Annual Financial Report - 16

RNS Number : 4079J

HSBC Holdings PLC

30 March 2010

Determination of fair value

Fair values are determined according to the following hierarchy:

· Level 1 - quoted market price: financial instruments with quoted prices for identical instruments in active markets.

· Level 2 - valuation technique using observable inputs: financial instruments with quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in inactive markets and financial instruments valued using models where all significant inputs are observable.

· Level 3 - valuation technique with significant unobservable inputs: financial instruments valued using valuation techniques where one or more significant inputs are unobservable.

The best evidence of fair value is a quoted price in an actively traded market. In the event that the market for a financial instrument is not active, a valuation technique is used.

The judgement as to whether a market is active may include, but is not restricted to, the consideration of factors such as the magnitude and frequency of trading activity, the availability of prices and the size of bid/offer spreads. The bid/offer spread represents the difference in prices at which a market participant would be willing to buy compared with the price at which they would be willing to sell. In inactive markets, obtaining assurance that the transaction price provides evidence of fair value or determining the adjustments to transaction prices that are necessary to measure the fair value of the instrument requires additional work during the valuation process.

The majority of valuation techniques employ only observable market data. However, certain financial instruments are valued on the basis of valuation techniques that feature one or more significant market inputs that are unobservable, and for them, the derivation of fair value is more judgemental. An instrument in its entirety is classified as valued using significant unobservable inputs if, in the opinion of management, a significant proportion of the instrument's carrying amount and/or inception profit ('day 1 gain or loss') is driven by unobservable inputs. 'Unobservable' in this context means that there is little or no current market data available from which to determine the price at which an arm's length transaction would be likely to occur. It generally does not mean that there is no market data available at all upon which to base a determination of fair value (consensus pricing data may, for example, be used). Furthermore, in some cases the majority of the fair value derived from a valuation technique with significant unobservable inputs may be attributable to observable inputs. Consequently, the effect of uncertainty in determining unobservable inputs will generally be less than the overall fair value of the financial instrument being measured. To help in understanding the extent and the range of this uncertainty, additional information is provided in the section headed 'Effect of changes in significant unobservable assumptions to reasonably possible alternatives' below.

In certain circumstances, primarily where debt is hedged with interest rate derivatives, HSBC records its own debt in issue at fair value, based on quoted prices in an active market for the specific instrument concerned, if available. When quoted market prices are unavailable, the own debt in issue is valued using valuation techniques, the inputs for which are either based upon quoted prices in an inactive market for the instrument, or are estimated by comparison with quoted prices in an active market for similar instruments. In both cases, the fair value includes the effect of applying the credit spread which is appropriate to HSBC's liabilities. For all issued debt securities, discounted cash flow modelling is used to separate the change in fair value that may be attributed to HSBC's credit spread movements from movements in other market factors such as benchmark interest rates or foreign exchange rates. Specifically, the change in fair value of issued debt securities attributable to the Group's own credit spread is computed as follows: for each security at each reporting date, an externally verifiable price is obtained or a price is derived using credit spreads for similar securities for the same issuer. Then, using discounted cash flow, each security is valued using a LIBOR-based discount curve. The difference in the valuations is attributable to the Group's own credit spread. This methodology is applied consistently across all securities.

Structured notes issued and certain other hybrid instrument liabilities are included within trading liabilities and are measured at fair value. The credit spread applied to these instruments is derived from the spreads at which HSBC issues structured notes. These market spreads are smaller than credit spreads observed for plain vanilla debt or in the credit default swap markets.

Gains and losses arising from changes in the credit spread of liabilities issued by HSBC reverse over the contractual life of the debt, provided that the debt is not repaid at a premium or a discount.

All net positions in non-derivative financial instruments, and all derivative portfolios, are valued at bid or offer prices as appropriate. Long positions are marked at bid prices; short positions are marked at offer prices.

The fair value of a portfolio of financial instruments is calculated as the product of the number of units and its quoted price and no block discounts are applied.

Fair value adjustments

The valuation models applied for 'level 2' and 'level 3' assets incorporate assumptions that HSBC believes would be made by a market participant to establish fair value. Fair value adjustments are adopted when HSBC considers that there are additional factors that would be considered by a market participant that are not incorporated within the valuation model. The magnitude of fair value adjustments depends upon many entity-specific factors, including modelling sophistication, the nature of products traded, and the size and type of risk exposures. For this reason, fair value adjustments may not be comparable across the banking industry.

HSBC classifies fair value adjustments as either 'risk-related' or 'model-related'. They form part of the portfolio fair value and are incorporated within the balance sheet values of the product types to which they have been applied. The majority of these adjustments relate to Global Banking and Markets. The magnitude and types of fair value adjustment adopted by Global Banking and Markets are listed in the following table:

Global Banking and Markets fair value adjustments

	At 31 December
	2009	2008
	US$m	US$m
Type:
Risk-related .........................................................................................................................	2,955	3,796
Bid-offer .........................................................................................................................	528	811
Uncertainty .....................................................................................................................	223	319
Credit risk adjustment ......................................................................................................	2,172	2,658
Other ..............................................................................................................................	32	8

Model-related ......................................................................................................................	457	487
Model limitation .............................................................................................................	391	381
Other ..............................................................................................................................	66	106

Inception profit (Day 1 P&L reserves) ...............................................................................	260	204

Total ..................................................................................................................................	3,672	4,487

The quantum of fair value adjustments has reduced by US$815 million during the year. Movements in the level of fair value adjustments do not necessarily result in the recognition of profits or losses within the income statement. For example, following enhancement of a model to incorporate an additional factor, the model value will have changed and so the fair value adjustment in respect of that factor will no longer be required. Similarly, if a position is unwound at a price inclusive of the fair value adjustment, then the fair value adjustment base will decrease, but no profit or loss will result.

The major movements occurred in the bid-offer and credit risk adjustment categories. The reduction of US$283 million in the bid-offer adjustment in 2009 largely reflected decreasing market bid-offer spreads as the market stabilised following the turmoil seen in the latter part of 2008.

The reduction of US$486 million in the credit risk adjustment in 2009 reflected the release of US$716 million due to the commutation of transactions with monoline insurers, which did not result in any material gain or loss being recognised in the income statement. It also reflected lower OTC derivative counterparty exposures, resulting from the tightening of credit spreads, the steepening of yield curves and the recovery in equity markets during the year, offset by increased probability of counterparty default.

Risk-related adjustments

'Risk-related' adjustments are driven, in part, by the magnitude of HSBC's market or credit risk exposure, and by external market factors, such as the size of market spreads.

Bid-Offer

IAS 39 requires that portfolios are marked at bid or offer, as appropriate. Bid prices represent the price at which a long position could be sold and offer prices represent the price at which a short position could be bought back. Valuation models will typically generate mid market values. The bid-offer adjustment reflects the cost that would be incurred if substantially all residual net portfolio market risks were closed using available hedging instruments or by disposing of or unwinding the actual position.

The majority of the bid-offer adjustment relates to OTC derivative portfolios. For each portfolio, the major risk types are identified. These may include, inter alia, delta (the sensitivity to changes in the price of an underlying), vega (the sensitivity to changes in volatilities) and basis risk (the sensitivity to changes in the spread between two rates). For each risk type, the net portfolio risks are first classified into buckets, and then a bid-offer spread is applied to each risk bucket based upon the market bid-offer spread for the relevant hedging instrument. The granularity of the risk bucketing is determined by reference to several factors, including the actual risk management practice undertaken by HSBC, the granularity of risk bucketing within the risk reporting process, and the extent of correlation between risk buckets. Within a risk type, the bid-offer adjustment for each risk bucket may be aggregated without offset or limited netting may be applied to reflect correlation between buckets. There is no netting applied between risk types or between portfolios that are not managed together for risk management purposes. There is no netting across legal entities.

Uncertainty

Certain model inputs may be less readily determinable from market data, and/or the choice of model itself may be more subjective, with less market evidence available from which to determine general market practice. In these circumstances, there exists a range of possible values that the financial instrument or market parameter may assume and an adjustment may be necessary to reflect the likelihood that in estimating the fair value of the financial instrument, market participants would adopt rather more conservative values for uncertain parameters and/or model assumptions than those used in the valuation model. Uncertainty adjustments are derived by considering the potential range of derivative portfolio valuation given the available market data. The objective of an uncertainty adjustment is to arrive at a fair value that is not overly prudent but rather reflects a level of prudence believed to be consistent with market pricing practice.

Uncertainty adjustments are applied to various types of exotic OTC derivative. For example, the correlation between one or more market rates may be an important component of an exotic derivative value and an uncertainty adjustment may be taken to reflect the range of possible values that market participants may assume for this parameter.

Credit risk adjustment

The credit risk adjustment is an adjustment to the valuation of OTC derivative contracts to reflect within fair value the possibility that the counterparty may default, and HSBC may not receive the full market value of the transactions. The calculation of the credit risk adjustment against monolines is described on page 163, and for all other counterparties on page 170.

Model-related adjustments

These adjustments are primarily related to internal factors, such as the ability of HSBC's models to incorporate all material market characteristics. A description of each adjustment type is given below:

Model limitation

Models used for portfolio valuation purposes, particularly for exotic derivative products, may be based upon a simplifying set of assumptions that do not capture all material market characteristics or may be less reliable under certain market conditions. Additionally, markets evolve, and models that were adequate in the past may require development to capture all material market characteristics in current market conditions. In these circumstances, model limitation adjustments are adopted outside the core valuation model.

The adjustment methodologies vary according to the nature of the model. The Quantitative Risk and Valuation Group, an independent quantitative support function reporting into Finance, highlights the requirement for model limitation adjustments and develops the methodologies employed. Over time, as model development progresses, model limitations are addressed within the core revaluation models and a model limitation adjustment is no longer needed.

Inception profit (Day 1 P&L reserves)

Inception profit adjustments are adopted where the fair value estimated by a valuation the model is based on one or more significant unobservable inputs, in accordance with IAS 39. At trade execution, the adjustment is equal to the inception profit which is the difference between the fair value and the price at which the transaction was undertaken. The balance is amortised to the 'observability boundary' based on the risk profile of the unobservable component. The 'observability boundary' is the point at which during the lifetime of the trade the previously unobservable significant input is expected to become observable, which at the extreme may be the maturity date.

An analysis of the movement in the deferred Day 1 P&L reserve is provided on page 426.

Transaction costs and the future costs of administering the OTC derivative portfolio are not included in the fair value calculation. These, along with trade origination costs such as brokerage fees and post-trade costs, are accounted for as part of either fee expense or operating expenses.

Credit risk adjustment methodology

HSBC adopts a credit risk adjustment (also frequently known as a 'credit valuation adjustment') against OTC derivative transactions to reflect within fair value the possibility that the counterparty may default, and HSBC may not receive the full market value of the transactions. HSBC calculates a separate credit risk adjustment for each HSBC legal entity, and within each entity for each counterparty to which the entity has exposure. The calculation of the monoline credit risk adjustment is described on page 163. The description below relates to the credit risk adjustment taken against counterparties other than monolines, which totalled US$1,009 million at 31 December 2009 (2008: US$1,492 million).

HSBC calculates the credit risk adjustment by applying the probability of default of the counterparty to the expected positive exposure to the counterparty, and multiplying the result by the loss expected in the event of default. The calculation is performed over the life of the potential exposure.

For most products, HSBC uses a simulation methodology to calculate the expected positive exposure. The methodology simulates the range of potential exposures of HSBC to the counterparty over the life of an instrument. The range of exposures is calculated across the portfolio of transactions with a counterparty to arrive at an expected overall exposure. The probability of default assumptions are based upon historic rating transition matrices. The credit rating used for a particular counterparty is that determined by HSBC's internal credit process. Rating transition is taken account of throughout the duration of the exposure. A standard loss given default assumption of 60 per cent is generally adopted. HSBC considers that an appropriate spread to reflect HSBC's own probability of default within the credit risk adjustment calculation is currently zero. Consequently, HSBC does not derive the adjustment on a bilateral basis and has a zero adjustment against derivative liabilities, often referred to as a 'debit valuation adjustment'. The simulation methodology includes credit mitigants such as counterparty netting agreements and collateral agreements with the counterparty.

For certain types of exotic derivatives where the products are not currently supported by the simulation, or for derivative exposures in smaller trading locations where the simulation tool is not yet available, HSBC adopts an alternative methodology. Alternative methodologies used by HSBC fall into two categories. One method maps transactions against the results for similar products which are accommodated by the simulation tool. Where such a mapping approach is not appropriate, a bespoke methodology is used, generally following the same principles as the simulation methodology, reflecting the key characteristics of the instruments but in a manner that is computationally less intensive. The calculation is applied at a trade level, with more limited recognition of credit mitigants such as netting or collateral agreements than used in the simulation methodology described previously.

The methodologies do not, in general, account for 'wrong-way risk'. Wrong-way risk arises where the underlying value of the derivative prior to any credit risk adjustment is related to the probability of default of the counterparty. A more detailed description of wrong-way risk is included on page 208. For particular transactions where there is significant wrong-way risk, a trade specific approach is applied to reflect the wrong-way risk within the valuation.

HSBC includes all third-party counterparties in the credit risk adjustment calculation and HSBC does not net credit risk adjustments across HSBC Group entities.

During 2009, there were no material changes made by HSBC to the methodologies used to calculate the credit risk adjustment.

Consideration of other methodologies for calculation of credit risk adjustments

(Unaudited)

The credit risk adjustment methodology used by HSBC, in the opinion of management, appropriately quantifies the exposure of HSBC to counterparty risk on its OTC derivative portfolio and appropriately reflects the risk management strategy of the business.

HSBC recognises that a variety of credit risk adjustment methodologies are adopted within the banking industry. Some of the key attributes that may differ between these methodologies are:

· the probability of default may be calculated from historical market data, or implied from current market levels for certain transaction types such as credit default swaps, either with or without an adjusting factor;

· some entities derive their own probability of default from a non-zero spread, which has the effect of reducing the overall adjustment;

· differing loss assumptions in setting the level of loss given defaults, which may utilise levels set by regulators for capital calculation purposes; and

· counterparty exclusions, whereby certain counterparty types (for example collateralised counterparties) are excluded from the calculation.

HSBC has estimated the impact of adopting two alternative methodologies on the level of its credit risk adjustment (excluding the monoline credit risk adjustment), as follows:

· adapting HSBC's existing methodology to utilise probabilities of default implied from credit default swaps with no adjustment factor applied and also implying HSBC's own probability of default from credit default swaps, results in an additional adjustment of US$170 million; and

· adapting HSBC's existing methodology to include HSBC's own probability of default from a non-zero spread based on historical data, excluding collateralised counterparties, and applying loss given default assumptions consistent with those used in regulatory capital calculations, results in a reduction of the credit risk adjustment of US$300 million.

A detailed description of the valuation techniques applied to instruments of particular interest follows:

Private equity

HSBC's private equity positions aregenerally classified as available for sale and are not traded in active markets. In the absence of an active market, an investment's fair value is estimated on the basis of an analysis of the investee's financial position and results, risk profile, prospects and other factors, as well as by reference to market valuations for similar entities quoted in an active market, or the price at which similar companies have changed ownership. The exercise of judgement is required because of uncertainties inherent in estimating fair value for private equity investments.

Debt securities, treasury and other eligible bills, and equities

The fair value of these instruments is based on quoted market prices from an exchange, dealer, broker, industry group or pricing service, when available. When they are unavailable, the fair value is determined by reference to quoted market prices for similar instruments, adjusted as appropriate for the specific circumstances of the instruments.

Illiquidity and a lack of transparency in the market for ABSs have resulted in less observable data being available. While quoted market prices are generally used to determine the fair value of these securities, valuation models are used to substantiate the reliability of the limited market data available and to identify whether any adjustments to quoted market prices are required.

In the absence of quoted market prices, fair value is determined using valuation techniques based on the calculation of the present value of expected future cash flows of the assets. The inputs to these valuation techniques are derived from observable market data and, where relevant, assumptions in respect of unobservable inputs. In respect of ABSs including residential MBSs, the valuation uses an industry standard model and the assumptions relating to prepayment speeds, default rates and loss severity based on collateral type, and performance, as appropriate. The valuations output is benchmarked for consistency against observable data for securities of a similar nature.

Derivatives

OTC (i.e. non-exchange traded) derivatives are valued using valuation models. Valuation models calculate the present value of expected future cash flows, based upon 'no-arbitrage' principles. For many vanilla derivative products, such as interest rate swaps and European options, the modelling approaches used are standard across the industry. For more complex derivative products, there may be some differences in market practice. Inputs to valuation models are determined from observable market data wherever possible, including prices available from exchanges, dealers, brokers or providers of consensus pricing. Certain inputs may not be observable in the market directly, but can be determined from observable prices via model calibration procedures. Finally, some inputs are not observable, but can generally be estimated from historical data or other sources. Examples of inputs that are generally observable include foreign exchange spot and forward rates, benchmark interest rate curves and volatility surfaces for commonly traded option products. Examples of inputs that may be unobservable include volatility surfaces, in whole or in part, for less commonly traded option products, and correlations between market factors such as foreign exchange rates, interest rates and equity prices.

Loans, including leveraged loans and loans held for securitisation

Loans held at fair value are valued from broker quotes and/or market data consensus providers when available. In the absence of an observable market, the fair value is determined using valuation techniques. These techniques include discounted cash flow models, which incorporate assumptions regarding an appropriate credit spread for the loan, derived from other market instruments issued by the same or comparable entities.

Structured notes

The fair value of structured notes valued using a valuation technique is derived from the fair value of the underlying debt security as described above, and the fair value of the embedded derivative is determined as described in the paragraph above on derivatives.

Fair value valuation bases

The table below provides an analysis of the various bases described above which have been deployed for valuing financial assets and financial liabilities measured at fair value in the consolidated financial statements.

The movement in the balances of assets and liabilities measured at fair value with significant unobservable inputs was mainly attributable to a decrease in the fair value of derivative assets, loans held for securitisation and the disposal of securities in other portfolios. At 31 December 2009, financial instruments measured at fair value using a valuation technique with significant unobservable inputs represented 2 per cent of total assets and liabilities measured at fair value (2008: 2 per cent).

Bases of valuing financial assets and liabilities measured at fair value

		Valuation techniques
	Quoted market price Level 1	Using observable inputs Level 2	With significant unobservable inputs Level 3		Total
	US$m	US$m		US$m	US$m
At 31 December 2009
Assets
Trading assets .........................................................	272,509	142,452		6,420	421,381
Financial assets designated at fair value ...................	24,184	11,773		1,224	37,181
Derivatives .............................................................	1,961	244,472		4,453	250,886
Financial investments: available for sale .................	163,149	178,168		10,214	351,531

Liabilities
Trading liabilities ....................................................	119,544	139,812		8,774	268,130
Financial liabilities designated at fair value ..............	27,553	52,032		507	80,092
Derivatives .............................................................	1,843	240,611		5,192	247,646

At 31 December 2008
Assets
Trading assets .........................................................	234,399	185,369		7,561	427,329
Financial assets designated at fair value ...................	14,590	13,483		460	28,533
Derivatives .............................................................	8,495	476,498		9,883	494,876
Financial investments: available for sale .................	103,949	173,157		9,116	286,222

Liabilities
Trading liabilities ....................................................	105,584	135,559		6,509	247,652
Financial liabilities designated at fair value ..............	23,311	51,276		-	74,587
Derivatives .............................................................	9,896	473,359		3,805	487,060

Financial instruments measured at fair value using a valuation technique with significant unobservable
inputs - Level 3

	Assets					Liabilities
	Available for sale	Held for trading	Designated at fair value through profit or loss		Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m	US$m		US$m	US$m	US$m		US$m	US$m
At 31 December 2009
Private equity investments ......	2,949	197		345	-	-		-	-
Asset-backed securities ............	4,270	944		-	-	-		-	-
Leveraged finance ...................	-	73		-	-	-		-	25
Loans held for securitisation ...	-	1,395		-	-	-		-	-
Structured notes ......................	-	196		-	-	5,055		-	-
Derivatives with monolines .....	-	-		-	1,305	-		-	-
Other derivatives ....................	-	-		-	3,148	-		-	5,167
Other portfolios ......................	2,995	3,615		879	-	3,719		507	-

	10,214	6,420		1,224	4,453	8,774		507	5,192

At 31 December 2008
Private equity investments ......	2,689	54		225	-	-		-	-
Asset-backed securities ............	4,264	882		-	95	-		-	565
Leveraged finance ...................	-	266		-	-	-		-	33
Loans held for securitisation....	-	2,133		-	-	-		-	-
Structured notes ......................	-	87		-	-	5,294		-	-
Derivatives with monolines .....	-	-		-	2,441	-		-	-
Other derivatives ....................	-	-		-	7,347	-		-	3,207
Other portfolios ......................	2,163	4,139		235	-	1,215		-	-

	9,116	7,561		460	9,883	6,509		-	3,805

At 31 December 2009, available-for-sale ABSs valued using a valuation technique with significant unobservable inputs principally comprised commercial property-related securities, leveraged finance-related securities and Alt-A securities with no particular concentration in any one category. Assets in other portfolios valued using a valuation technique with significant unobservable inputs were principally holdings in an Asian bond portfolio where the credit spreads are not directly observable.

Trading assets valued using a valuation technique with significant unobservable inputs principally comprised ABSs, loans held for securitisation and other portfolios. The ABSs are classified in Level 3 as a result of the unobservability of the underlying price of the assets. Loans held for securitisations are valued using a proprietary model which utilises inputs relating to the credit spread of the obligor. Other portfolios include holdings in various bonds, preference shares and debentures where the unobservability relates to the prices of the underlying securities. The decrease during the year was due to a reduction in the fair value of loans held for securitisation and disposals of positions within other portfolios.

Derivative products with monolines valued using techniques with unobservable inputs decreased during the year as a result of a decrease in exposure to the monoline counterparties, primarily as a result of decreasing credit spreads and from commutations undertaken. The primary unobservable input relates to the probability of default of the counterparty. Further details of the transactions with monoline counterparties are shown on page 163.

Derivative products valued using valuation techniques with significant unobservable inputs included certain correlation products, such as foreign exchange basket options, equity basket options, foreign exchange-interest rate hybrid transactions and long-dated option transactions. Examples of the latter are equity options, interest rate and foreign exchange options and certain credit derivatives. Credit derivatives include certain tranched CDS transactions. The decrease in Level 3 derivative assets during the year was mainly due to a decrease in the fair value of structured credit transactions.

Trading liabilities valued using a valuation technique with significant unobservable inputs principally comprised equity-linked structured notes which are issued by HSBC and provide the counterparty with a return that is linked to the performance of certain equity securities, and other portfolios. The notes are classified as Level 3 due to the unobservability of parameters such as long-dated equity volatilities and correlations between equity prices, between equity prices and interest rates and between interest rates and foreign exchange rates. The movement in Level 3 trading liabilities during the year was primarily due to the issue of new equity derivative linked structures classified in other portfolios, partially offset by transfers out of Level 3 as a result of increased observability of long-dated volatilities.

The increase in derivative liabilities valued using a valuation technique with significant unobservable inputs was primarily attributable to the transfer into Level 3 of swaps linked to securitisation structures whose valuation utilises inputs relating to the prepayment rates for the underlying asset pools which are unobservable. This was partially offset by transfers out of structured interest rate and equity derivatives due to increased observability of long-dated swaptions and equity volatilities.

Reconciliation of fair value measurements in Level 3 of the fair value hierarchy

The following table provides a reconciliation of the movement between opening and closing balances of Level 3 financial instruments, measured at fair value using a valuation technique with significant unobservable inputs:

Movement in Level 3 financial instruments

	Assets					Liabilities
	Available for sale	Held for trading	Designated at fair value through profit or loss		Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m	US$m		US$m	US$m	US$m		US$m	US$m

At 1 January 2009 ..................	9,116	7,561		460	9,883	6,509		-	3,805
Total gains/(losses) recognised in profit or loss ....................	(260)	(730)		97	(5,275)	(107)		(3)	(1,372)
Total gains recognised in other comprehensive income ........	617	85		-	119	301		10	94
Purchases ................................	1,785	1,598		260	-	22		-	-
New issuances ..........................	-	-		-	-	2,522		500	-
Sales ........................................	(806)	(2,166)		(13)	-	-		-	-
Settlements .............................	(1,059)	(295)		(6)	(104)	(1,266)		-	(206)
Transfers out ..........................	(3,043)	(1,077)		-	(1,057)	(537)		-	(620)
Transfers in ............................	3,864	1,444		426	887	1,330		-	3,491

At 31 December 2009 .............	10,214	6,420		1,224	4,453	8,774		507	5,192

Total gains/(losses) recognised in profit or loss relating to those assets and liabilities held on 31 December 2009 ..............	(371)	(596)		98	(3,753)	(136)		(3)	(135)

For available-for-sale securities, the unobservability of valuations of asset-backed (particularly Alt-A and leveraged finance-related) securities and the Asian bond portfolio discussed on page 173 resulted in assets in these categories being transferred or purchased into Level 3 during 2009. Transfers out of Level 3 were primarily in respect of commercial property related ABSs due to certain valuations in these asset categories becoming observable during 2009.

For trading assets, transfers into Level 3 arose principally on ABSs, fixed income securities and a syndicated loan position where valuations for the specific instruments were not observable. Transfers out also related principally to ABSs and fixed income securities as valuations for specific instruments became observable. Purchases relate primarily to the unwind of certain ABS total return swap funding transactions, in which HSBC's market risk position did not change, but securities were purchased in place of the derivative transactions.

For derivative assets, transfers out of Level 3 were driven by decreases in residual maturity of longer-dated equity options to below the observability boundary, movement in equity prices leading to previously out-of-the money or in-the-money options becoming closer to at-the-money options, and some increased observability of long-dated swaption and foreign exchange volatilities. Transfers in were largely driven by the unobservability of prepayment rates on swaps linked to third-party securitisations.

For held-for-trading liabilities, transfers into Level 3 were primarily due to a reduction in the observability of volatilities and gap risk parameters on embedded derivatives within issued structured notes. Transfers out of Level 3 were driven by similar factors as derivative assets, also relating to embedded derivatives within issued structured notes.

For derivative liabilities, the unobservability of prepayment rates on securitisation swaps was the main reason for transfers into Level 3. Transfers out of Level 3 were driven by similar factors as derivative assets.

During 2009, there were no significant transfers between Levels 1 and 2.

For assets and liabilities classified as held for trading, realised and unrealised gains and losses are presented in the income statement under 'Trading income excluding net interest income'.

Fair value changes on long term debt designated at fair value and related derivatives are presented in the income statement under 'Changes in fair value of long-term debt issued and related derivatives'. The income statement line item 'Net income/(expense) from other financial instruments designated at fair value' captures fair value movements on all other financial instruments designated at fair value and related derivatives.

Realised gains and losses from available-for-sale securities are presented under 'Gains less losses of financial investments' in the income statement while unrealised gains and losses are presented in 'Fair value gains/(losses) within 'Available-for-sale investments' in other comprehensive income/ (expense).

Effect of changes in significant unobservable assumptions to reasonably possible alternatives

As discussed above, the fair value of financial instruments are, in certain circumstances, measured using valuation techniques that incorporate assumptions that are not evidenced by prices from observable current market transactions in the same instrument and are not based on observable market data. The following table shows the sensitivity of these fair values to reasonably possible alternative assumptions:

Sensitivity of fair values to reasonably possible alternative assumptions

	Reflected in profit or loss		Reflected in equity
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m
At 31 December 2009
Derivatives, trading assets and trading liabilities²³ .	984	(577)	-	-
Financial assets and liabilities designated at fair value	102	(98)	-	-
Financial investments: available for sale ...............	-	-	1,161	(1,157)

At 31 December 2008
Derivatives, trading assets and trading liabilities²³ .	1,266	(703)	-	-
Financial assets and liabilities designated at fair value	30	(30)	-	-
Financial investments: available for sale ...............	-	-	984	(1,005)

For footnote, see page 195.

The decrease in the effect of changes in significant unobservable inputs in relation to derivatives, trading assets and trading liabilities during the year primarily reflected the decreased sensitivity to the assumptions for the derivative portfolios. The increase in the effect of changes in significant unobservable inputs for available-for-sale assets arose from the increase in private equity holdings in Level 3 and from increased sensitivity to the assumptions for ABSs.

Sensitivity of fair values to reasonably possible alternative assumptions by Level 3 instrument type

	Reflected in profit or loss		Reflected in equity
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m
At 31 December 2009
Private equity investments ...................................	54	(54)	302	(299)
Asset-backed securities .........................................	41	(41)	734	(735)
Leveraged finance ................................................	1	(1)	-	-
Loans held for securitisation ................................	16	(16)	-	-
Structured notes ...................................................	3	(3)	-	-
Derivatives with monolines ..................................	333	(25)	-	-
Other derivatives .................................................	309	(332)	-	-
Other portfolios ...................................................	329	(203)	125	(123)

	Reflected in profit or loss		Reflected in equity
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m
At 31 December 2008 ..........................................
Private equity investments ...................................	28	(28)	234	(261)
Asset-backed securities .........................................	90	(91)	667	(660)
Leveraged finance ................................................	2	(2)	-	-
Loans held for securitisation ................................	41	(41)	-	-
Structured notes ...................................................	8	(8)	-	-
Derivatives with monolines ..................................	341	(250)	-	-
Other derivatives .................................................	652	(224)	-	-
Other portfolios ...................................................	134	(89)	83	(84)

Favourable and unfavourable changes are determined on the basis of changes in the value of the instrument as a result of varying the levels of the unobservable parameters using statistical techniques. When parameters are not amenable to statistical analysis, quantification of uncertainty is judgemental.

When the fair value of a financial instrument is affected by more than one unobservable assumption, the above table reflects the most favourable or most unfavourable change from varying the assumptions individually.

In respect of private equity investments, the valuations are assessed on an asset by asset basis using a valuation methodology appropriate to the specific investment, in line with industry guidelines. In many of the methodologies, the principal assumption is the valuation multiple to be applied to the main financial indicators. This may be determined with reference to multiples for comparable listed companies and includes discounts for marketability.

For ABSs whose prices are unobservable, models are used to generate the expected value of the asset. The principal assumptions in these models are based on benchmark information about prepayment speeds, default rates, loss severities and the historical performance of the underlying assets. The models used are calibrated by using securities for which external market information is available.

For leveraged finance, loans held for securitisation and derivatives with monolines the principal assumption concerns the appropriate value to be attributed to the counterparty credit risk. This requires estimation of exposure at default, probability of default and recovery in the event of default. For loan transactions, assessment of exposure at default is straightforward. For derivative transactions, a future exposure profile is generated on the basis of current market data. Probabilities of default and recovery levels are estimated using market evidence, which may include financial information, historical experience, CDS spreads and consensus recovery levels.

In the absence of such evidence, management's best estimate is used.

For structured notes and other derivatives, principal assumptions concern the value to be attributed to future volatility of asset values and the future correlation between asset values. These principal assumptions include credit volatilities and correlations used in the valuation of structured credit derivatives (including leveraged credit derivatives). For such unobservable assumptions, estimates are based on available market data, which may include the use of a proxy method to derive a volatility or a correlation from comparable assets for which market data is more readily available, and/or an examination of historical levels.

Changes in fair value recorded in the income statement

The following table quantifies the changes in fair values recognised in profit or loss during the year in respect of assets and liabilities held at the end of the year whose fair values are estimated using valuation techniques that incorporate significant assumptions that are not evidenced by prices from observable current market transactions in the same instrument, and are not based on observable market data:

	2009	2008
	US$m	US$m
Recorded profit/(loss) on:
Derivatives, trading assets and trading liabilities ..................	(4,620)	779
Financial assets and liabilities designated at fair value .........	95	109

The loss during the year included changes in the fair value of monoline and CDPC-related credit derivatives which use a valuation technique with significant unobservable inputs. Additionally, there was a decline in the fair value of other structured credit derivatives attributable to the tightening of credit spreads during the year.

In general, many Level 3 instruments are risk managed using derivatives which employ a valuation technique with observable inputs. However, the associated gains on these derivatives in the year are not reflected in the table above. The table details the total change in fair value of these instruments; it does not isolate the component attributable to unobservable inputs.

HSBC Holdings

The following table provides an analysis of the basis for valuing financial assets and financial liabilities measured at fair value in the financial statements:

Bases of valuing HSBC Holdings' financial assets and liabilities measured at fair value

		Valuation techniques
	Quoted market price	Using observable inputs	With significant unobservable inputs
	Level 1	Level 2		Level 3	Total
	US$m	US$m		US$m	US$m
At 31 December 2009
Assets
Derivatives .......................................................	-	2,981		-	2,981
Financial investments: available for sale ...........	-	-		2,455	2,455

Liabilities
Financial liabilities designated at fair value ........	12,549	4,360		-	16,909
Derivatives .......................................................	-	362		-	362

At 31 December 2008
Assets
Derivatives .......................................................	-	3,682		-	3,682
Financial investments: available for sale ...........	-	-		2,629	2,629

Liabilities
Financial liabilities designated at fair value ........	13,321	3,068		-	16,389
Derivatives .......................................................	-	1,324		-	1,324

Financial investments measured using a valuation technique with significant unobservable inputs comprise fixed-rate preferred securities and senior notes purchased from HSBC undertakings. The unobservable elements of the valuation technique include the use of implied credit spreads and simplified bond pricing assumptions.

	Assets available for sale
	US$m

At 1 January 2009 ...............................	2,629
Total gains or losses:
- recognised in profit or loss ...........	(2)
- recognised in other comprehensive income ......................................	103
Settlements ..........................................	(275)

At 31 December 2009 .........................	2,455

Total gains or losses recognised in profit or loss relating to those assets and liabilities held on 31 December 2009	(2)

Effect of changes in significant unobservable assumptions to reasonably possible alternatives

In certain circumstances, the fair value of financial instruments are measured using valuation models that incorporate assumptions that are not supported by prices from observable current market transactions in the same instrument and are not based on observable market data. The following table shows the sensitivity of non-derivative financial instruments to reasonably possible alternative assumptions:

	Reflected in equity
	Favourable changes	Unfavourable changes
	US$m	US$m
Financial investments available for sale

At 31 December 2009	115	(107)
At 31 December 2008 .	113	(97)

Assessing available-for-sale assets for impairment

HSBC's policy on impairment of available-for-sale assets is described on page 375. The following is a description of HSBC's application of that policy.

A systematic impairment review is carried out periodically of all available-for-sale assets, and all available indicators are considered to determine whether there is any objective evidence that an impairment may have occurred, whether as the result of a single loss event or as the combined effect of several events.

Debt securities

When assessing available-for-sale debt securities for objective evidence of impairment at the balance sheet date, HSBC considers all available evidence, including observable data or information about events specifically relating to the securities which may result in a shortfall in recovery of future cash flows. These events may include a significant financial difficulty of the issuer, a breach of contract such as a default, bankruptcy or other financial reorganisation, or the disappearance of an active market for the debt security because of financial difficulties relating to the issuer.

These types of specific events and other factors such as information about the issuers' liquidity, business and financial risk exposures, levels of and trends in default for similar financial assets, national and local economic trends and conditions, and the fair value of collateral and guarantees may be considered individually, or in combination, to determine if there is objective evidence of impairment of a debt security.

In addition, when assessing available-for-sale ABSs for objective evidence of impairment, HSBC considers the performance of underlying collateral and the extent and depth of market price declines. Changes in credit ratings are considered but a downgrade of a security's credit rating is not, of itself, evidence of impairment. The primary indicators of potential impairment are considered to be adverse fair value movements, and the disappearance of an active market for the securities.

At 31 December 2009, the population of available-for-sale ABSs identified as being most at risk of impairment included residential MBSs backed by sub-prime and Alt-A mortgages originated in the US, commercial MBSs orginated in the US and Europe and CDOs with considerable exposure to these sectors. The estimated future cash flows of these securities are assessed to determine whether any of their cash flows are unlikely to be recovered as a result of events occurring on or before the balance sheet date.

In particular, for residential and commercial MBSs the estimated future cash flows are assessed by determining the future projected cash flows arising on the underlying collateral taking into consideration the delinquency status of underlying loans, the probability of delinquent loans progressing to default, the proportion of the advances subsequently recoverable and the prepayment profiles of the underlying assets. Management uses externally available data and applies judgement when determining the appropriate assumptions in respect of these factors. HSBC uses a modelling approach which incorporates historically observed progression rates to default, to determine if the decline in aggregate projected cash flows from the underlying collateral will lead to a shortfall in contractual cash flows. In such cases the security is considered to be impaired.

In respect of CDOs, in order to determine whether impairment has occurred, the expected future cash flows of the CDOs are compared with the total of the underlying collateral on the non-defaulted assets and the recovery value of the defaulted assets. In the event of a shortfall, the CDO is considered to be impaired.

When a security benefits from a contract provided by a monoline insurer that insures payments of principal and interest, the expected recovery on the contract is assessed in determining the total expected credit support available to the ABS.

Equity securities

Objective evidence of impairment for available-for‑sale equity securities may include specific information about the issuer as detailed above, but may also include information about significant changes in technology, markets, economics or the law that provides evidence that the cost of the equity securities may not be recovered.

A significant or prolonged decline in the fair value of the asset below its cost is also objective evidence of impairment. In assessing whether it is significant, the decline in fair value is evaluated against the original cost of the asset at initial recognition. In assessing whether it is prolonged, the decline is evaluated against the period in which the fair value of the asset has been below its original cost at initial recognition.

For impairment losses on available-for-sale equity and debt securities, see pages 31 and 35, respectively. Any impairment losses relating to ABSs recognised in the income statement are recorded as 'Loan impairment charges and other credit risk provisions'. Impairment losses incurred on assets held by consolidated securities investment conduits (excluding Solitaire) are offset by a credit to the impairment line for the amount of the loss borne by capital note holders.

Fair values of financial instruments not carried at fair value

Financial instruments that are not carried at fair value on the balance sheet include loans and advances to banks and customers, deposits by banks, customer accounts, debt securities in issue and subordinated liabilities. Their fair values are, however, provided for information by way of note disclosure and are calculated as described below.

The calculation of fair value incorporates HSBC's estimate of the amount at which financial assets could be exchanged, or financial liabilities settled, between knowledgeable, willing parties in an arm's length transaction. It does not reflect the economic benefits and costs that HSBC expects to flow from the instruments' cash flows over their expected future lives. Other reporting entities may use different valuation methodologies and assumptions in determining fair values for which no observable market prices are available, so comparisons of fair values between entities may not be meaningful and users are advised to exercise caution when using this data.

As a consequence of the market turmoil there has been a significant reduction in the secondary market demand for US consumer lending assets. Uncertainty over the extent and timing of future credit losses, together with a near absence of liquidity for non-prime ABSs and loans, continued to be reflected in a low volume of bid prices at 31 December 2009. It is not possible from the indicative market prices that are available to distinguish between the relative discount to nominal value within the fair value measurement that reflects cash flow impairment due to expected losses to maturity, and the discount that the market is demanding for holding an illiquid asset. Under impairment accounting for loans and advances, there is no requirement to adjust the carrying value to reflect illiquidity as HSBC's intention is to fund assets until the earlier of prepayment, charge-off or repayment on maturity. The fair value, by contrast, reflects both incurred loss and loss expected through the life of the asset, a discount for illiquidity and a credit spread which reflects the market's current risk preferences. This usually differs from the credit spread applicable in the market at the time the loan was underwritten and funded.

The estimated fair values at 31 December 2009 and 31 December 2008 of loans and advances to customers in North America reflected the combined effect of these conditions. As a result, the fair values are substantially lower than the carrying amount of customer loans held on-balance sheet and lower than would otherwise be reported under more normal market conditions. Accordingly, the fair values reported do not reflect HSBC's estimate of the underlying long-term value of the assets. Fair values at the balance sheet date of the assets and liabilities set out below are estimated for the purpose of disclosure as follows:

· Loans and advances to banks and customers

The fair value of loans and advances is based on observable market transactions, where available. In the absence of observable market transactions, fair value is estimated using discounted cash flow models. Performing loans are grouped, as far as possible, into homogeneous pools segregated by maturity and coupon rates. In general, contractual cash flows are discounted using HSBC's estimate of the discount rate that a market participant would use in valuing instruments with similar maturity, re‑pricing and credit risk characteristics.

The fair value of a loan portfolio reflects both loan impairments at the balance sheet date and estimates of market participants' expectations of credit losses over the life of the loans. For impaired loans, fair value is estimated by discounting the future cash flows over the time period they are expected to be recovered.

· Financial investments

The fair values of listed financial investments are determined using bid market prices. The fair values of unlisted financial investments are determined using valuation techniques that take into consideration the prices and future earnings streams of equivalent quoted securities.

· Deposits by banks and customer accounts

For the purpose of estimating fair value, deposits by banks and customer accounts are grouped by remaining contractual maturity. Fair values are estimated using discounted cash flows, applying current rates offered for deposits of similar remaining maturities. The fair value of a deposit repayable on demand is assumed to be the amount payable on demand at the balance sheet date.

· Debt securities in issue and subordinated liabilities

Fair values are determined using quoted market prices at the balance sheet date where available, or by reference to quoted market prices for similar instruments.

The fair values in this note are stated at a specific date and may be significantly different fromthe amounts which will actually be paid on the maturity or settlement dates of the instruments. In many cases, it would not be possible to realise immediately the estimated fair values given the size of the portfolios measured. Accordingly, these fair values do not represent the value of these financial instruments to HSBC as a going concern.

For all classes of financial instruments, fair value represents the product of the value of a single instrument, multiplied by the number of instruments held. No block discount or premium adjustments are made. The fair values of intangible assets related to the businesses which originate and hold the financial

instruments subject to fair value measurement, such as values placed on portfolios of core deposits, credit card and customer relationships, are not included in the above because they are not classified as financial instruments. Accordingly, an aggregation of fair value measurements does not approximate to the value of the organisation as a going concern.

The following is a list of financial instruments whose carrying amount is a reasonable approximation of fair value because, for example, they are short-term in nature or reprice to current market rates frequently:

Assets

Cash and balances at central banks

Items in the course of collection from other banks

Hong Kong Government certificates of indebtedness

Endorsements and acceptances

Short-term receivables within 'Other assets'

Accrued income

Liabilities

Hong Kong currency notes in circulation

Items in the course of transmission to other banks

Investment contracts with discretionary participation features within 'Liabilities under insurance contracts'

Endorsements and acceptances

Short-term payables within 'Other liabilities'

Accruals

Fair values of financial instruments which are not carried at fair value on the balance sheet

	At 31 December 2009		At 31 December 2008
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Assets
Loans and advances to banks ............................................................	179,781	179,658	153,766	153,363
Loans and advances to customers .....................................................	896,231	855,780	932,868	876,239
Financial investments: debt securities ...............................................	17,526	18,097	14,013	15,057
Financial investments: treasury and other eligible bills ......................	101	101	-	-

Liabilities
Deposits by banks ............................................................................	124,872	124,856	130,084	130,129
Customer accounts ...........................................................................	1,159,034	1,160,036	1,115,327	1,115,291
Debt securities in issue ......................................................................	146,896	145,888	179,693	170,599
Subordinated liabilities ......................................................................	30,478	30,307	29,433	28,381

Fair values of financial instruments held for sale which are not carried at fair value on the balance sheet

	At 31 December 2009		At 31 December 2008
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Assets classified as held for sale
Loans and advances to banks and customers .....................................	1,356	1,316	11	11
Financial investments: debt securities ...............................................	-	-	37	37

Analysis of loans and advances to customers by geographical segment

	At 31 December 2009		At 31 December 2008
	Carrying amount	Fair Value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Loans and advances to customers
Europe .............................................................................................	439,481	431,158	426,191	417,256
Hong Kong ......................................................................................	99,381	99,694	100,220	100,490
Rest of Asia-Pacific²⁴ .......................................................................	80,043	79,972	80,661	77,391
Middle East²⁴ ...................................................................................	22,844	22,538	27,295	27,296
North America²⁵ ..............................................................................	206,853	174,957	256,214	211,346
Latin America ..................................................................................	47,629	47,461	42,287	42,460

	896,231	855,780	932,868	876,239

For footnotes, see page 195.

HSBC Holdings

The methods used by HSBC Holdings to determine fair values of financial instruments for the purpose of measurement and disclosure are described above.

The following table provides an analysis of the fair value of financial instruments not carried at fair value on the balance sheet:

Fair values of HSBC Holdings' financial instruments not carried at fair value on the balance sheet

	2009		2008
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Assets
Loans and advances to HSBC undertakings ..............	23,212	23,871	11,804	12,670

Liabilities
Amounts owed to HSBC undertakings .....................	3,711	3,827	4,042	4,218
Debt securities in issue ............................................	2,839	3,141	-	-
Subordinated liabilities .............................................	14,406	15,666	14,017	13,940

Special purpose entities

This section contains disclosures about HSBC-sponsored SPEs that are included in HSBC's consolidated balance sheet, with a particular focus on SPEs containing exposures affected by the turmoil in credit markets which began in mid-2007, and those that are not consolidated by HSBC under IFRSs. In addition to the disclosures about SPEs, information on other off-balance sheet arrangements has been included in this section.

HSBC enters into certain transactions with customers in the ordinary course of business which involve the establishment of SPEs to facilitate or secure customer transactions.

HSBC structures that utilise SPEs are authorised centrally when they are established to ensure appropriate purpose and governance. The activities of SPEs administered by HSBC are closely monitored by senior management. HSBC's involvement with SPE transactions is described below.

HSBC-sponsored SPEs

HSBC sponsors the formation of entities which are designed to accomplish certain narrow and well-defined objectives, such as securitising financial assets or effecting a lease, and this requires a form of legal structure that restricts the assets and liabilities within the structure to the single purpose for which it was established. HSBC consolidates these SPEs when the substance of the relationship indicates that HSBC controls them. In assessing control, all relevant factors are considered, including qualitative and quantitative aspects. For example:

Qualitative factors - in substance:

· the activities of the SPE are being conducted on behalf of HSBC according to HSBC's specific business needs so that it obtains benefit from the SPE's operation. This might be evidenced, for example, by HSBC providing a significant level of support to the SPE; and

· HSBC has the decision-making powers to obtain the majority of the benefits of the activities of the SPE.

Quantitative factors - hereinafter referred to as 'the majority of risks and rewards of ownership'. In substance:

· HSBC has rights to obtain the majority of the benefits of the SPE and therefore may be exposed to risks incidental to the activities of the SPE; and

· HSBC retains the majority of the residual or ownership risks related to the SPE or its assets in order to obtain benefits from its activities.

In a number of cases, these SPEs are accounted for off-balance sheet under IFRSs where HSBC does not have the majority of the risks and rewards of ownership of the SPE. However, in certain circumstances and after careful consideration of the facts, HSBC consolidates an SPE when the qualitative features of its involvement indicate that, in substance, the activities of the SPE are being conducted on behalf of HSBC, even though HSBC does not obtain the majority of risks and rewards of ownership.

HSBC reassesses the required consolidation accounting tests whenever there is a change in the substance of the relationship between HSBC and an SPE, for example, when the nature of HSBC's involvement or the governing rules, contractual arrangements or capital structure of the SPE change. The most significant categories of SPEs are discussed in more detail below.

Structured investment vehicles and conduits

Structured investment vehicles

Structured investment vehicles ('SIV's) are SPEs which invest in diversified portfolios of interest-earning assets, generally funded through issues of commercial paper ('CP'), medium-term notes ('MTN's) and other senior debt to take advantage of the spread differentials between the assets in the SIV and the funding cost. Prior to the implementation of Basel II, it was capital efficient to many bank investors to invest in highly-rated investment securities in this way. HSBC sponsored the establishment of two SIVs, Cullinan Finance Limited ('Cullinan') and Asscher Finance Limited ('Asscher') which are now in the process of voluntary liquidation following completion of the transfer of their portfolios of investment securities and derivatives to the three new structured investment conduits ('SIC's) established in 2008 in order to remove the risk of having to make forced asset sales. Mazarin Funding Limited ('Mazarin'), an asset-backed CP conduit, and Barion Funding Limited ('Barion'), a term-funding vehicle, were set up in respect of Cullinan; and Malachite Funding Limited ('Malachite'), a term-funding vehicle, was set up in respect of Asscher. Cullinan and Asscher retain only residual cash balances to facilitate the voluntary liquidation process.

At 31 December 2009, all the capital notes in Cullinan and Asscher had been redeemed and replaced by capital notes in the new SICs (2008: 8.7 per cent of Asscher's capital notes remained outstanding).

Conduits

HSBC sponsors and manages two types of conduits which issue CP: multi-seller conduits and SICs. HSBC has consolidated these conduits from inception because it is exposed to the majority of risks and rewards of ownership.

Securities investment conduits

Solitaire, HSBC's principal securities investment conduit, purchases highly rated ABSs to facilitate tailored investment opportunities. HSBC's other SICs, Mazarin, Barion and Malachite, evolved from the restructuring of HSBC's sponsored SIVs as discussed above.

Multi-seller conduits

These vehicles were established for the purpose of providing access to flexible market-based sources of finance for HSBC's clients, for example, to finance discrete pools of third-party originated trade and vehicle finance loan receivables. HSBC's principal multi-seller conduits are Regency Assets Limited ('Regency'), Bryant Park Funding Limited LLC ('Bryant Park'), Abington Square Funding LLC ('Abington Square', inactive since March 2008) and Performance Trust.

The multi-seller conduits purchase or fund interests in diversified pools of third-party assets financed by issuing CP or drawing advances from HSBC. The cash flows received by the conduits from the third-party assets are used to service the funding and provide a commercial rate of return for HSBC for structuring, for various other administrative services, and for the liquidity and credit support it gives to the conduits. The asset pools acquired by the conduits are structured so that the credit enhancement the conduits receive, which equates to senior investment grade ratings, and the benefit of liquidity facilities typically provided by HSBC mean that the CP issued by the multi-seller conduits is itself highly rated.

Ratings analysis of assets held by HSBC's SIVs and conduits

	Solitaire	Other SICs	Total SICs	Total multi-seller conduits	Total SICs	Total SIVs
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
S&P ratings at 31 December 2009
AAA ....................................................	5.2	6.7	11.9	6.2		-
AA .......................................................	3.0	4.1	7.1	1.3		-
A .........................................................	0.8	6.0	6.8	1.8		-
BBB .....................................................	0.7	0.8	1.5	0.5		-
BB .......................................................	0.2	0.3	0.5	0.5		-
B ..........................................................	0.4	0.3	0.7	-		-
CCC .....................................................	1.0	1.0	2.0	-		-
CC .......................................................	0.3	0.4	0.7	-		-
D .........................................................	0.1	0.1	0.2	-		-

Total investments ..................................	11.7	19.7	31.4	10.3		-
Cash and other investments ....................	1.1	0.3	1.4	0.6		-

	12.8	20.0	32.8	10.9		-

S&P ratings at 31 December 2008
AAA ....................................................	8.1	12.0	20.1	6.1	20.1	0.3
AA .......................................................	0.7	1.4	2.1	1.8	2.1	-
A .........................................................	1.0	4.7	5.7	1.6	5.7	-
BBB .....................................................	0.8	1.0	1.8	1.2	1.8	-
BB .......................................................	0.3	0.4	0.7	0.2	0.7	-
B ..........................................................	0.1	0.2	0.3	0.5	0.3	-
CCC .....................................................	0.2	0.2	0.4	1.8	0.4	-
D .........................................................	-	-	-	0.3	0.0	-

Total investments ..................................	11.2	19.9	31.1	13.5	31.1	0.3
Cash and other investments ....................	0.9	0.3	1.2	0.4	1.2	0.1

	12.1	20.2	32.3	13.9	32.3	0.4

The migration to lower ratings during 2009 is a result of the performance of the underlying assets being outside the expectations established at inception of the original securitisations, and changes to the ratings methodology of the principal rating agencies.

At 31 December 2009, 6.8 per cent of the SICs' exposures to sub-prime and US Alt-A mortgages, which in aggregate amounted to US$0.4 billion, remained AAA rated (2008: 62.7 per cent, US$4.2 billion), while 30.5 per cent, which in aggregate amounted to US$1.8 billion, remained investment grade (2008: 94 per cent, US$6.3 billion).

It should be noted that securities purchased by SICs typically benefit from substantial transaction-specific credit enhancements such as subordinated tranches and/or excess spread, which absorb any credit losses before they fall on the tranche held by the SPE.

At 31 December 2009, the SIVs did not hold any CP issued by SICs set up by HSBC (2008: US$0.3 billion). As described above, by 31 December 2008 all the original assets held by the SIVs had been transferred to the new SICs, with the exception of residual cash balances.

Weighted average life of portfolios

	Solitaire	Other SICs	Total SICs	Total multi-seller conduits	Total SICs	Total SIVs
Weighted average life (years)

At 31 December 2009 .............	6.3	4.1	4.9	2.4		-
At 31 December 2008 ...............	5.8	3.9	4.6	1.6		-

Composition of asset portfolio

	Solitaire	Other SICs	Total SICs	Total multi-seller conduits²⁶	Total SICs	Total SIVs
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
Asset class at 31 December 2009
Structured finance
Vehicle loans and equipment leases .......................................	-	-	-	3.0		-
Consumer receivables .................	-	-	-	0.8		-
Credit card receivables ...............	0.2	-	0.2	1.3		-
Residential MBSs .......................	3.8	4.6	8.4	0.3		-
Commercial MBSs .....................	2.4	3.3	5.7	0.2		-
Auto floor plan ..........................	-	-	-	0.5		-
Trade receivables .......................	-	-	-	2.8		-
Student loan securities ................	2.3	1.8	4.1	-		-
Vehicle finance loan securities ...	0.1	0.2	0.3	-		-
Leverage loan securities .............	1.9	2.3	4.2	-		-
Other ABSs ................................	1.0	1.8	2.8	1.2		-

	11.7	14.0	25.7	10.1		-

Finance
Commercial bank securities and deposits ...................................	0.1	4.8	4.9	0.6		-
Investment bank debt securities .	-	0.8	0.8	-		-
Finance company debt securities	-	0.2	0.2	0.2		-
Other assets ...............................	1.0	0.2	1.2	-		-

	1.1	6.0	7.1	0.8		-

	12.8	20.0	32.8	10.9		-

Sub-prime mortgages ....................	0.7	1.5	2.2	-		-
US Alt-A ......................................	1.9	1.8	3.7	-		-

	2.6	3.3	5.9	-		-

Asset class at 31 December 2008
Structured finance
Vehicle loans and equipment leases .......................................	-	-	-	3.9		-
Consumer receivables .................	-	-	-	0.7		-
Credit card receivables ...............	0.2	-	0.2	1.4		-
Residential MBSs .......................	4.4	5.7	10.1	0.6		-
Commercial MBSs .....................	2.1	3.1	5.2	0.2		-
Auto floor plan ..........................	-	-	-	2.2		-
Trade receivables .......................	-	-	-	2.7		-
Student loan securities ................	2.2	2.0	4.2	-		-
Vehicle finance loan securities ...	-	0.3	0.3	-		-
Leverage loan securities .............	1.5	2.2	3.7	-		-
Other ABSs ................................	0.8	1.3	2.1	1.7		-

	11.2	14.6	25.8	13.4		-

Finance
Commercial bank securities and deposits ...................................	-	4.4	4.4	0.4		-
Investment bank debt securities .	-	0.5	0.5	-		-
Finance company debt securities	-	0.4	0.4	-		0.3
Other assets ...............................	0.9	0.3	1.2	0.1		0.1

	0.9	5.6	6.5	0.5		0.4

	12.1	20.2	32.3	13.9		0.4

Sub-prime mortgages ....................	0.9	1.3	2.2	-		-
US Alt-A ......................................	2.3	2.2	4.5	-		-

	3.2	3.5	6.7	-		-

For footnote, see page 195.

Asset analysis by geographical origination for multi-seller conduits²⁷

	At 31 December
	2009	2008
	US$bn	US$bn

Europe ...................................................................................................................................	6.1	7.5
Rest of Asia-Pacific ...............................................................................................................	0.6	0.9
North America ......................................................................................................................	4.2	5.5

	10.9	13.9

For footnote, see page 195.

Total assets by balance sheet classification

	Solitaire	Other SICs	Total SICs	Total multi-seller conduits	Total SICs	Total SIVs
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
At 31 December 2009
Financial instruments designated at fair value .................................	0.1	-	0.1	-		-
Loans and advances to banks .....	-	-	-	0.3		-
Loans and advances to customers ................................................	-	-	-	10.3		-
Financial investments ................	11.6	19.8	31.4	-		-
Other assets ...............................	1.1	0.2	1.3	0.3		-

	12.8	20.0	32.8	10.9		-

At 31 December 2008
Financial instruments designated at fair value .................................	0.1	-	0.1	-		-
Derivative assets ........................	-	0.2	0.2	0.1		-
Loans and advances to banks .....	-	0.1	0.1	-		0.1
Loans and advances to customers ................................................	-	-	-	13.4		-
Financial investments ................	11.1	19.9	31.0	-		0.3
Other assets ...............................	0.9	-	0.9	0.4		-

	12.1	20.2	32.3	13.9		0.4

Funding structure

	Solitaire			Other SICs			Total SICs			Total multi-seller conduits			Total SIVs
	Total	Provided by HSBC		Total	Provided by HSBC		Total	Provided by HSBC		Total	Provided by HSBC		Total	Provided by HSBC
	US$bn		US$bn	US$bn		US$bn	US$bn		US$bn	US$bn		US$bn	US$bn		US$bn
At 31 December 2009
Capital notes .............	-		-	0.7		-	0.7		-	-		-	-		-
Drawn liquidity facility ................................	7.6		7.6	-		-	7.6		7.6	-		-	-		-
Commercial paper .....	10.8		0.7	10.1		10.1	20.9		10.8	10.3		-	-		-
Medium-term notes ...	-		-	3.8		3.8	3.8		3.8	-		-	-		-
Term repos executed .	-		-	10.2		10.2	10.2		10.2	-		-	-		-

	18.4		8.3	24.8		24.1	43.2		32.4	10.3		-	-		-

At 31 December 2008
Capital notes .............	-		-	0.9		-	0.9		-	-		-	-		-
Drawn liquidity facility ................................	2.4		2.4	-		-	2.4		2.4	-		-	-		-
Commercial paper .....	17.2		8.3	10.5		10.4	27.7		18.7	12.9		2.1	-		-
Medium-term notes ...	-		-	3.4		3.4	3.4		3.4	-		-	0.1		-
Term repos executed .	0.8		0.8	13.3		13.3	14.1		14.1	-		-	-		-

	20.4		11.5	28.1		27.1	48.5		38.6	12.9		2.1	0.1		-

Weighted average life of the funding liabilities

	Solitaire	Other SICs	Total SICs	Total multi-seller conduits	Total SICs	Total SIVs
	Years	Years	Years	Years	US$bn	Years
At 31 December 2009
CP funding ................................	0.2	0.1	0.1	0.1		n/a
MTN funding ............................	-	10.3	10.3	-		n/a

At 31 December 2008
CP funding ................................	0.1	0.2	0.1	0.1		n/a
MTN funding ............................	n/a	7.3	7.3	n/a		0.1

The majority of CP and MTN funding issued by the SIVs was repaid in full during 2008 using the proceeds from the asset sales to the new SICs. The CP and MTNs matured in early 2009.

HSBC's maximum exposure

Conduits

Mazarin

· HSBC is exposed to the par value of Mazarin's assets through the provision of a liquidity facility equal to the lesser of the amortised cost of issued senior debt and the amortised cost of non-defaulted assets. At 31 December 2009, HSBC's exposure amounted to US$13.6 billion (2008: US$15.5 billion). First loss protection is provided through the capital notes issued by Mazarin, which are substantially all held by third parties.

· In addition, at 31 December 2009, HSBC held 1.3 per cent of Mazarin's capital notes (2008: 1.3 per cent), which have a par value of US$17 million (2008: US$17 million), and a carrying amount of US$0.6 million (2008: US$0.6 million).

Barion and Malachite

· These SICs are term funded by HSBC, consequently HSBC's primary exposure to them is represented by the amortised cost of the debt required to support the non-cash assets of the vehicles. At 31 December 2009 this amounted to US$10.5 billion (2008: US$11.7 billion).

· First loss protection is provided through the capital notes issued by these vehicles, which are substantially all held by third parties.

· In addition, at 31 December 2009, HSBC held 3.76 per cent (2008: 3.53 per cent) of the capital notes issued by these vehicles which have a par value of US$37 million (2008: US$35 million), and a carrying amount of US$2.0 million (2008: US$1.3 million).

Solitaire

· CP issued by Solitaire benefits from a 100 per cent liquidity facility provided by HSBC. First loss credit protection against CP-funded securities, after any transaction-specific credit enhancement (as described on page 155) and retained reserves, is provided by HSBC in the form of letters of credit with a combined notional value of US$1.2 billion at 31 December 2009 (2008: US$1.2 billion).

· At 31 December 2009, US$7.6 billion of Solitaire's assets were funded by the draw-down of the liquidity facility (2008: US$2.4 billion). HSBC is exposed to credit losses on the drawn amounts.

· HSBC's maximum exposure to Solitaire is limited to the amortised cost of non-cash equivalent assets, which represents the risk that HSBC may be required to fund the vehicle in the event the debt is redeemed without reinvestment from third parties.

· HSBC's maximum exposure at 31 December 2009 amounted to US$18.4 billion (2008: US$20.4 billion).

Multi-seller conduits

· HSBC provides transaction-specific liquidity facilities to each of its multi-seller conduits, designed to be drawn in order to ensure the repayment of the CP issued. At 31 December 2009, the committed liquidity facilities amounted to US$14.4 billion (2008: US$17.1 billion).

· First loss protection is provided through transaction-specific credit enhancements, for example, over-collateralisation and excess spread. These credit enhancements are provided by the originator of the assets and not by HSBC. In addition, a layer of secondary loss protection is provided by HSBC in the form of programme-wide enhancement facilities, and at 31 December 2009 this amounted to US$0.6 billion (2008: US$0.6 billion). HSBC's maximum exposure is equal to the transaction-specific liquidity facilities offered to the multi-seller conduits, as described above.

· The liquidity facilities are set to support total commitments and therefore exceed the funded assets at both 31 December 2009 and 31 December 2008.

· In consideration of the significant first loss protection afforded by the structure, the credit enhancements and a range of indemnities provided by the various obligors, HSBC carries only a minimal risk of loss from the programme.

Structured investment vehicles

· Cullinan and Asscher's only assets are cash equivalents with liabilities to the extent of the liquidation costs and cash balances due to Mazarin, Barion and Malachite. These remain HSBC's only residual exposure in respect of the SIVs (2008: Cullinan held Mazarin CP amounting to US$0.3 billion).

Money market funds

HSBC has established and manages a number of money market funds which provide customers with tailored investment opportunities with a set of narrow and well-defined objectives. In most cases, they are not consolidated by HSBC because the Group's holdings in them are not of sufficient size to represent the majority of the risks and rewards of ownership.

Investors in money market funds generally have no recourse other than to the assets in the funds, so asset holdings are designed to meet expected fund liabilities. Usually, money market funds are constrained in their operations should the value of their assets and their ratings fall below predetermined thresholds. The risks to HSBC are, therefore, contingent, arising from the reputational damage which could occur if an HSBC-sponsored money market fund was thought to be unable to meet withdrawal requests on a timely basis or in full.

In aggregate, HSBC has established money market funds with total assets of US$99 billion at 31 December 2009 (2008: US$102.7 billion).

The main sub-categories of money market funds are:

· US$73.6 billion (2008: US$72.0 billion) in Constant Net Asset Value ('CNAV') funds, which invest in shorter-dated and highly-rated money market securities with the objective of providing investors with a highly liquid and secure investment;

· US$0.7 billion (2008: US$2.7 billion) in French domiciled dynamique ('dynamic') funds and Irish 'enhanced' funds, together Enhanced Variable Net Asset Value ('Enhanced VNAV') funds, which invest in longer-dated money market securities to provide investors with a higher return than traditional money market funds; and

· US$24.7 billion (2008: US$28.0 billion) in various other money market Variable Net Asset Value ('VNAV') funds, including funds domiciled in Brazil, France, India and Mexico.

These money market funds invest in diverse portfolios of highly-rated debt instruments, and historically included limited holdings in instruments issued by SIVs. At 31 December 2009, these funds had no exposure to instruments issued by SIVs (2008: US$0.5 billion).

Constant Net Asset Value funds

During 2008, action was taken by HSBC in respect of the CNAV funds to maintain their AAA rating and mitigate any forced sale of liquid assets to meet potential redemptions. As a consequence, HSBC incurred losses totalling US$114 million in 2008.

As a result of this action, HSBC concluded that the relationship with these CNAV funds had substantively changed, so HSBC consolidated them from 30 September 2008. It was not necessary for any further action to be taken by HSBC in 2009 in respect of maintaining the rating of the CNAV funds.

Total assets of HSBC's CNAV funds which are on‑balance sheet

	At 31 December
	2009	2008	2008
	US$bn	2008	US$bn

ABSs ............................	0.3		0.8
Certificates of deposit ..	16.6		13.0
CP ...............................	12.0		13.5
Asset-backed CP ..........	4.6		4.6
Floating rate notes .......	-		5.2
Government agency bonds ...........................	6.6		1.9
Other assets .................	2.3		4.8

Total ...........................	42.4		43.8

The associated liabilities included on HSBC's balance sheet at 31 December 2009 amounted to US$41.5 billion (2008: US$43.1 billion) and are shown in 'Other liabilities'. The associated interest

income from the funds and the expense payable to third-party holders of units in the funds are presented within 'Net interest income on trading activities'.

HSBC's maximum exposure

HSBC's maximum exposure to consolidated and unconsolidated CNAV funds is represented by HSBC's investment in the units of each CNAV fund, and by the maximum limit of any letters of limited indemnity provided to the CNAV funds. HSBC's exposure to investment in units within the CNAV funds at 31 December 2009 amounted to US$1.0 billion (2008: US$0.7 billion). There was no exposure to letters of limited indemnity (2008: US$58 million).

Enhanced Variable Net Asset Value funds

Enhanced VNAV funds price their assets on a fair value basis and, consequently, prices may change from one day to the next. These funds pursue an 'enhanced' investment strategy, as part of which investors accept greater credit and duration risk in the expectation of higher returns.

During 2008, HSBC consolidated two of its French dynamic money market funds as a result of continued redemptions by unitholders. HSBC's aggregate holdings in these funds at 31 December 2009 amounted to €0.5 billion (US$0.6 billion (2008: €0.5 billion (US$0.6 billion)).

HSBC's maximum exposure

HSBC's maximum exposure to consolidated and unconsolidated Enhanced VNAV and consolidated and unconsolidated VNAV funds is represented by its investment in the units of each fund. HSBC's maximum exposure at 31 December 2009 amounted to US$0.6 billion (2008: US$0.6 billion) and US$0.2 billion (2008: US$1.6 billion), for Enhanced VNAV and VNAV funds, respectively.

Total assets of HSBC's money market funds which are on-balance sheet by balance sheet classification

	At 31 December
	2009	2008
	US$bn	US$bn

Cash .............................	-	0.3
Trading assets ...............	42.8	43.3
Other assets ..................	0.3	2.3

	43.1	45.9

Non-money market investment funds

Through its fund management business, HSBC has established a large number of non-money market funds to enable customers to invest in a range of assets, typically equities and debt securities. At the launch of a fund HSBC, as fund manager, usually provides a limited amount of initial capital known as 'seed capital' to enable the fund to start purchasing assets. These holdings are normally redeemed over time. The majority of these funds are off-balance sheet for HSBC because the Group's limited economic interest means it does not have the majority of the risks and rewards of ownership. As the non-money market funds explicitly provide investors with tailored risk, the risk to HSBC is restricted to its own investments in the funds.

In aggregate, HSBC has established non-money market funds with total assets of US$255.4 billion at 31 December 2009 (2008: US$200.3 billion).

The main sub-categories of non-money market funds are:

· US$115.6 billion (2008: US$83.1 billion) in specialist funds, comprising fundamental active specialists and active quantitative specialists;

· US$121.7 billion (2008: US$96.2 billion) in local investment management funds which invest in domestic products, primarily for retail and private clients; and

· US$18.1 billion (2008: US$21.0 billion) in multi-manager funds which offer fund of funds and manager of manager products across a diversified portfolio of assets.

Total assets of HSBC's on-balance sheet non-money market funds by balance sheet classification

	At 31 December
	2009	2008
	US$bn	US$bn

Cash ..................................	0.2	0.4
Trading assets ....................	0.2	0.2
Financial instruments designated at fair value ...	5.3	2.3
Financial investments ........	-	0.8

	5.7	3.7

HSBC's maximum exposure

HSBC's maximum exposure to consolidated and unconsolidated non-money market funds is represented by its investment in the units of each respective fund. HSBC's exposure at 31 December 2009 amounted to US$6.8 billion (2008: US$4.4 billion).

Securitisations

HSBC uses SPEs to securitise customer loans and advances that it has originated, mainly in order to diversify its sources of funding for asset origination and for capital efficiency purposes. In such cases, the loans and advances are transferred by HSBC to the SPEs for cash, and the SPEs issue debt securities to investors to fund the cash purchases. Credit enhancements to the underlying assets may be used to obtain investment grade ratings on the senior debt issued by the SPEs. HSBC has also established securitisation programmes in the US and Germany where loans originated by third parties are securitised. Most of these vehicles are not consolidated by HSBC as it is not exposed to the majority of risks and rewards of ownership in the SPEs. In 2009, demand for the securitised products remained low.

In addition, HSBC uses SPEs to mitigate the capital absorbed by some of the customer loans and advances it has originated. Credit derivatives are used to transfer the credit risk associated with such customer loans and advances to an SPE, using securitisations commonly known as synthetic securitisations. These SPEs are consolidated when HSBC is exposed to the majority of risks and rewards of ownership.

Total assets of HSBC's securitisations which are on-balance sheet, by balance sheet classification

	At 31 December
	2009	2008
	US$bn	US$bn

Trading assets .......................	0.9	1.3
Loans and advances to customers............................	35.4	50.8
Other assets ..........................	1.4	1.1
Derivatives ...........................	1.2	1.4

	38.9	54.6

These assets include US$0.9 billion (2008: US$1.3 billion) of exposure to US sub-prime mortgages.

Total assets of HSBC's securitisations which are off‑balance sheet

	2009	2008
	US$bn	US$bn

HSBC originated assets........	0.6	0.6
Non-HSBC originated assets: - term securitisation programmes .................	10.5	13.5

	11.1	14.1

HSBC's financial investments in off-balance sheet securitisations at 31 December 2009 amounted to US$0.1 billion (2008: US$0.2 billion). These assets include assets which are classified as available-for-sale securities and measured at fair value, and have been securitised by HSBC under arrangements by which HSBC retains a continuing involvement in them. Further details are provided in Note 20 on the Financial Statements.

HSBC's maximum exposure

The maximum exposure is the aggregate of any holdings of notes issued by these vehicles and the reserve account positions intended to provide credit support under certain pre-defined circumstances to senior note holders. HSBC is not obligated to provide further funding. At 31 December 2009, HSBC's maximum exposure to consolidated and unconsolidated securitisations amounted to US$8.0 billion (2008: US$8.0 billion).

Other

HSBC also establishes SPEs in the normal course of business for a number of purposes, for example, structured credit transactions for customers to provide finance to public and private sector infrastructure projects, and for asset and structured finance ('ASF') transactions.

Structured credit transactions

HSBC provides structured credit transactions to third‑party professional and institutional investors who wish to obtain exposure, sometimes on a leveraged basis, to a reference portfolio of debt instruments. In such structures, the investor receives returns referenced to the underlying portfolio by purchasing notes issued by the SPEs. HSBC enters into contracts with the SPEs, generally in the form of derivatives, in order to pass the required risks and rewards of the reference portfolios to the SPEs. HSBC's risk in relation to the derivative contracts with the SPEs is managed within HSBC's trading market risk framework (see 'Market risk' on page 250).

In certain transactions HSBC is exposed to risk often referred to as gap risk. Gap risk typically arises in transactions where the aggregate potential claims against the SPE by HSBC pursuant to one or more derivatives could be greater than the value of the collateral held by the SPE and securing such derivatives. HSBC often mitigates such gap risk by incorporating in the SPE transaction features which

allow for deleveraging, a managed liquidation of the portfolio, or other mechanisms. Following the inclusion of such risk reduction mechanisms, HSBC has, in certain circumstances, retained all or a portion of the underlying exposure in the transaction. When this retained exposure represents ABSs, it has been included in 'Nature and extent of HSBC's exposures' on page 157.

Often, transactions are facilitated through SPEs to enable the notes issued to the investors to be rated. The SPEs are not consolidated by HSBC when the investors bear substantially all the risks and rewards of ownership through the notes.

The total fair value of liabilities (notes issued and derivatives) in structured credit transaction SPEs was US$20.6 billion at 31 December 2009 (2008: US$21.2 billion). There were no SPEs that were consolidated by HSBC included in these amounts (2008: US$0.3 billion).

Other uses of SPEs

HSBC participates in Public-Private Partnerships to provide financial support for infrastructure projects initiated by government authorities. The funding structure is commonly achieved through the use of SPEs. HSBC consolidates these SPEs when it is exposed to the majority of risks and rewards of the vehicles.

HSBC's ASF business specialises in leasing and arranging finance for aircraft and other physical assets, which it is customary to ring-fence through the use of SPEs, and in structured loans and deposits, where SPEs introduce cost efficiencies. HSBC consolidates these SPEs when the substance of the relationship indicates that HSBC controls the SPE.

HSBC's risks and rewards of ownership in these SPEs are in respect of its on-balance sheet assets and liabilities.

HSBC's maximum exposures to SPEs

The following tables show the total assets of the various types of SPEs, and the amount and types of funding provided by HSBC to these SPEs. The tables also show HSBC's maximum exposure to the SPEs and, within that exposure, the types of liquidity and credit enhancements provided by HSBC. The maximum exposures to SPEs represent HSBC's maximum possible risk exposure that could occur as a result of the Group's arrangements and commitments to SPEs. The maximum amounts are contingent in nature, and may arise as a result of drawdowns under liquidity facilities, where these have been provided, and any other funding commitments, or as a result of any loss protection provided by HSBC to the SPEs. The conditions under which such exposure might arise differ depending on the nature of each SPE and HSBC's involvement with it. The aggregation of such maximum exposures across the different forms of SPEs results in a theoretical total maximum exposure number. The elements of the maximum exposure to an SPE are not necessarily additive and a detailed explanation of how maximum exposures are determined is provided under each category of SPE.

HSBC's maximum exposure to consolidated SPEs affected by the recent market turmoil

		Securities			Enhanced		Non-money market funds
	SIVs	investment conduits²⁸	Multi-seller conduits	CNAV funds	VNAV funds	VNAV funds	Specialist funds	Local funds²⁹	Securit- isations³⁰	Other	Total
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
At 31 December 2009
Total assets ............................... ................................................	-	32.8	10.9	42.4	0.7	-	0.4	5.3	38.9	-	131.4
Direct lending³¹ .....................	-	-	-	-	-	-	-	-	0.9	-	0.9
ABSs³¹ ...................................	-	25.7	-	0.3	0.2	-	-	-	-	-	26.2
ABCP ....................................	-	-	-	4.6	-	-	-	-	-	-	4.6
Other .....................................	-	7.1	10.9	37.5	0.5	-	0.4	5.3	38.0	-	99.7

Funding provided by HSBC .........	-	32.4	-	0.9	0.6	-	0.1	5.3	2.9	-	42.2
CP .........................................	-	10.8	-	-	-	-	-	-	-	-	10.8
MTNs ....................................	-	3.8	-	-	-	-	-	-	2.8	-	6.6
Junior notes ...........................	-	-	-	-	-	-	-	-	0.1	-	0.1
Term repos executed .............	-	10.2	-	-	-	-	-	-	-	-	10.2
Investments in funds ..............	-	-	-	0.9	0.6	-	0.1	5.3	-	-	6.9
Drawn liquidity facility...........	-	7.6	-	-	-	-	-	-	-	-	7.6
Capital notes³² .......................	-	-	-	-	-	-	-	-	-	-	-

Total maximum exposure to consolidated SPEs ................... ................................................	-	42.5	14.4	0.9	0.6	-	0.1	5.3	7.9	-	71.7

Liquidity and credit enhancements
Deal-specific liquidity facilities ............................................	-	-	14.4	-	-	-	-	-	-	-	14.4
Indemnities³⁴ .........................	-	-	-	-	-	-	-	-	-	-	-
Programme-wide liquidity facilities ..............................	-	29.1	-	-	-	-	-	-	-	-	29.1
Programme-wide limited credit enhancements .....................	-	1.2	0.6	-	-	-	-	-	-	-	1.8
Other liquidity and credit enhancements .....................	-	-	-	-	-	-	-	-	0.1	-	0.1

HSBC's maximum exposure to consolidated SPEs affected by the recent market turmoil (continued)

		Securities			Enhanced		Non-money market funds
	SIVs	investment conduits²⁸	Multi-seller conduits	CNAV funds	VNAV funds	VNAV funds	Specialist funds	Local funds²⁹	Securit- isations³⁰	Other	Total
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
At 31 December 2008
Total assets ............................... ................................................	0.4	32.3	13.9	43.8	0.7	1.4	0.6	3.1	54.6	0.3	151.1
Direct lending³¹ .....................	-	-	-	-	-	-	-	-	1.3	-	1.3
ABSs³¹ ...................................	-	25.8	-	0.8	-	-	-	-	-	-	26.6
ABCP ....................................	-	-	-	4.6	-	-	-	-	-	-	4.6
Other .....................................	0.4	6.5	13.9	38.4	0.7	1.4	0.6	3.1	53.3	0.3	118.6

Funding provided by HSBC .........	-	38.6	2.1	0.7	0.6	1.3	0.2	3.2	0.7	0.2	47.6
CP .........................................	-	18.7	2.1	-	-	-	-	-	-	-	20.8
MTNs ....................................	-	3.4	-	-	-	-	-	-	0.4	0.2	4.0
Junior notes ...........................	-	-	-	-	-	-	-	-	0.3	-	0.3
Term repos executed .............	-	14.1	-	-	-	-	-	-	-	-	14.1
Investments in funds ..............	-	-	-	0.7	0.6	1.3	0.2	3.2	-	-	6.0
Drawn liquidity facility...........	-	2.4	-	-	-	-	-	-	-	-	2.4
Capital notes³² .......................	-	-	-	-	-	-	-	-	-	-	-

Total maximum exposure to consolidated SPEs³³ ................. ................................................	-	47.6	17.1	0.8	0. 0.6	1.3	0.2	3.2	7.8	0.2	78.8

Liquidity and credit enhancements
Deal-specific liquidity facilities ............................................	-	-	17.1	-	-	-	-	-	-	-	17.1
Indemnities³⁴ .........................	-	-	-	0.1	-	-	-	-	-	-	0.1
Programme-wide liquidity facilities ..............................	-	34.8	-	-	-	-	-	-	-	-	34.8
Programme-wide limited credit enhancements .....................	-	1.2	0.6	-	-	-	-	-	-	-	1.8
Other liquidity and credit enhancements .....................	-	-	-	-	-	-	-	-	0.1	-	0.1

For footnotes, see page 195.

HSBC's maximum exposure to unconsolidated SPEs

	Securitisations³⁵		Money market funds³⁵			Non-money market funds³⁵
	HSBC originated assets	Non-HSBC originated assets³⁶	CNAV funds	Enhanced VNAV funds	VNAV funds	Specialist funds	Local funds³⁷	Multi- manager funds	Other	Total
	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn	US$bn
At 31 December 2009
Total assets .................................................... ....................................................................	0.6	10.5	31.2	-	24.7	115.2	116.4	18.1	20.6	337.3

Funding provided by HSBC .............................	-	0.1	0.1	-	0.2	1.1	0.2	0.1	8.8	10.6
MTNs ........................................................	-	0.1	-	-	-	-	-	-	8.8	8.9
Investments in funds ..................................	-	-	0.1	-	0.2	1.1	0.2	0.1	-	1.7

Total maximum exposure to unconsolidated SPEs ............................................................ ....................................................................	-	0.1	0.1	-	0.2	1.1	0.2	0.1	3.2	5.0

At 31 December 2008
Total assets .................................................... ....................................................................	0.6	13.5	28.2	2.0	26.6	82.5	93.1	21.0	20.9	288.4

Funding provided by HSBC .............................	-	0.2	-	-	0.3	-	1.0	-	8.3	9.8
MTNs ........................................................	-	0.2	-	-	-	-	-	-	8.3	8.5
Investments in funds ..................................	-	-	-	-	0.3	-	1.0	-	-	1.3
						-
Total maximum exposure to unconsolidated SPEs ............................................................ ....................................................................	-	0.2	-	-	0.3	-	1.0	-	4.1	5.6

For footnotes, see page 195.

Third-party sponsored SPEs

Through standby liquidity facility commitments, HSBC has exposure to third-party sponsored SIVs, conduits and securitisations under normal banking arrangements on standard market terms. These exposures are quantified below.

HSBC's commitments under liquidity facilities to third-party SIVs, conduits and securitisations

	Commit- ments	Drawn
	US$bn	US$bn
At 31 December 2009
Third-party conduits .....	1.3	0.3
Third-party securitisations ...........	0.7	0.1

	2.0	0.4

At 31 December 2008
Third-party conduits .....	1.1	0.1
Third-party securitisations ...........	0.6	0.1

	1.7	0.2

Other exposures to third-party SIVs, conduits and securitisations where a liquidity facility has been provided

	At 31 December
	2009	2008
	US$bn	US$bn

Derivative assets ..............	0.1	-

Other off-balance sheet arrangements and commitments

Financial guarantees, letters of credit and similar undertakings

Note 39 on the Financial Statements describes various types of guarantees and discloses the maximum potential future payments under such arrangements. Credit risk associated with all forms of guarantees is assessed in the same manner as for on-balance sheet credit advances and, where necessary, provisions for assessed impairment are included in 'Other provisions'.

Commitments to lend

Undrawn credit lines are disclosed in Note 39 on the Financial Statements. The majority by value of undrawn credit lines arise from 'open to buy' lines on personal credit cards, advised overdraft limits and other pre-approved loan products, and mortgage offers awaiting customer acceptance. HSBC generally has the right to change or terminate any conditions of a personal customer's overdraft, credit card or other credit line upon notification to the customer. In respect of corporate commitments to lend, in most cases HSBC's position will be protected through restrictions on access to funding in the event of material adverse change.

Leveraged finance transactions

Loan commitments in respect of leveraged finance transactions are accounted for as derivatives where it is HSBC's intention to sell the loan after origination. Further information is provided on page 165.

Footnotes to Impact of Market Turmoil

1 Total includes holdings of ABSs issued by Freddie Mac and Fannie Mae.

2 'Income and expense' recorded in the income statement represents the accrual of the effective interest rate and, for 2009, also includes US$163 million in respect of impairment (2008: US$26 million). The effect on the income statement for 2008 shows the income and expense post-reclassification. In 2008 pre-reclassification, the assets were held at fair value and a loss of US$1,371 million was recorded in the period up to reclassification.

3 Effect on the income statement during the period had the reclassification not occurred.

4 Included in the write-downs during the half year to 31 December 2008 were US$26 million relating to reclassified leveraged finance exposures, which had previously been presented under leveraged finance loans.

5 The carrying amount includes funded loans plus the net exposure to unfunded leveraged finance commitments, held within fair value through the profit or loss.

6 'Directly held' includes assets held by Solitaire where HSBC provides first loss protection and assets held directly by the Group.

7 Impairment charges allocated to capital note holders represent impairments where losses would be borne by external third-party investors in the structures.

8 Mortgage-backed securities ('MBS's), asset-backed securities ('ABS's) and collateralised debt obligations ('CDO's).

9 During 2009, for disclosure purposes, certain other residential MBSs were reclassified to commercial property mortgage-related assets. Comparatives have been restated accordingly.

10 High grade assets rated AA or AAA.

11 Gains or losses on the net principal exposure (footnote 17) recognised in the income statement as a result of changes in the fair value of the asset.

12 Fair value gains and losses on the net principal exposure (footnote 17) recognised in other comprehensive income as a result of the changes in the fair value of available-for-sale assets.

13 Realised fair value gains and losses on the net principal exposure (footnote 17) recognised in the income statement as a result of the disposal of assets or the receipt of cash flows from assets.

14 Reclassified from equity on impairment, disposal or payment. This includes impairment losses recognised in the income statement in respect of the net principal exposure (footnote 17) of available-for-sale assets. Payments are the contractual cash flows received on the assets.

15 The gross principal is the redemption amount on maturity or, in the case of an amortising instrument, the sum of the future redemption amounts through the residual life of the security.

16 A credit default swap ('CDS') gross protection is the gross principal of the underlying instrument that is protected by CDSs.

17 Net principal exposure is the gross principal amount of assets that are not protected by CDSs. It includes assets that benefit from monoline protection, except where this protection is purchased with a CDS.

18 Carrying amount of the net principal exposure.

19 Net exposure after legal netting and any other relevant credit mitigation prior to deduction of the credit risk adjustment.

20 Cumulative fair value adjustment recorded against OTC derivative counterparty exposures to reflect the creditworthiness of the counterparty.

21 Funded exposure represents the loan amount advanced to the customer, less any fair value write-downs, net of fees held on deposit.

22 Unfunded exposures represent the contractually committed loan facility amount not yet drawn down by the customer, less any fair value write-downs, net of fees held on deposit.

23 Derivatives, trading assets and trading liabilities are presented as one category to reflect the manner in which these financial instruments are risk-managed.

24 The Middle East is disclosed as a separate geographical region with effect from 1 January 2009. Previously, it formed part of Rest of Asia-Pacific. Comparative data have been restated accordingly.

25 The reasons for the significant difference between carrying amount and fair value of loans and advances to customers in North America are discussed on page 179.

26 Assets within multi-seller conduits are classified as collateralised loans. Under IFRSs, the conduits cannot recognise the underlying assets.

27 For details of the geographical origin of the mortgage loans held at fair value and ABSs, including those represented by MBSs and CDOs held in consolidated SIVs and securities investment conduits, see 'Nature and extent of HSBC's exposures' on page 157.

28 The securities investment conduits include Mazarin, Barion, Malachite and Solitaire.

29 Local investment management funds.

30 Also includes consolidated SPEs that hold mortgage loans held at fair value.

31 These assets only include those measured at fair value. For details on the geographical origin of the mortgage loans held at fair value and ABSs, including those represented by MBSs and CDOs held in consolidated SIVs and securities investment conduits, see 'Nature and extent of HSBC's exposures' on page 157. The geographical origin of the loans and receivables held by the multi-seller conduits is disclosed on page 185.

32 The carrying amount of HSBC's holding of capital notes in the securities investment conduits amounted to US$2.6 million (2008: US$1.9 million) with a par value of US$54 million (2008: US$52 million).

33 Total maximum exposure to consolidated SPEs as at 31 December 2008 has been restated to reflect more accurately the Group's exposure to certain securitisation vehicles in which a proportion of the maximum exposure to risk of loss is borne by third-party noteholders.

34 Two limited letters of indemnity which were in place in respect of CNAV funds at 31 December 2008 expired in April 2009.

35 HSBC's financial investments in off-balance sheet money market funds and non-money market funds have been classified as available-for-sale securities, and measured at fair value. HSBC's financial investments in off-balance sheet securitisations have been classified as trading assets and available-for-sale securities, and measured at fair value.

36 In the US, HSBC has established securitisation programmes where term-funded SPEs are used to securitise third-party originated mortgages, mainly sub-prime and Alt-A residential mortgages. The majority of these SPEs are not consolidated by HSBC as it is not exposed to the majority of the risk and rewards of ownership in the SPEs. No liquidity facility has been provided by HSBC.

37 Local investment management funds.

This information is provided by RNS

The company news service from the London Stock Exchange

END

ACSURVWRRSAOORR

Companies

HSBC Holdings (HSBA)

Thursday, 9th May 2024

COMPANIES COVERED:

RBN AAF HBR

Airtel Africa left investors underwhelmed despite customer growth, Robinson’s share price jumps on profit upgrade and Harbour Energy nudges higher on trading update.

Full Archive

UK 100

Latest directors dealings

6 hours ago SSP Group
6 hours ago Real Estate Investors
6 hours ago WPP
6 hours ago Spectris
7 hours ago Clarkson

All directors dealings today