Annual Financial Report - 24 of 41

RNS Number : 8662D

HSBC Holdings PLC

30 March 2011

 



Liquidity and funding

(Audited)

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

The objective of our liquidity framework is to be very conservative and adaptable to changing business models, markets and regulation.

The objective of our liquidity and funding management framework is to ensure that all foreseeable funding commitments can be met when due, and that access to the wholesale markets is co‑ordinated and cost-effective. To this end, we maintain a diversified funding base comprising core retail and corporate customer deposits and institutional balances. We augment this with wholesale funding and portfolios of highly liquid assets diversified by currency and maturity which are held to enable us to respond quickly and smoothly to unforeseen liquidity requirements.

We adapt our liquidity and funding risk management framework in response to changes in the mix of business that we undertake, and to changes in the nature of the markets in which we operate. We also seek to continuously evolve and strengthen our liquidity and funding risk management framework. As part of this process, we have refined the way in which we characterise core deposits. The characterisation takes into account the activities and operating environment in the entity originating the deposit, the nature of the customer and the size and pricing of the deposit. This exercise has resulted in a revised internal calculation of advances to core funding ratio (discussed more fully below), and comparatives have been restated accordingly. While total core deposits at the Group consolidated level have not changed materially, there have been some revisions to individual entities.

We employ a number of measures to monitor liquidity risk. The emphasis on the 'ratio of net

liquid assets to customer deposits', as reported in the Annual Report and Accounts 2009, has been reduced and a 'stressed one month coverage ratio', an extension of our projected cash flow scenario analysis, is now used as a simple and more useful metric to express liquidity risk. The bank also manages its intra-day liquidity positions so that it is able to meet payment and settlement obligations on a timely basis. Payment flows in real time gross settlement systems, expected peak payment flows and large time-critical payments are monitored during the day and the intra-day collateral position is managed so that there is liquidity available to meet payments.

Policies and procedures

(Audited)

The management of liquidity and funding is primarily undertaken locally in our operating entities in compliance with practices and limits set by the Risk Management Meeting. These limits vary according to the depth and liquidity of the market in which the entities operate. It is our policy that each banking entity should be self-sufficient when funding its own operations. Exceptions are permitted for certain short-term treasury requirements and start-up operations or for branches which do not have access to local deposit markets. These entities are funded from our largest banking operations and within clearly defined internal and regulatory guidelines and limits. The limits place formal restrictions on the transfer of resources between our entities and reflect the broad range of currencies, markets and time zones within which we operate.

Elements of our liquidity and funding management process

·  projecting cash flows by major currency under various stress scenarios and considering the level of liquid assets necessary in relation thereto;

·  monitoring balance sheet liquidity and advances to core funding ratios against internal and regulatory requirements;

·  maintaining a diverse range of funding sources with back-up facilities;

·  managing the concentration and profile of debt maturities;

·  managing contingent liquidity commitment exposures within pre-determined caps;

·  maintaining debt financing plans;

·  monitoring depositor concentration in order to avoid undue reliance on large individual depositors and ensure a satisfactory overall funding mix; and

·  maintaining liquidity and funding contingency plans. These plans identify early indicators of stress conditions and describe actions to be taken in the event of difficulties arising from systemic or other crises, while minimising adverse long-term implications for the business.

Primary sources of funding

(Audited)

Current accounts and savings deposits payable on demand or at short notice form a significant part of our funding, and we place considerable importance on maintaining their stability. For deposits, stability depends upon preserving depositor confidence in our capital strength and liquidity, and on competitive and transparent pricing.

We also access professional markets in order to provide funding for non-banking subsidiaries that do not accept deposits, to align asset and liability maturities and currencies and to maintain a presence in local money markets. Market disruption continued to have adverse effects on the liquidity and funding risk profile of the banking system in 2010. Despite these challenges, we have continued to have good access to debt capital markets. Group entities issued US$26bn of term debt securities in the public capital markets in 2010.

In aggregate, our banking entities are liquidity providers to the interbank market, placing significantly more funds with other banks than they themselves borrow. Our main operating subsidiary that does not accept deposits is HSBC Finance, which is funded principally by taking term funding in the professional markets and securitising assets. At 31 December 2010, US$65bn (2009: US$82bn) of HSBC Finance's liabilities were drawn from professional markets, utilising a range of products, maturities and currencies.

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

(Audited)

	On        demand           US$m		Due       within 3         months           US$m		Due       between       3 and 12         months           US$m		Due       between         1 and 5            years           US$m		Due          after 5            years           US$m
At 31 December 2010
Deposits by banks ................................................	42,481		70,072		8,393		7,949		1,346
Customer accounts ...............................................	881,575		244,501		89,557		23,209		3,483
Trading liabilities .................................................	300,703		-		-		-		-
Financial liabilities designated at fair value ...........	7,421		3,786		7,825		35,583		61,575
Derivatives ..........................................................	255,046		531		1,143		2,065		942
Debt securities in issue ..........................................	1,320		48,062		41,939		62,148		16,255
Subordinated liabilities ..........................................	34		1,491		1,863		10,001		51,293
Other financial liabilities ......................................	24,834		24,378		7,944		2,184		824
	1,513,414		392,821		158,664		143,139		135,718
Loan and other credit-related commitments .........	524,394		51,732		14,023		11,964		400
Financial guarantees and similar contracts ............	18,491		9,233		12,231		7,082		2,399
	2,056,299		453,786		184,918		162,185		138,517
At 31 December 2009
Deposits by banks ................................................	39,484		85,922		18,925		6,180		1,359
Customer accounts ...............................................	800,199		277,071		71,243		45,561		7,911
Trading liabilities .................................................	268,130		-		-		-		-
Financial liabilities designated at fair value ...........	6,628		1,050		5,976		36,185		67,209
Derivatives ..........................................................	245,027		300		1,002		467		320
Debt securities in issue ..........................................	124		49,493		38,445		66,661		22,663
Subordinated liabilities ..........................................	43		481		3,020		8,660		52,304
Other financial liabilities ......................................	22,500		25,123		5,732		2,354		1,103
	1,382,135		439,440		144,343		166,068		152,869
Loan and other credit-related commitments54 ......	494,269		36,726		11,810		12,495		2,750
Financial guarantees and similar contracts54 .........	16,561		11,169		12,737		9,096		3,688
	1,892,965		487,335		168,890		187,659		159,307

For footnote, see page 174.

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

Cash flows payable in respect of customer accounts are primarily contractually repayable on demand or at short notice. However, in practice, short-term deposit balances remain stable as inflows and outflows broadly match and a significant portion of loan commitments expire without being drawn upon.

The management of liquidity risk

(Audited)

We use a number of principal measures to manage liquidity risk, as described below.

Advances to core funding ratio

We emphasise the importance of core customer deposits as a source of funds to finance lending to customers, and discourage reliance on short-term professional funding. This is achieved by placing limits on banking entities which restrict their ability to increase loans and advances to customers without corresponding growth in their core customer deposits or long-term debt funding. This measure is referred to as the 'advances to core funding' ratio. Previously, we utilised the 'advances to deposits' ratio.

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

The three principal banking entities listed in the table below represented 62% of our total core deposits at 31 December 2010 (31 December 2009: 63%). The table shows that loans and advances to customers in our principal banking entities are overwhelmingly financed by reliable and stable sources of funding. We would meet any unexpected net cash outflows by selling securities and accessing additional funding sources such as interbank or collateralised lending markets.

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

(Audited)

	Advances to core funding ratio during:				Stressed one month coverage ratio during:
	2010		2009		2010		2009
	%		%		%		%
HSBC Bank plc55
Year-end .....................................................................	103.0		105.0		111.1		103.2
Maximum ...................................................................	109.7		116.0		111.3		108.1
Minimum ....................................................................	102.6		105.0		103.2		101.3
Average ......................................................................	106.0		110.6		108.2		103.9
The Hongkong and Shanghai Banking Corporation55
Year-end .....................................................................	70.3		55.5		144.6		153.2
Maximum ...................................................................	70.3		62.0		165.4		153.2
Minimum ....................................................................	55.5		55.5		132.6		134.3
Average ......................................................................	63.6		57.5		148.8		144.8
HSBC Bank USA
Year-end .....................................................................	98.3		101.0		108.5		105.3
Maximum ...................................................................	104.3		111.1		118.5		128.0
Minimum ....................................................................	94.2		99.5		105.3		105.3
Average ......................................................................	98.0		106.1		112.3		118.7
Total of HSBC's other principal banking entities56
Year-end .....................................................................	89.1		85.9		119.6		124.8
Maximum ...................................................................	89.1		89.2		126.5		124.8
Minimum ....................................................................	85.7		81.2		118.1		116.3
Average ......................................................................	87.0		85.9		122.2		120.5

For footnotes, see page 174.

Stressed one month coverage ratio

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

Projected cash flow scenario analysis

We use a number of standard projected cash flow

scenarios designed to model combinations of both Group-specific and market-wide liquidity crises, in which the rate and timing of deposit withdrawals and drawdowns on committed lending facilities are varied, and the ability to access interbank funding and term debt markets and to generate funds from asset portfolios is restricted. The scenarios are modelled by all our banking entities and by HSBC Finance. The appropriateness of the assumptions under each scenario is regularly reviewed. In addition to our standard projected cash flow scenarios, individual entities are required to design their own scenarios to reflect specific local market conditions, products and funding bases.

Limits for cumulative net cash flows under stress scenarios are set for each banking entity and for HSBC Finance. Both ratio and cash flow limits reflect the local market place, the diversity of funding sources available and the concentration risk from large depositors. Compliance with entity level limits is monitored centrally by Group Finance and reported regularly to the Risk Management Meeting.

HSBC Finance

As HSBC Finance is unable to accept standard retail customer deposits, it takes funding from the professional markets. HSBC Finance uses a range of measures to monitor funding risk, including projected cash flow scenario analysis and caps placed on the amount of unsecured term funding that can mature in any rolling three-month and rolling 12‑month periods. HSBC Finance also maintains access to committed sources of secured funding and has in place committed backstop lines for short-term refinancing commercial paper ('CP') programmes. A CP programme is a short-term, unsecured funding tool used to manage day to day cash flow needs. In agreement with the rating agencies, issuance under this programme will not exceed 100% of committed bank backstop lines.

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

HSBC Finance - funding

(Audited)

	At 31 December
	2010		2009
	US$bn		US$bn
Maximum amounts of unsecured term funding maturing in any rolling:
-  3 month period ..................	5.1		5.2
-  12 month period ................	10.8		12.3
Unused committed sources of secured funding57 ....................................	0.5		0.4
Committed backstop lines from non-Group entities in support of CP programmes .........................	4.3		5.3

For footnote, see page 174.

Contingent liquidity risk

(Audited)

In the normal course of business, we provide customers with committed facilities, including committed backstop lines to conduit vehicles sponsored by HSBC and standby facilities to corporate customers. These facilities increase our funding requirements when customers choose to raise drawdown levels over and above their normal utilisation rates. The liquidity risk consequences of increased levels of drawdown are analysed in the form of projected cash flows under different stress scenarios. The Risk Management Meeting also sets limits for non-cancellable contingent funding commitments by Group entity after due consideration of each entity's ability to fund them. The limits are split according to the borrower, the liquidity of the underlying assets and the size of the committed line.

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

(Audited)

	HSBC Bank				HSBC Bank USA				HSBC Bank Canada				The Hongkong and Shanghai Banking Corporation
	2010		2009		2010		2009		2010		2009		2010		2009
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
Conduits
Client-originated assets58 ....
- total lines ....................	7.8		7.4		4.0		6.4		0.2		0.3		-		0.3
- largest individual lines ..	0.7		0.8		0.4		0.4		0.1		0.1		-		0.3
HSBC-managed assets59 ......	25.6		29.1		-		-		-		-		-		-
Other conduits60 .................	-		-		1.4		1.3		-		-		-		-
Single-issuer liquidity facilities
Five largest61 ......................	4.2		4.3		5.3		6.1		2.0		2.0		1.4		1.2
Largest market sector62 ......	8.4		7.9		4.9		4.7		3.8		2.9		2.4		1.5

For footnotes, see page 174.

HSBC Holdings

(Audited)

HSBC Holdings' primary sources of cash are dividends received from subsidiaries, interest on and repayment of intra-group loans and interest earned on its own liquid funds. HSBC Holdings also raises ancillary funds in the debt capital markets through subordinated and senior debt issuance. Cash is primarily used for the provision of capital to subsidiaries, interest payments to debt holders and dividend payments to shareholders.

HSBC Holdings is also subject to contingent liquidity risk by virtue of loan and other credit-related commitments and guarantees and similar contracts issued. Such commitments and guarantees are only issued after due consideration of HSBC

Holdings' ability to finance the commitments and guarantees and the likelihood of the need arising.

HSBC Holdings actively manages the cash flows from its subsidiaries to optimise the amount of cash held at the holding company level. The ability of subsidiaries to pay dividends or advance monies to HSBC Holdings depends on, among other things, their respective regulatory capital requirements, statutory reserves, and financial and operating performance. The wide range of our activities means that HSBC Holdings is not dependent on a single source of profits to fund its dividend payments to shareholders. During 2010, HSBC Holdings continued to have full access to debt capital markets at market rates and issued US$5.0bn of capital instruments (2009: US$5.3bn).

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

(Audited)

	On        demand		Due       within 3        months		Due       between       3 and 12         months		Due       between         1 and 5            years		Due          after 5            years
	US$m		US$m		US$m		US$m		US$m
At 31 December 2010
Amounts owed to HSBC undertakings ..............	-		163		1,332		1,453		-
Financial liabilities designated at fair value ......	-		219		658		5,810		24,215
Derivatives .....................................................	827		-		-		-		-
Debt securities in issue .....................................	-		35		106		2,110		1,559
Subordinated liabilities .....................................	-		219		657		3,504		28,670
Other financial liabilities .................................	-		1,782		-		-		-
	827		2,418		2,753		12,877		54,444
Loan commitments .........................................	2,720		-		-		-		-
Financial guarantees and similar contracts .......	46,988		-		-		-		-
	50,535		2,418		2,753		12,877		54,444
At 31 December 2009
Amounts owed to HSBC undertakings ..............	-		292		25		3,477		-
Financial liabilities designated at fair value ......	-		229		687		6,205		26,152
Derivatives .....................................................	362		-		-		-		-
Debt securities in issue .....................................	-		37		112		2,346		1,698
Subordinated liabilities .....................................	-		243		728		3,881		32,232
Other financial liabilities .................................	-		1,239		-		-		-
	362		2,040		1,552		15,909		60,082
Loan commitments .........................................	3,240		-		-		-		-
Financial guarantees and similar contracts .......	35,073		-		-		-		-
	38,675		2,040		1,552		15,909		60,082

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

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

Market risk

(Audited)

Market risk is the risk that movements in market factors, including foreign exchange rates and commodity prices, interest rates, credit spreads and equity prices, will reduce our income or the value of our portfolios.

We separate exposures to market risk into trading and non-trading portfolios. Trading portfolios include positions arising from market-making, position-taking and others designated as marked to market.

Non-trading portfolios include positions that primarily arise from the interest rate management of our retail and commercial banking assets and liabilities, financial investments designated as available for sale and held to maturity, and exposures arising from our insurance operations.

Market risk arising in our insurance businesses is discussed in 'Risk management of insurance operations' on pages 155 to 171.

Monitoring and limiting market risk exposure

(Audited)

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

The management of market risk is principally undertaken in Global Markets using risk limits approved by the GMB. Limits are set for portfolios, products and risk types, with market liquidity being a primary factor in determining the level of limits set. Group Risk, an independent unit within GMO, is responsible for our market risk management policies and measurement techniques. Each major operating entity has an independent market risk management and control function which is responsible for measuring market risk exposures in accordance with the policies defined by Group Risk, and monitoring and reporting these exposures against the prescribed limits on a daily basis.

Each operating entity is required to assess the market risks arising on each product in its business and to transfer them to either its local Global Markets unit for management, or to separate books managed under the supervision of the local Asset and Liability Management Committee ('ALCO'). Our aim is to ensure that all market risks are consolidated within operations that have the necessary skills, tools, management and governance to manage them professionally. In certain cases where the market risks cannot be fully transferred, we use simulation modelling to identify the impact of varying scenarios on valuations and net interest income.

We employ a range of tools to monitor and limit market risk exposures. These include sensitivity analysis, value at risk ('VAR') and stress testing.

Sensitivity analysis

(Unaudited)

We use sensitivity measures to monitor the market risk positions within each risk type, for example, the present value of a basis point movement in interest rates for interest rate risk. Sensitivity limits are set for portfolios, products and risk types, with the depth of the market being one of the principal factors in determining the level of limits set.

Value at risk

(Audited)

VAR is a technique that estimates the potential losses on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence.

The VAR models we use are based predominantly on historical simulation. These models derive plausible future scenarios from past series of recorded market rates and prices, taking into account inter-relationships between different markets and rates such as interest rates and foreign exchange rates. The models also incorporate the effect of option features on the underlying exposures.

Our historical simulation models assess potential market movements with reference to data from the past two years and calculate VAR to a 99% confidence level and for a one-day holding period.

Although a valuable guide to risk, VAR should always be viewed in the context of its limitations:

·  the use of historical data as a proxy for estimating future events may not encompass all potential events, particularly those which are extreme in nature;

·  the use of a one-day holding period assumes that all positions can be liquidated or the risk offset in one day. This may not fully reflect the market risk arising at times of severe illiquidity, when a one‑day holding period may be insufficient to liquidate or hedge all positions fully;

·  the use of a 99% confidence level, by definition, does not take into account losses that might occur beyond this level of confidence;

·  VAR is calculated on the basis of exposures outstanding at the close of business and therefore does not necessarily reflect intra-day exposures; and

·  VAR is unlikely to reflect loss potential on exposures that only arise under significant market moves.

We routinely validate the accuracy of our VAR models by back-testing the actual daily profit and loss results, adjusted to remove non-modelled items such as fees and commissions, against the corresponding VAR numbers. Statistically, we would expect to see losses in excess of VAR only 1% of the time over a one-year period. The actual number of excesses over this period can therefore be used to gauge how well the models are performing.

Stress testing

(Audited)

In recognition of VAR's limitations, we augment it with stress testing to evaluate the potential impact on portfolio values of more extreme, although plausible, events or movements in a set of financial variables. The process is governed by the Stress Testing Review Group forum which, in conjunction with regional risk managers, determines the scenarios to be applied at portfolio and consolidated levels, as follows:

·     sensitivity scenarios consider the impact of any single risk factor or set of factors that are unlikely to be captured within the VAR models, such as the break of a currency peg;

·     technical scenarios consider the largest move in each risk factor, without consideration of any underlying market correlation;

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

·     historical scenarios incorporate historical observations of market movements during previous periods of stress which would not be captured within VAR.

Stress testing results provide senior management with an assessment of the financial effect such events would have on our profit.

Trading and non-trading portfolios

(Audited)

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

	Portfolio
	Trading		Non-trading
Risk type
Foreign exchange and commodity ....................	VAR		VAR63
Interest rate ......................	VAR		VAR64
Equity ...............................	VAR		Sensitivity
Credit spread .....................	VAR		VAR65

For footnotes, see page 174.

Value at risk of the trading and non-trading portfolios

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

Value at risk (excluding credit spread VAR)

(Audited)

	2010		2009
	US$m		US$m
At 31 December ..............	266.6		204.5
Average ...........................	199.8		156.1
Minimum .........................	139.5		105.7
Maximum ........................	285.7		204.5

The rise in interest rate volatility, coupled with a modest increase in underlying interest rate exposure, resulted in a higher VAR and higher maximum VAR at the end of 2010 compared with the end of 2009. The volatility in the other asset classes in 2010 was lower than in 2009.

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

Daily VAR (excluding credit spread) (US$m) (Unaudited)

The major contributor to our Group trading and non-trading VAR was Global Markets.

The histogram below illustrates the frequency of daily revenue arising from Global Markets' trading, balance sheet management and other trading activities.

Daily revenue

(Unaudited)

	2010		2009
	US$m		US$m
Average daily revenue ......	49.3		59.9
Standard deviation66 .........	37.8		38.4

For footnote, see page 174.

An analysis of the frequency distribution of daily revenue shows that there were nine days with negative revenues during 2010 compared with

11 days in the same period ended 31 December 2009. The most frequent result was daily revenue of between US$30m and US$40m with 41 occurrences, compared with between US$30m and US$40m and between US$40m and US$50m with 29 occurrences each in 2009.

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

Daily distribution of Global Markets' trading, balance sheet management and other trading revenues⁶⁷

(Unaudited)

2010 Number of days		2009 Number of days
US$m		US$m
< Profit and loss frequency		< Profit and loss frequency

For footnote, see page 174.

Trading portfolios

(Audited)

Risk measurement and control

Our control of market risk in the trading portfolios is based on a policy of restricting individual operations to trading within a list of permissible instruments authorised for each site by Group Risk, of enforcing rigorous new product approval procedures, and of restricting trading in the more complex derivative products only to offices with appropriate levels of product expertise and robust control systems.

The VAR for trading intent activity within Global Markets at 31 December 2010 was US$80.8m (2009: US$95.1m). This is analysed below by risk type:

VAR by risk type for trading intent activities⁶⁸

(Audited)

	Foreign exchange and     commodity		Interest                 rate		Equity		Credit           spread69		Total70
	US$m		US$m		US$m		US$m		US$m
At 31 December 2010 ............................	24.9		49.5		13.0		39.1		80.8
At 31 December 2009 ..............................	19.5		42.6		17.5		59.3		95.1
Average
2010 .....................................................	27.2		51.6		9.2		62.0		113.4
2009 .....................................................	20.6		51.3		11.3		58.0		85.3
Minimum
2010 .....................................................	8.0		34.7		2.9		33.7		55.0
2009 .....................................................	11.1		35.6		4.9		31.9		54.3
Maximum
2010 .....................................................	62.9		88.9		21.6		102.5		212.2
2009 .....................................................	46.7		78.0		18.7		94.3		132.5

For footnotes, see page 174.

The VAR for overall trading intent activity as at 31 December 2010 was lower than at the end of 2009, because of reduced volatility in various asset classes. However, the wider band in VAR observed in 2010 was driven by an increase in client-led transactions and reduced portfolio diversification benefit, which resulted in occasionally higher VAR utilisation, as reflected in the above summary statistics.

Credit spread risk

(Audited)

The risk associated with movements in credit spreads is primarily managed through sensitivity limits, stress testing and VAR for those portfolios on which it is calculated.

At 31 December 2010, the Group credit spread VAR was US$41.9m (2009: US$72.7m). The decrease arose from the effect of volatile credit spread scenarios rolling off from the VAR calculation.

Credit spread risk also arises on credit derivative transactions entered into by Global Banking in order to manage the risk concentrations within our corporate loan portfolio and so enhance capital efficiency. The mark-to-market of these transactions is reflected in the income statement. At 31 December 2010, the credit VAR on the credit derivatives transactions entered into by Global Banking was US$12.3m (2009: US$13.8m).

Gap risk

Even for transactions that are structured to render the risk to HSBC negligible under a wide range of market conditions or events, there exists a remote possibility that a significant gap event could lead to loss. A gap event could arise from a significant change in market price with no accompanying trading opportunity, with the result that the threshold is breached beyond which the risk profile changes from no risk to full exposure to the underlying structure. Such movements may occur, for example, when, in reaction to an adverse event or unexpected news announcement, the market for a specific investment becomes illiquid, making hedging impossible.

Given their characteristics, these transactions make little or no contribution to VAR or to traditional market risk sensitivity measures. We capture their risks within our stress testing scenarios and monitor gap risk on an ongoing basis. We regularly consider the probability of gap loss, and fair value adjustments are booked against this risk. We did not incur any material gap loss in respect of such transactions in 2010.

Non-trading portfolios

(Audited)

Risk measurement and control

The principal objective of market risk management of non-trading portfolios is to optimise net interest income. Interest rate risk in non-trading portfolios arises principally from mismatches between the future yield on assets and their funding cost, as a result of interest rate changes. Analysis of this risk is complicated by having to make assumptions on embedded optionality within certain product areas such as the incidence of mortgage prepayments, and from behavioural assumptions regarding the economic duration of liabilities which are contractually repayable on demand such as current accounts.

Our control of market risk in the non-trading portfolios is based on transferring the risks to the books managed by Global Markets or the local ALCO. The net exposure is typically managed through the use of interest rate swaps within agreed limits. The VAR for these portfolios is included within the Group VAR (see 'Value at risk of the trading and non-trading portfolios' on page 146).

Credit spread risk

The risk associated with movements in credit spreads is primarily managed through sensitivity limits, stress testing, and VAR for those portfolios where VAR is calculated. We have introduced credit spread as a separate risk type within our VAR models on a global basis. The VAR shows the effect on income from a one-day movement in credit spreads over a two-year period, calculated to a 99% confidence interval.

At 31 December 2010, the sensitivity of equity capital to the effect of movements in credit spreads, based on credit spread VAR, on our available-for‑sale debt securities was US$264m (2009: US$535m). After including the gross exposure for the SICs consolidated within our balance sheet, this exposure rose to US$299m (2009: US$549m). This sensitivity is calculated before taking into account losses which would have been absorbed by the capital note holders. At 31 December 2010, the capital note holders can absorb the first US$2.2bn (2009: US$2.2bn) of any losses incurred by the SICs before we incur any equity losses.

The decrease in this sensitivity at 31 December 2010 compared with 31 December 2009 can be explained by the effect of lower volatility in credit spread scenarios observed during 2010.

Equity securities classified as available for sale

Fair value of equity securities classified as available for sale

(Audited)

	2010		2009
	US$bn		US$bn
Private equity holdings71 .........................................................................................................	2.8		4.0
Funds invested for short-term cash management .....................................................................	0.5		0.8
Investment to facilitate ongoing business72 .............................................................................	1.0		1.2
Other strategic investments ....................................................................................................	3.7		3.1
	8.0		9.1

For footnotes, see page 174.

Market risk arises on equity securities classified as available for sale. The fair value of these securities at 31 December 2010 was US$8.0bn (2009: US$9.1bn).

The fair value of the constituents of equity securities classified as available for sale can fluctuate considerably. A 10% reduction in their value at 31 December 2010 would have reduced our equity by US$0.8bn (2009: US$0.9bn). For details of the impairment incurred on available-for-sale equity securities, see 'Securitisation exposures and other structured products' on page 128.

Structural foreign exchange exposures

(Unaudited)

Structural foreign exchange exposures represent net investments in subsidiaries, branches and associates, the functional currencies of which are currencies other than the US dollar. An entity's functional currency is the currency of the primary economic environment in which the entity operates.

Exchange differences on structural exposures are recognised in other comprehensive income. We use the US dollar as our presentation currency in our consolidated financial statements because the US dollar and currencies linked to it form the major currency bloc in which we transact and fund our business. Our consolidated balance sheet is, therefore, affected by exchange differences between the US dollar and all the non-US dollar functional currencies of underlying subsidiaries.

We hedge structural foreign exchange exposures only in limited circumstances. Our structural foreign exchange exposures are managed with the primary objective of ensuring, where practical, that our consolidated capital ratios and the capital ratios of individual banking subsidiaries are largely protected from the effect of changes in exchange rates. This is usually achieved by ensuring that, for each subsidiary bank, the ratio of structural exposures in a given currency to risk-weighted assets denominated

in that currency is broadly equal to the capital ratio of the subsidiary in question.

We may also transact hedges where a currency in which we have structural exposures is considered to be significantly overvalued and it is possible in practice to transact a hedge. Any hedging is undertaken using forward foreign exchange contracts which are accounted for under IFRSs as hedges of a net investment in a foreign operation, or by financing with borrowings in the same currencies as the functional currencies involved. No forward foreign exchange hedges were in place during 2010 in respect of our consolidated Group structural foreign exchange position.

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

Sensitivity of net interest income

(Unaudited)

A principal element of our management of market risk in non-trading portfolios is monitoring the sensitivity of projected net interest income under varying interest rate scenarios (simulation modelling). We aim to mitigate the effect of prospective interest rate movements which could reduce future net interest income, while balancing the cost of such hedging activities on the current net revenue stream.

For simulation modelling, our businesses use a combination of scenarios relevant to them and their local markets and standard scenarios which are required throughout HSBC. The standard scenarios are consolidated to illustrate the combined pro forma effect on our consolidated portfolio valuations and net interest income.

The table below sets out the effect on future net interest income of incremental 25 basis point parallel falls or rises in all yield curves worldwide at the beginning of each quarter during the 12 months from 1 January 2011.

Assuming no management actions, a sequence of such rises would increase planned net interest income for 2011 by US$882m (2010: US$695m), while a sequence of such falls would decrease planned net interest income by US$1,525m (2010: US$1,563m). These figures incorporate the effect of any option features in the underlying exposures.

Sensitivity of projected net interest income⁷³

(Unaudited)

	US dollar            bloc         US$m		Rest of   Americas            bloc         US$m		Hong Kong         dollar            bloc         US$m		Rest of            Asia            bloc         US$m		Sterling            bloc         US$m		Euro            bloc         US$m		Total         US$m
Change in 2011 projected net interest income arising from a shift in yield curves of:
+25 basis points at the beginning of each quarter ..	164		72		191		245		292		(82)		882
-25 basis points at the beginning of each quarter ..	(550)		(68)		(280)		(143)		(546)		62		(1,525)
Change in 2010 projected net interest income arising from a shift in yield curves of:
+25 basis points at the beginning of each quarter ..	13		92		416		112		363		(301)		695
-25 basis points at the beginning of each quarter ..	(382)		(46)		(507)		(133)		(689)		194		(1,563)

For footnote, see page 174.

The interest rate sensitivities set out in the table above are illustrative only and are based on simplified scenarios.

The figures represent the effect of the pro forma movements in net interest income based on the projected yield curve scenarios and our current interest rate risk profile. This effect, however, does not incorporate actions that would be taken by Balance Sheet Management within Global Markets or in the business units to mitigate the impact of this interest rate risk; in reality, Balance Sheet Management seeks proactively to change the interest rate risk profile to minimise losses and optimise net revenues. The projections above also assume that interest rates of all maturities move by the same amount and, therefore, do not reflect the potential effect on net interest income of some rates changing while others remain unchanged. In addition, the projections take account of the effect on net interest income of anticipated differences in changes between interbank interest rates and interest rates linked to other bases (such as Central Bank rates or product rates over which the entity has discretion in terms of the timing and extent of rate changes). The projections make other simplifying assumptions too, including that all positions run to maturity.

Projecting the movement in net interest income from prospective changes in interest rates is a complex interaction of structural and managed exposures. Our exposure to the effect of movements in interest rates on our net interest income arises in two main areas, core deposit franchises and Balance Sheet Management:

·     core deposit franchises are exposed to changes in the cost of deposits raised and spreads on wholesale funds. The net interest income benefit of core deposits increases as interest rates rise and decreases as interest rates fall. This risk is asymmetrical in a very low interest rate environment, however, as there is limited room to lower deposit pricing in the event of interest rate reductions; and

·     residual interest rate risk is managed within Balance Sheet Management, under our policy of transferring interest rate risk to Balance Sheet Management to be managed within defined limits and with flexibility as to the instruments used.

The table above reflects the fact that our deposit taking businesses will generally benefit from rising rates which will be partially offset by increased funding costs in Balance Sheet Management given our simplifying assumption of unchanged Balance Sheet Management positioning. Additionally, the benefit to deposit taking businesses of rising rates is also offset by the increased funding cost of trading assets, which is recorded in 'Net interest income' and therefore captured in the above table, whereas the income from such assets is recorded in 'Net trading income'.

The main drivers of the year on year changes in the sensitivity of the Group's net interest income to the change in rates shown in the table were lower implied yield curves, changes in Balance Sheet Management positioning, and changed expectations for deposit pricing for some currencies in a rising rate environment.

We monitor the sensitivity of reported reserves to interest rate movements on a monthly basis by assessing the expected reduction in valuation of available-for-sale portfolios and cash flow hedges due to parallel movements of plus or minus 100 basis points in all yield curves. The table below describes the sensitivity of our reported reserves to these movements at the end of 2010 and 2009 and the maximum and minimum month-end figures during these years:

Sensitivity of reported reserves to interest rate movements

(Unaudited)

	US$m		Maximum             impact              US$m		Minimum             impact              US$m
At 31 December 2010
+ 100 basis point parallel move in all yield curves ........................................	(6,162)		(6,162)		(3,096)
As a percentage of total shareholders' equity ................................................	(4.2%)		(4.2%)		(2.1%)
- 100 basis point parallel move in all yield curves ........................................	6,174		6,174		3,108
As a percentage of total shareholders' equity ................................................	4.2%		4.2%		2.1%
At 31 December 2009
+ 100 basis point parallel move in all yield curves ........................................	(3,096)		(3,438)		(2,715)
As a percentage of total shareholders' equity ................................................	(2.4%)		(2.7%)		(2.1%)
- 100 basis point parallel move in all yield curves ........................................	3,108		3,380		2,477
As a percentage of total shareholders' equity ................................................	2.4%		2.6%		1.9%

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

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

Defined benefit pension schemes

(Audited)

Market risk arises within our defined benefit pension schemes to the extent that the obligations of the schemes are not fully matched by assets with determinable cash flows. Pension scheme obligations fluctuate with changes in long-term interest rates, inflation, salary levels and the longevity of scheme members. Pension scheme assets include equities and debt securities, the cash flows of which change as equity prices and interest

rates vary. There is a risk that market movements in equity prices and interest rates could result in asset values which, taken together with regular ongoing contributions, are insufficient over time to cover the level of projected obligations and these, in turn, could increase with a rise in inflation and members living longer. Management, together with the trustees who act on behalf of the pension scheme beneficiaries, assess these risks using reports prepared by independent external actuaries, take action and, where appropriate, adjust investment strategies and contribution levels accordingly.

HSBC's defined benefit pension schemes

(Audited)

	2010		2009
	US$bn		US$bn
Liabilities (present value) ...	32.6		30.6
	%		%
Assets:
Equities ..............................	20		21
Debt securities ....................	66		67
Other (including property) .	14		12
	100		100

For details of our defined benefit schemes, see Note 7 on the Financial Statements, and for pension risk management, see page 172.

HSBC Holdings

(Audited)

As a financial services holding company, HSBC Holdings has limited market risk activity. Its activities predominantly involve maintaining sufficient capital resources to support the Group's diverse activities; allocating these capital resources across our businesses; earning dividend and interest income on its investments in our businesses; providing dividend payments to HSBC Holdings' equity shareholders and interest payments to providers of debt capital; and maintaining a supply of short-term cash resources. It does not take proprietary trading positions.

The main market risks to which HSBC Holdings is exposed are interest rate risk and foreign currency risk. Exposure to these risks arises from short-term cash balances, funding positions held, loans to subsidiaries, investments in long-term financial assets and financial liabilities including debt capital issued. The objective of HSBC Holdings' market risk management strategy is to reduce exposure to these risks and minimise volatility in economic income, cash flows and distributable reserves. Market risk for HSBC Holdings is monitored by the Holdings ALCO (formerly the Structural Positions Review Group).

HSBC Holdings has entered into a number of cross-currency swaps to manage the market risk arising on certain long-term debt capital issues for which hedge accounting has not been applied.
Changes in the market values of these swaps are recognised directly in the income statement. HSBC Holdings expects that these swaps will be held to final maturity with the accumulated changes in market value consequently trending to zero.

Certain loans to subsidiaries of a capital nature that are not denominated in the functional currency of either the provider or the recipient are accounted for as financial assets. Changes in the carrying amount of these assets due to exchange differences are taken directly to the income statement. These loans, and the associated foreign exchange exposures, are eliminated on a Group consolidated basis.

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

Sensitivity of net interest income

(Unaudited)

HSBC Holdings monitors net interest income sensitivity over a 5-year time horizon reflecting the longer-term perspective on interest rate risk management appropriate to a financial services holding company. The table below sets out the effect on HSBC Holdings' future net interest income over a 5-year time horizon of incremental 25 basis point parallel falls or rises in all yield curves worldwide at the beginning of each quarter during the 12 months from 1 January 2011.

Sensitivity of HSBC Holdings' net interest income to interest rate movements⁷³

(Unaudited)

Change in projected net interest income as at 31 December  arising from a shift in yield curves	US dollar bloc		Sterling bloc		Euro bloc		Total
	US$m		US$m		US$m		US$m
2010
of + 25 basis points at the beginning of each quarter
0-1 year .............................................................	(6)		19		11		24
2-3 years ...........................................................	(56)		75		62		81
4-5 years ...........................................................	(79)		71		58		50
of - 25 basis points at the beginning of each quarter
0-1 year .............................................................	6		(19)		(11)		(24)
2-3 years ...........................................................	56		(75)		(62)		(81)
4-5 years ...........................................................	79		(71)		(58)		(50)
2009
of + 25 basis points at the beginning of each quarter
0-1 year .............................................................	(13)		18		11		16
2-3 years ...........................................................	(172)		75		19		(78)
4-5 years ...........................................................	(165)		105		6		(54)
of - 25 basis points at the beginning of each quarter
0-1 year .............................................................	12		(18)		(11)		(17)
2-3 years ...........................................................	172		(75)		(19)		78
4-5 years ...........................................................	165		(105)		(6)		54

For footnote, see page 174.

The interest rate sensitivities tabulated above are illustrative only and are based on simplified scenarios. The figures represent the effect of pro forma movements in net interest income based on our projected yield curve scenarios, HSBC Holdings' current interest rate risk profile and assumed changes to that profile during the next five years. Changes to assumptions concerning the risk profile over the next five years can have a significant impact on the net interest income sensitivity for that period. The figures do not take into account the effect of actions that could be taken to mitigate this interest rate risk, however.

Interest repricing gap table

The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included within the Group VAR but is managed on a repricing gap basis. The interest rate repricing gap table below analyses the full term structure of interest rate mismatches within HSBC Holdings' balance sheet. The year-on-year movement in the repricing gap was mainly due to the refinancing of maturing interest bearing capital liabilities with perpetual fixed rate issues.

Repricing gap analysis of HSBC Holdings

(Audited)

	Total		Up to         1 year		1-5 years		5-10 years		More than     10 years		Non-      interest      bearing
	US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2010
Cash at bank and in hand:
- balances with HSBC undertakings ..........	459		339		-		-		-		120
Derivatives ..................................................	2,327		-		-		-		-		2,327
Loans and advances to HSBC undertakings ..	21,238		19,351		-		290		605		992
Financial investments ..................................	2,025		-		300		900		731		94
Investments in subsidiaries ...........................	92,899		1,785		875		1,164		-		89,075
Other assets .................................................	393		-		-		-		-		393
Total assets .................................................	119,341		21,475		1,175		2,354		1,336		93,001
Amounts owed to HSBC undertakings ..........	(2,932)		(2,266)		-		-		-		(666)
Financial liabilities designated at fair values .	(16,288)		-		(7,184)		(4,740)		(3,509)		(855)
Derivatives ..................................................	(827)		-		-		-		-		(827)
Debt securities in issue .................................	(2,668)		-		(1,664)		-		(1,004)		-
Other liabilities ............................................	(1,232)		-		-		-		-		(1,232)
Subordinated liabilities .................................	(13,313)		(750)		(1,579)		(2,140)		(8,680)		(164)
Total equity .................................................	(81,331)		-		-		(7,450)		-		(73,881)
Other non-interest bearing liabilities ............	(750)		-		-		-		-		(750)
Total liabilities and equity ............................	(119,341)		(3,016)		(10,427)		(14,330)		(13,193)		(78,375)
Off-balance sheet items attracting interest rate sensitivity .........................................	-		(15,302)		7,221		4,403		3,409		269
Net interest rate risk gap .............................	-		3,157		(2,031)		(7,573)		(8,448)		14,895
Cumulative interest rate gap ........................	-		3,157		1,126		(6,447)		(14,895)		-
At 31 December 2009
Cash at bank and in hand:
- balances with HSBC undertakings ..........	224		224		-		-		-		-
Derivatives ..................................................	2,981		-		-		-		-		2,981
Loans and advances to HSBC undertakings ..	23,212		16,980		3,084		-		1,896		1,252
Financial investments ..................................	2,455		-		-		300		1,610		545
Investments in subsidiaries ...........................	86,247		1,866		1,217		-		875		82,289
Other assets .................................................	674		-		-		-		-		674
Total assets .................................................	115,793		19,070		4,301		300		4,381		87,741
Amounts owed to HSBC undertakings ..........	(3,711)		(2,898)		-		-		-		(813)
Financial liabilities designated at fair values .	(16,909)		-		(6,108)		(5,017)		(5,015)		(769)
Derivatives ..................................................	(362)		-		-		-		-		(362)
Debt securities in issue .................................	(2,839)		-		(1,784)		-		(1,055)		-
Other liabilities ............................................	(1,257)		-		-		-		-		(1,257)
Subordinated liabilities .................................	(14,406)		(2,850)		(865)		(3,117)		(7,382)		(192)
Total equity .................................................	(75,876)		-		-		-		(3,650)		(72,226)
Other non-interest bearing liabilities ............	(433)		-		-		-		-		(433)
Total liabilities and equity ............................	(115,793)		(5,748)		(8,757)		(8,134)		(17,102)		(76,052)
Off-balance sheet items attracting interest rate sensitivity .........................................	-		(15,302)		6,275		6,306		4,051		(1,330)
Net interest rate risk gap .............................	-		(1,980)		1,819		(1,528)		(8,670)		10,359
Cumulative interest rate gap ........................	-		(1,980)		(161)		(1,689)		(10,359)		-

Value at risk

Total foreign exchange VAR arising within HSBC Holdings in 2010 and 2009 was as follows:

HSBC Holdings - foreign exchange VAR

(Audited)

	Foreign exchange
	2010      US$m		2009       US$m
At 31 December ........................	40.4		83.2
Average .....................................	56.6		76.6
Minimum ...................................	40.2		55.2
Maximum ..................................	83.2		190.8

The foreign exchange risk largely arises from loans to subsidiaries of a capital nature that are not denominated in the functional currency of either the provider or the recipient and which are accounted for as financial assets. Changes in the carrying amount of these loans due to foreign exchange rate differences are taken directly to HSBC Holdings' income statement. These loans, and the associated foreign exchange exposures, are eliminated on a Group consolidated basis.

Operational risk

(Unaudited)

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

The objective of our operational risk management is to manage and control operational risk in a cost effective manner within targeted levels of operational risk consistent with our risk appetite, as defined by the GMB.

A formal governance structure provides oversight over the management of operational risk. A Global Operational Risk and Control Committee, which reports to the Risk Management Meeting, meets at least quarterly to discuss key risk issues and review the effective implementation of our operational risk management framework.

In each of our subsidiaries, business managers are responsible for maintaining an acceptable level of internal control, commensurate with the scale and nature of operations. They are responsible for identifying and assessing risks, designing controls and monitoring the effectiveness of these controls. The operational risk management framework helps managers to fulfil these responsibilities by defining a standard risk assessment methodology and providing a tool for the systematic reporting of operational loss data.

A centralised database is used to record the results of the operational risk management process. Operational risk self-assessments are input and maintained by business units. To ensure that operational risk losses are consistently reported and monitored at Group level, all Group companies are required to report individual losses when the net loss is expected to exceed US$10,000.

Further details of our approach to Operational Risk Management can be found in Pillar 3 Disclosures 2010 which is published as a separate document on www.hsbc.com.

Legal risk

(Unaudited)

Each operating company is required to implement procedures to manage legal risk that conform to our standards. Legal risk falls within the definition of operational risk and includes contractual risk, dispute risk, legislative risk and non-contractual rights risk.

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

·     Dispute risk consists of the risks that an HSBC company is subject to when it is involved in or managing a potential or actual dispute.

·     Legislative risk is the risk that an HSBC company fails to adhere to the laws of the jurisdictions in which it operates.

·     Non-contractual rights risk is the risk that an HSBC company's assets are not properly owned or are infringed by others, or an HSBC company infringes another party's rights.

We have a global legal function to assist management in controlling legal risk. The function provides legal advice and support in managing claims against our companies, as well as in respect of non-routine debt recoveries or other litigation against third parties.

The GMO Legal department oversees the global legal function and is headed by the Group General Counsel. There are legal departments in 58 of the countries in which we operate. There are also regional legal functions in each of Europe, North America, Latin America, the Middle East, and Asia‑Pacific headed by Regional General Counsels.

Our operating companies must notify the appropriate legal department immediately any litigation is either threatened or commenced against HSBC or an employee. Any claims which exceed US$1.5m or equivalent must be advised to the

appropriate regional legal department and the regional legal department must immediately advise the GMO Legal department if any such claim exceeds US$5m. The appropriate regional legal department must also be immediately advised (and must in turn immediately advise the GMO Legal department) of any action by a regulatory authority, where the proceedings are criminal, or where the claim might materially affect our reputation. Insofar as matters relate to GB&M or GPB, notification should also be made to GB&M Legal in London. All such matters are then reported to the Risk Management Meeting in a monthly paper.

In addition, our operating companies are required to submit semi-annual returns detailing outstanding claims where the claim (or group of similar claims) exceeds US$10m, where the action is by a regulatory authority, where the proceedings are criminal, where the claim might materially affect our reputation, or, where the GMO Legal department has requested returns be completed for a particular claim. These returns are used for reporting to the Risk Management Meeting, the Group Audit Committee and the Board, and disclosure in the Annual Report and Accounts andInterim Report, if appropriate.

Compliance risk

(Unaudited)

Compliance risk falls within the definition of operational risk. All Group companies are required to observe the letter and spirit of all relevant laws, codes, rules, regulations and standards of good market practice. These rules, regulations, other standards and Group policies include those relating to anti-money laundering, counter terrorist financing and sanctions compliance.

The Group Compliance function supports line management in ensuring that there are adequate policies and procedures, and is responsible for maintaining adequate resources to mitigate compliance risk. The GMO Compliance department oversees the global compliance function and is headed by the Head of Group Compliance who in turn reports to the Group Chief Risk Officer. There are compliance teams in all of the countries where we operate. These compliance teams are principally overseen by Regional Compliance Officers located in Europe, North America, Latin America, the Middle East and Asia-Pacific.

Group Compliance policies and procedures require the prompt identification and escalation to GMO Compliance of all actual or suspected breaches of any law, rule, regulation, Group policy or other relevant requirement. These escalation procedures are supplemented by a requirement for the submission of compliance certificates at the half-year and year-end by all Group companies detailing any known breaches as above. The contents of these escalation and certification processes are used for reporting to the Risk Management Meeting, the Group Risk Committee and the Board and disclosure in the Annual Report and Accounts and Interim Report, if appropriate.

Group security and fraud risk

(Unaudited)

Security and fraud risk issues are managed at Group level by Group Security and Fraud Risk. This unit, which has responsibility for physical risk, fraud, information and contingency risk, and security and business intelligence, is fully integrated within the central GMO Risk function. This enables management to identify and mitigate the effect of the permutations of these and other non-financial risks on our business lines across the jurisdictions in which we operate.

Risk management of insurance operations

(Audited)

We operate a bancassurance model which provides insurance products for customers with whom we have a banking relationship. Insurance products are sold to all customer groups, mainly utilising retail branches, the internet and phone centres. PFS customers attract the majority of sales and comprise the majority of policyholders.

Many of these insurance products are manufactured by our subsidiaries. This allows us to retain the risks and rewards associated with writing insurance contracts as both the underwriting profit and the commission paid by the manufacturer to the bank distribution channel are kept within the Group.

Where we consider it operationally more effective, third parties are engaged to manufacture insurance products for sale through our banking network. We work with a limited number of market-leading partners to provide the products. These arrangements earn us a commission.

Our bancassurance business operates in all six of our geographical regions with over 30 legal entities, the majority of which are subsidiaries of banking legal entities, manufacturing insurance products.

The insurance contracts we sell primarily relate to core underlying banking activities, such as savings and investment products, and credit life products.

 

END

 

 

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