new Head of Group Financial Crime Compliance with particular expertise and experience in US law and regulation. This was followed by the appointment of a new Global Head of Regulatory Compliance and in April 2013, we commenced the restructuring of our existing Compliance sub-function within Global Risk into two new sub-functions: Financial Crime Compliance and Regulatory Compliance, jointly supported by Compliance Shared Services. This restructuring is ongoing and will allow us to:

·     manage different types of regulatory and financial crime compliance risk more effectively;

·     focus our efforts appropriately in addressing the issues highlighted by regulatory investigations and reviews, internal audits and risk assessments of our past business activities; and

·     ensure we have in place clear, robust accountability and appropriate expertise and processes for all areas of compliance risk.

Financial Crime Compliance will focus on setting policy and managing risks in the following areas:

·      anti-money laundering, counter terrorist financing and proliferation finance;

·      sanctions; and

·      anti-bribery and corruption.

Regulatory Compliance will focus on setting policy and managing risks in the following areas:

·      conduct of business;

·      market conduct; and

·      general regulatory compliance management including stakeholder support.

We have also continued to invest in the Compliance sub-functions, having doubled spending on the function generally between 2010 and 2012 and increased headcount by over 250% between 2010 and 30 June 2013. This further investment will continue throughout 2013.

In conjunction with the continued implementation of the wider Group strategy, including measures to implement global standards, streamline processes and procedures and simplify our global business activity through the disposal or closure of non-strategic and/or underperforming positions or businesses, these measures should position us well to meet significantly increased levels of new regulation and of activity from regulators and law enforcement agencies in pursuing investigations in relation to possible breaches of regulation. In addition, they will ensure we have in place the appropriate people, processes, systems and training to manage emerging risks, new products and businesses and evolving markets.

It is clear that the level of inherent compliance risk that we face will continue to remain high for the foreseeable future. However, we consider that good progress is being and will continue to be made in ensuring that we are well placed to effectively manage those risks.

Reputational risk

Reputational risk can arise from issues, activities and associations that might pose a threat to the reputation of the Group, locally, regionally or internationally.

As noted in the compliance risk section above, we have continued to take steps to tackle the root causes of the deficiencies that, amongst other things, led to the Group entering into DPAs with various US authorities in relation to investigations regarding inadequate compliance with anti-money laundering and sanctions law in December 2012.

A number of measures to address the requirements of the DPAs and otherwise to enhance our anti-money laundering and sanctions compliance framework have been taken and/or are ongoing. These measures, which should also serve over time to enhance our reputational risk management, include the following:

·     simplifying our business through the ongoing implementation of our Group strategy, including the adoption of a global risk filter which should help to standardise our approach to doing business in higher risk countries;

·     a substantial increase in resources and investment allocated to the Compliance function, and its reorganisation into two sub-functions (see 'Compliance risk' above);

·     an increase in dedicated reputational risk resources in each region in which we operate;

·     the continued roll out of training and communication about the HSBC Values programme that defines the way everyone in the Group should act and seeks to ensure that the Values are embedded into our business as usual operations; and

·     the ongoing development and implementation of the Global Standards by which we conduct our businesses. This includes ensuring there is a globally consistent approach to knowing and retaining our customers and enforcing a consistent global sanctions policy.

Detecting and preventing illicit actors' access to the global financial system calls for constant vigilance and HSBC will continue to cooperate closely with all governments to achieve success. This is integral to the execution of HSBC's strategy, to our core values and to preserving and enhancing our reputation.

The reputational risk policies and practices remain unchanged from those reported on page 278 of the Annual Report and Accounts 2012, with the following exception. The Regional Reputational Risk Policy Committees, with the exception of Asia-Pacific, have been demised and their role has been subsumed into Regional Risk Management Committees. Minutes in respect of reputational issues from the regional committees continue to be tabled at Group Reputational Risk Policy Committee.

 

END

 

 

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