Annual Financial Report - 28

RNS Number : 4135J

HSBC Holdings PLC

30 March 2010

	Page
Financial Statements
Consolidated income statement ...................	353
Consolidated statement of comprehensive income ...........................................................	354
Consolidated balance sheet .........................	355
Consolidated statement of cash flows..........	356
Consolidated statement of changes in equity .............................................................	357
HSBC Holdings balance sheet .....................	360
HSBC Holdings statement of cash flows......	361
HSBC Holdings statement of changes in equity .............................................................	362
Footnotes to Financial Statements ..........	364

Notes on the Financial Statements
1	Basis of preparation ..............................	365
2	Summary of significant accounting policies .................................................	369
3	Net income/(expense) from financial instruments designated at fair value	385
4	Gains arising from dilution of interests in associates ........................................	386
5	Net earned insurance premiums ..........	386
6	Net insurance claims incurred and movement in liabilities to policyholders .......................................	387
7	Net operating income ............................	388
8	Employee compensation and benefits	388
9	Auditors' remuneration .........................	400
10	Share-based payments ...........................	401
11	Tax expense .............................................	407
12	Dividends .................................................	410
13	Earnings per share .................................	411
14	Segmental analysis ................................	412
15	Analysis of financial assets and liabilities by measurement basis ......	418

		Page
16	Trading assets ........................................	422
17	Financial assets designated at fair value .....................................................	423
18	Derivatives ..............................................	424
19	Financial investments ...........................	428
20	Transfers of financial assets not qualifying for de-recognition ..........	431
21	Interests in associates and joint ventures ................................................	432
22	Goodwill and intangible assets ..........	434
23	Property, plant and equipment ...........	439
24	Investments in subsidiaries ..................	442
25	Other assets .............................................	444
26	Trading liabilities .................................	445
27	Financial liabilities designated at fair value ..............................................	445
28	Debt securities in issue .........................	446
29	Other liabilities ......................................	447
30	Liabilities under insurance contracts	447
31	Provisions ...............................................	450
32	Subordinated liabilities .......................	450
33	Maturity analysis of assets and liabilities .............................................	454
34	Foreign exchange exposures ...............	455
35	Assets charged as security for liabilities and collateral accepted as security for assets ..........................	456
36	Minority interests ..................................	457
37	Called up share capital and other equity instruments ..............................	457
38	Notes on the statement of cash flows ..	461
39	Contingent liabilities, contractual commitments and guarantees ..........	463
40	Lease commitments ................................	465
41	Rights issue .............................................	466
42	Litigation ................................................	467
43	Related party transactions ..................	468
44	Events after the balance sheet date ....	471

Consolidated income statement for the year ended 31 December 2009

		2009	2008	2007
	Notes	US$m	US$m	US$m

Interest income .............................................................................		62,096	91,301	92,359
Interest expense ...........................................................................		(21,366)	(48,738)	(54,564)

Net interest income ......................................................................		40,730	42,563	37,795

Fee income ....................................................................................		21,403	24,764	26,337
Fee expense ...................................................................................		(3,739)	(4,740)	(4,335)

Net fee income ..............................................................................		17,664	20,024	22,002

Trading income excluding net interest income ........................		6,236	847	4,458
Net interest income on trading activities ..................................		3,627	5,713	5,376

Net trading income ..........................................................................		9,863	6,560	9,834

Changes in fair value of long-term debt issued and related derivatives		(6,247)	6,679	2,812
Net income/(expense) from other financial instruments designated at fair value .................................................................................		2,716	(2,827)	1,271

Net income/(expense) from financial instruments designated at fair value ............................................................................................	3	(3,531)	3,852	4,083

Gains less losses from financial investments .....................................		520	197	1,956
Gains arising from dilution of interests in associates .........................	4	-	-	1,092
Dividend income ..............................................................................		126	272	324
Net earned insurance premiums ........................................................	5	10,471	10,850	9,076
Gains on disposal of French regional banks .......................................		-	2,445	-
Other operating income ...................................................................		2,788	1,808	1,439

Total operating income ................................................................		78,631	88,571	87,601

Net insurance claims incurred and movement in liabilities to policyholders ...............................................................................	6	(12,450)	(6,889)	(8,608)

Net operating income before loan impairment charges and other credit risk provisions .....................................................		66,181	81,682	78,993

Loan impairment charges and other credit risk provisions ................	7	(26,488)	(24,937)	(17,242)

Net operating income ...................................................................	7	39,693	56,745	61,751

Employee compensation and benefits ..............................................	8	(18,468)	(20,792)	(21,334)
General and administrative expenses ................................................		(13,392)	(15,260)	(15,294)
Depreciation and impairment of property, plant and equipment ......	23	(1,725)	(1,750)	(1,714)
Goodwill impairment ........................................................................	22	-	(10,564)	-
Amortisation and impairment of intangible assets ............................	22	(810)	(733)	(700)

Total operating expenses .............................................................		(34,395)	(49,099)	(39,042)

Operating profit ...........................................................................		5,298	7,646	22,709

Share of profit in associates and joint ventures .................................	21	1,781	1,661	1,503

Profit before tax ............................................................................		7,079	9,307	24,212

Tax expense ....................................................................................	11	(385)	(2,809)	(3,757)

Profit for the year .........................................................................		6,694	6,498	20,455

Profit attributable to shareholders of the parent company ...............		5,834	5,728	19,133
Profit attributable to minority interests ...........................................		860	770	1,322

		US$	US$	US$

Basic earnings per ordinary share¹ ....................................................	13	0.34	0.41	1.44
Diluted earnings per ordinary share¹ .................................................	13	0.34	0.41	1.42

For footnote, see page 364.

The accompanying notes on pages 365 to 471, the audited sections of 'Report of the Directors: Risk' on pages 196 to 293, 'Critical accounting policies' on pages 61 to 65 and the audited sections of 'Report of the Directors: Impact of Market Turmoil' on pages 151 to 195 form an integral part of these financial statements.

Consolidated statement of comprehensive income for the year ended 31 December 2009

	2009	2008	2007
	US$m	US$m	US$m

Profit for the year .....................................................................................	6,694	6,498	20,455

Other comprehensive income/(expense)
Available-for-sale investments ...................................................................	10,817	(21,904)	(973)
- fair value gains/(losses) .......................................................................	9,821	(23,722)	756
- fair value gains transferred to income statement on disposal ...............	(648)	(1,316)	(1,826)
- amounts transferred to the income statement in respect of impairment losses ..................................................................................................	2,391	1,779	86
- income taxes ......................................................................................	(747)	1,355	11

Cash flow hedges ........................................................................................	772	124	(791)
- fair value gains/(losses) .......................................................................	481	(1,720)	625
- fair value (gains)/losses transferred to income statement ....................	808	1,754	(1,886)
- income taxes ......................................................................................	(517)	90	470

Actuarial gains/(losses) on defined benefit plans .........................................	(2,608)	(1,175)	1,525
- before income taxes ...........................................................................	(3,586)	(1,609)	2,167
- income taxes ......................................................................................	978	434	(642)

Share of other comprehensive income/(expense) of associates and joint ventures .................................................................................................	149	(559)	372
Exchange differences .................................................................................	4,975	(12,123)	5,946

Other comprehensive income/(expense) for the year, net of tax ................	14,105	(35,637)	6,079

Total comprehensive income/(expense) for the year .................................	20,799	(29,139)	26,534

Total comprehensive income/(expense) for the year attributable to:
- shareholders of the parent company ...................................................	19,529	(29,143)	24,866
- minority interests ...............................................................................	1,270	4	1,668

	20,799	(29,139)	26,534

Consolidated balance sheet at 31 December 2009

		2009	2008
	Notes	US$m	US$m
ASSETS

Cash and balances at central banks ...............................................................................		60,655	52,396
Items in the course of collection from other banks ......................................................		6,395	6,003
Hong Kong Government certificates of indebtedness ...................................................		17,463	15,358
Trading assets ..............................................................................................................	16	421,381	427,329
Financial assets designated at fair value ........................................................................	17	37,181	28,533
Derivatives ..................................................................................................................	18	250,886	494,876
Loans and advances to banks .......................................................................................		179,781	153,766
Loans and advances to customers .................................................................................		896,231	932,868
Financial investments ..................................................................................................	19	369,158	300,235
Other assets .................................................................................................................	25	44,534	37,822
Current tax assets ........................................................................................................		2,937	2,552
Prepayments and accrued income ................................................................................		12,423	15,797
Interests in associates and joint ventures ......................................................................	21	13,011	11,537
Goodwill and intangible assets ......................................................................................	22	29,994	27,357
Property, plant and equipment ....................................................................................	23	13,802	14,025
Deferred tax assets .......................................................................................................	11	8,620	7,011

Total assets .................................................................................................................		2,364,452	2,527,465

LIABILITIES AND EQUITY

Liabilities
Hong Kong currency notes in circulation .....................................................................		17,463	15,358
Deposits by banks ........................................................................................................		124,872	130,084
Customer accounts .......................................................................................................		1,159,034	1,115,327
Items in the course of transmission to other banks ......................................................		5,734	7,232
Trading liabilities .........................................................................................................	26	268,130	247,652
Financial liabilities designated at fair value ...................................................................	27	80,092	74,587
Derivatives ..................................................................................................................	18	247,646	487,060
Debt securities in issue .................................................................................................	28	146,896	179,693
Other liabilities ............................................................................................................	29	68,640	72,384
Current tax liabilities ...................................................................................................		2,140	1,822
Liabilities under insurance contracts .............................................................................	30	53,707	43,683
Accruals and deferred income .......................................................................................		13,190	15,448
Provisions ...................................................................................................................	31	1,965	1,730
Deferred tax liabilities ..................................................................................................	11	1,837	1,855
Retirement benefit liabilities ........................................................................................	8	6,967	3,888
Subordinated liabilities ..................................................................................................	32	30,478	29,433

Total liabilities ............................................................................................................		2,228,791	2,427,236

Equity
Called up share capital .................................................................................................	37	8,705	6,053
Share premium account ................................................................................................		8,413	8,463
Other equity instruments .............................................................................................		2,133	2,133
Other reserves .............................................................................................................		22,236	(3,747)
Retained earnings .........................................................................................................		86,812	80,689

Total shareholders' equity ...........................................................................................		128,299	93,591
Minority interests ........................................................................................................	36	7,362	6,638

Total equity .................................................................................................................		135,661	100,229

Total equity and liabilities ............................................................................................		2,364,452	2,527,465

S K Green, Group Chairman

Consolidated statement of cash flows for the year ended 31 December 2009

		2009	2008	2007
	Notes	US$m	US$m	US$m

Cash flows from operating activities
Profit before tax ..............................................................................		7,079	9,307	24,212

Adjustments for:
- non-cash items included in profit before tax ..............................	38	31,384	41,305	21,701
- change in operating assets .........................................................	38	(20,803)	18,123	(176,538)
- change in operating liabilities ....................................................	38	14,645	(63,413)	250,095
- elimination of exchange differences² .........................................		(19,024)	36,132	(18,602)
- net gain from investing activities ..............................................		(1,910)	(4,195)	(2,209)
- share of profits in associates and joint ventures .........................		(1,781)	(1,661)	(1,503)
- dividends received from associates .............................................		414	655	363
- contributions paid to defined benefit plans .................................		(974)	(719)	(1,393)
- tax paid .....................................................................................		(2,132)	(5,114)	(5,088)

Net cash generated from operating activities ....................................		6,898	30,420	91,038

Cash flows from investing activities
Purchase of financial investments ....................................................		(304,629)	(277,023)	(260,980)
Proceeds from the sale and maturity of financial investments ..........		241,341	223,138	238,647
Purchase of property, plant and equipment ......................................		(2,000)	(2,985)	(2,720)
Proceeds from the sale of property, plant and equipment .................		4,701	2,467	3,178
Proceeds from the sale of loan portfolios .........................................		4,852	9,941	1,665
Net purchase of intangible assets ......................................................		(956)	(1,169)	(950)
Net cash inflow/(outflow) from acquisition of or increase in stake of subsidiaries ...............................................................................		(677)	1,313	(623)
Net cash inflow from disposal of subsidiaries ....................................		45	2,979	187
Net cash outflow from acquisition of or increase in stake of associates .................................................................................		(62)	(355)	(351)
Net cash inflow from the consolidation of funds ..............................		-	16,500	1,600
Proceeds from disposal of associates and joint ventures ....................		308	101	69

Net cash used in investing activities .................................................		(57,077)	(25,093)	(20,278)

Cash flows from financing activities
Issue of ordinary share capital ..........................................................		18,398	467	474
- rights issue .................................................................................		18,326	-	-
- other .........................................................................................		72	467	474

Issue of other equity instruments ......................................................		-	2,133	-
Net (purchases)/sales of own shares for market-making and investment purposes .....................................................................		(176)	(194)	126
Purchases of own shares to meet share awards and share option awards ...............................................................................		(51)	(808)	(636)
On exercise of share options ............................................................		12	27	104
Subordinated loan capital issued ........................................................		2,959	7,094	5,705
Subordinated loan capital repaid .......................................................		(4,637)	(350)	(689)
Dividends paid to shareholders of the parent company .....................		(4,264)	(7,211)	(6,003)
Dividends paid to minority interests .................................................		(702)	(714)	(718)
Dividends paid to holders of other equity instruments ......................		(269)	(92)	-

Net cash generated from/(used in) financing activities ......................		11,270	352	(1,637)

Net increase/(decrease) in cash and cash equivalents .............		(38,909)	5,679	69,123

Cash and cash equivalents at 1 January .............................................		278,872	297,009	215,486
Exchange differences in respect of cash and cash equivalents ...........		10,803	(23,816)	12,400

Cash and cash equivalents at 31 December .......................................	38	250,766	278,872	297,009

For footnote, see page 364.

Consolidated statement of changes in equity for the year ended 31 December 2009

	2009
					Other reserves
	Called up share capital	Share premium⁴	Other equity instru- ments	Retained earnings^3,5	Available- for-sale fair value reserve	Cash flow hedging reserve⁶	Foreign exchange reserve	Share- based payment reserve	Merger reserve^3,7	Total share- holders' equity	Minority interests	Total equity
	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m

At 1 January .................................................	6,053	8,463	2,133	80,689	(20,550)	(806)	(1,843)	1,995	17,457	93,591	6,638	100,229
Profit for the year ........................................	-	-	-	5,834	-	-	-	-	-	5,834	860	6,694

Other comprehensive income (net of tax) ....	-	-	-	(2,536)	10,603	791	4,837	-	-	13,695	410	14,105
Available-for-sale investments ......................	-	-	-	-	10,603	-	-	-	-	10,603	214	10,817
Cash flow hedges ...........................................	-	-	-	-	-	791	-	-	-	791	(19)	772
Actuarial gains/(losses) on defined benefit plans .........................................................	-	-	-	(2,685)	-	-	-	-	-	(2,685)	77	(2,608)
Share of other comprehensive income of associates and joint ventures .....................	-	-	-	149	-	-	-	-	-	149	-	149
Exchange differences ....................................	-	-	-	-	-	-	4,837	-	-	4,837	138	4,975

Total comprehensive income for the year ....	-	-	-	3,298	10,603	791	4,837	-	-	19,529	1,270	20,799

Shares issued under employee share plans ......	4	69	-	-	-	-	-	-	-	73	-	73
Shares issued in lieu of dividends and amounts arising thereon⁴ ...........................	118	(119)	-	1,670	-	-	-	-	-	1,669	-	1,669
Shares issued in respect of rights issue ...........	2,530	-	-	-	-	-	-	-	15,796	18,326	-	18,326
Dividends to shareholders ..............................	-	-	-	(5,639)	-	-	-	-	-	(5,639)	(832)	(6,471)
Tax credit on dividends .................................	-	-	-	50	-	-	-	-	-	50	-	50
Own shares adjustment ..................................	-	-	-	(227)	-	-	-	-	-	(227)	-	(227)
Exercise and lapse of share options and vesting of share awards ..............................	-	-	-	807	-	-	-	(769)	-	38	-	38
Cost of share-based payment arrangements ...	-	-	-	-	-	-	-	683	-	683	-	683
Income taxes on share-based payments .........	-	-	-	9	-	-	-	-	-	9	-	9
Other movements .........................................	-	-	-	210	(18)	(11)	-	16	-	197	77	274
Transfers⁷ .....................................................	-	-	-	5,945	-	-	-	-	(5,945)	-	-	-
Net increase in minority interest arising on acquisitions, disposals and capital issuance .	-	-	-	-	-	-	-	-	-	-	209	209

At 31 December ...........................................	8,705	8,413	2,133	86,812	(9,965)	(26)	2,994	1,925	27,308	128,299	7,362	135,661

Consolidated statement of changes in equity for the year ended 31 December 2009 (continued)

	2008
					Other reserves
	Called up share capital	Share premium⁴	Other equity instru- ments⁸	Retained earnings^3,5	Available- for-sale fair value reserve	Cash flow hedging reserve⁶	Foreign exchange reserve	Share- based payment reserve	Merger reserve^3,7	Total share- holders' equity	Minority interests	Total equity
	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m

At 1 January .................................................	5,915	8,134	-	81,097	850	(917)	10,055	1,968	21,058	128,160	7,256	135,416
Profit for the year ........................................	-	-	-	5,728	-	-	-	-	-	5,728	770	6,498

Other comprehensive income (net of tax) ....	-	-	-	(1,605)	(21,474)	106	(11,898)	-	-	(34,871)	(766)	(35,637)
Available-for-sale investments ......................	-	-	-	-	(21,474)	-	-	-	-	(21,474)	(430)	(21,904)
Cash flow hedges ...........................................	-	-	-	-	-	106	-	-	-	106	18	124
Actuarial gains/(losses) on defined benefit plans .........................................................	-	-	-	(1,046)	-	-	-	-	-	(1,046)	(129)	(1,175)
Share of other comprehensive income of associates and joint ventures .....................	-	-	-	(559)	-	-	-	-	-	(559)	-	(559)
Exchange differences ....................................	-	-	-	-	-	-	(11,898)	-	-	(11,898)	(225)	(12,123)

Total comprehensive income for the year ....	-	-	-	4,123	(21,474)	106	(11,898)	-	-	(29,143)	4	(29,139)

Shares issued under employee share plans ......	20	450	-	-	-	-	-	-	-	470	-	470
Shares issued in lieu of dividends and amounts arising thereon⁴ ...........................	118	(121)	-	3,596	-	-	-	-	-	3,593	-	3,593
Capital securities issued⁸ ................................	-	-	2,133	-	-	-	-	-	-	2,133	-	2,133
Dividends to shareholders .............................	-	-	-	(11,301)	-	-	-	-	-	(11,301)	(813)	(12,114)
Own shares adjustment ..................................	-	-	-	(1,002)	-	-	-	-	-	(1,002)	-	(1,002)
Exercise and lapse of share options and vesting of share awards ..............................	-	-	-	827	-	-	-	(848)	-	(21)	-	(21)
Cost of share-based payment arrangements ...	-	-	-	-	-	-	-	819	-	819	-	819
Other movements .........................................	-	-	-	(252)	74	5	-	56	-	(117)	73	(44)
Transfers⁷ .....................................................	-	-	-	3,601	-	-	-	-	(3,601)	-	-	-
Net increase in minority interest arising on acquisitions, disposals and capital issuance .	-	-	-	-	-	-	-	-	-	-	118	118

At 31 December ...........................................	6,053	8,463	2,133	80,689	(20,550)	(806)	(1,843)	1,995	17,457	93,591	6,638	100,229

	2007
				Other reserves
	Called up share capital	Share premium⁴	Retained earnings^3,5	Available- for-sale fair value reserve	Cash flow hedging reserve⁶	Foreign exchange reserve	Share- based payment reserve	Merger reserve^3,7	Total share- holders' equity	Minority interests	Total equity
	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m	US$m

At 1 January ...................................................................	5,786	7,789	65,397	2,005	(101)	4,307	2,111	21,058	108,352	6,576	114,928
Profit for the year ..........................................................	-	-	19,133	-	-	-	-	-	19,133	1,322	20,455
Other comprehensive income (net of tax) ......................	-	-	1,951	(1,156)	(810)	5,748	-	-	5,733	346	6,079
Available-for-sale investments .......................................	-	-	-	(1,156)	-	-	-	-	(1,156)	183	(973)
Cash flow hedges ............................................................	-	-	-	-	(810)	-	-	-	(810)	19	(791)
Actuarial gains/(losses) on defined benefit plans ..............	-	-	1,579	-	-	-	-	-	1,579	(54)	1,525
Share of other comprehensive income of associates and joint ventures .............................................................	-	-	372	-	-	-	-	-	372	-	372
Exchange differences ......................................................	-	-	-	-	-	5,748	-	-	5,748	198	5,946

Total comprehensive income for year ............................	-	-	21,084	(1,156)	(810)	5,748	-	-	24,866	1,668	26,534

Shares issued under employee share plans ........................	17	460	-	-	-	-	-	-	477	-	477
Shares issued in lieu of dividends and amounts arising thereon⁴ ..........................................................	112	(115)	4,354	-	-	-	-	-	4,351	-	4,351
Dividends to shareholders................................................	-	-	(10,241)	-	-	-	-	-	(10,241)	(788)	(11,029)
Own shares adjustment ...................................................	-	-	(510)	-	-	-	-	-	(510)	-	(510)
Exercise and lapse of share options and vesting of share awards ................................................................	-	-	758	-	-	-	(751)	-	7	-	7
Cost of share-based payment arrangements ....................	-	-	-	-	-	-	870	-	870	-	870
Income taxes on share-based payments ..........................	-	-	(65)	-	-	-	-	-	(65)	-	(65)
Other movements ..........................................................	-	-	320	1	(6)	-	(262)	-	53	(91)	(38)
Net increase in minority interest arising on acquisitions, disposals and capital issuance ......................................	-	-	-	-	-	-	-	-	-	(109)	(109)

At 31 December .............................................................	5,915	8,134	81,097	850	(917)	10,055	1,968	21,058	128,160	7,256	135,416

Dividends per ordinary share at 31 December 2009 were US$0.34 (2008: US$0.93; 2007: US$0.87).

For footnotes, see page 364.

HSBC Holdings balance sheet at 31 December 2009

		2009	2008
	Notes	US$m	US$m

ASSETS

Cash at bank and in hand:
- balances with HSBC undertakings .......................................................................		224	443
Derivatives ...............................................................................................................	18	2,981	3,682
Loans and advances to HSBC undertakings ................................................................		23,212	11,804
Financial investments ...............................................................................................		2,455	2,629
Other assets ..............................................................................................................		4	25
Current tax assets ......................................................................................................		562	-
Prepayments and accrued income ..............................................................................		102	58
Investments in subsidiaries ........................................................................................	24	86,247	81,993
Property, plant and equipment ..................................................................................		6	6
Deferred tax assets ....................................................................................................	11	-	42

Total assets ...............................................................................................................		115,793	100,682


LIABILITIES AND EQUITY

Liabilities
Amounts owed to HSBC undertakings ........................................................................		3,711	4,042
Financial liabilities designated at fair value ................................................................	27	16,909	16,389
Derivatives ...............................................................................................................	18	362	1,324
Debt securities in issue ...............................................................................................	28	2,839	-
Other liabilities .........................................................................................................	29	1,257	1,816
Current tax liabilities .................................................................................................		-	219
Accruals and deferred income ....................................................................................		419	288
Deferred tax liabilities ...............................................................................................	11	14	-
Subordinated liabilities ...............................................................................................	32	14,406	14,017

Total liabilities ..........................................................................................................		39,917	38,095

Equity
Called up share capital ...............................................................................................	37	8,705	6,053
Share premium account .............................................................................................		8,413	8,463
Other equity instruments ...........................................................................................	37	2,133	2,133
Merger reserve and other reserves .............................................................................		35,127	25,341
Other reserves ...........................................................................................................		3,642	3,503
Retained earnings ......................................................................................................		17,856	17,094

Total equity ..............................................................................................................		75,876	62,587

Total equity and liabilities .........................................................................................		115,793	100,682

S K Green, Group Chairman

HSBC Holdings statement of cash flows for the year ended 31 December 2009

		2009	2008
	Notes	US$m	US$m
Cash flows from operating activities
Profit before tax ..........................................................................................................		(2,058)	7,931

Adjustments for:
- non-cash items included in profit before tax ..........................................................	38	5,974	3,619
- change in operating assets .....................................................................................	38	(11,077)	3,263
- change in operating liabilities ................................................................................	38	2,040	(2,035)
- elimination of exchange differences² .....................................................................		1	-
- tax (paid)/received ................................................................................................		266	(370)

Net cash (used in)/generated from operating activities .................................................		(4,854)	12,408

Cash flows from investing activities
Purchase of financial investments ................................................................................		-	(300)
Proceeds from sale of financial investments ................................................................		275	349
Purchase of property, plant and equipment ..................................................................		(2)	(5)
Net cash outflow from acquisition of or increase in stake of subsidiaries .......................		(10,344)	(14,320)

Net cash used in investing activities .............................................................................		(10,071)	(14,276)

Cash flows from financing activities
Issue of ordinary share capital ......................................................................................		18,333	467
- rights issue ............................................................................................................		18,261	-
- other .....................................................................................................................		72	467

Issue of other equity instruments .................................................................................		-	2,133
Purchases of own shares to meet share awards and share option awards ........................		-	(54)
On exercise of share options ........................................................................................		12	3
Subordinated loan capital issued ....................................................................................		2,456	6,705
Subordinated loan capital repaid ...................................................................................		(4,380)	-
Debt securities issued ....................................................................................................		2,818	-
Dividends paid .............................................................................................................		(4,264)	(7,211)
Dividends paid to holders of other equity instruments ..................................................		(269)	(92)

Net cash generated from financing activities ................................................................		14,706	1,951

Net increase/(decrease) in cash and cash equivalents .........................................		(219)	83

Cash and cash equivalents at 1 January .........................................................................		443	360

Cash and cash equivalents at 31 December ...................................................................	38	224	443

For footnote, see page 364.

HSBC Holdings statement of changes in equity for the year ended 31 December 2009

	2009
						Other reserves
	Called up share capital	Share premium⁴	Other equity instru- ments	Retained earnings⁹	Available- for-sale fair value reserve		Other paid-in capital	Share- based payment reserve	Merger and other reserves⁷	Total share- holders' equity
	US$m	US$m	US$m	US$m		US$m	US$m	US$m	US$m	US$m

At 1 January .................	6,053	8,463	2,133	17,094		190	1,318	1,995	25,341	62,587
Profit for the year ........	-	-	-	(1,096)		-	-	-	-	(1,096)
Other comprehensive income (net of tax) ...	-	-	-	-		63	-	-	-	63
Available-for-sale investments ...............	-	-	-	-		103	-	-	-	103
Income tax ...................	-	-	-	-		(40)	-	-	-	(40)

Total comprehensive income for the year ..	-	-	-	(1,096)		63	-	-	-	(1,033)
Shares issued under employee share plans	4	69	-	-		-	-	-	-	73
Shares issued in lieu of dividends and amounts arising thereon⁴ .........	118	(119)	-	1,670		-	-	-	-	1,669
Shares issued in respect of rights issue .................	2,530	-	-	-		-	-	-	15,731	18,261
Dividends to shareholders	-	-	-	(5,639)		-	-	-	-	(5,639)
Own shares adjustment ..	-	-	-	(188)		-	-	-	-	(188)
Exercise and lapse of share options and vesting of share awards ..............	-	-	-	-		-	146	(146)	-	-
Cost of share-based payment arrangements	-	-	-	-		-	-	163	-	163
Income taxes on share- based payments .........	-	-	-	19		-	-	-	-	19
Equity investments granted to employees of subsidiaries under employee share plans	-	-	-	-		-	-	(99)	-	(99)
Other movements .........	-	-	-	51		-	-	12	-	63
Transfers⁷ .....................	-	-	-	5,945		-	-	-	(5,945)	-

At 31 December ............	8,705	8,413	2,133	17,856		253	1,464	1,925	35,127	75,876

	2008
						Other reserves
	Called up share capital	Share premium⁴	Other equity instru- ments⁸	Retained earnings⁹	Available- for-sale fair value reserve		Other paid-in capital	Share- based payment reserve	Merger and other reserves⁷	Total share- holders' equity
	US$m	US$m	US$m	US$m		US$m	US$m	US$m	US$m	US$m

At 1 January .................	5,915	8,134	-	14,209		482	1,181	1,968	28,942	60,831
Profit for the year ........	-	-	-	7,644		-	-	-	-	7,644

Other comprehensive income (net of tax) ...	-	-	-	-		(292)	-	-	-	(292)
Available-for-sale investments ...............	-	-	-	-		(356)	-	-	-	(356)
Income tax ...................	-	-	-	-		64	-	-	-	64

Total comprehensive income for the year ..	-	-	-	7,644		(292)	-	-	-	7,352
Shares issued under employee share plans	20	450	-	-		-	-	-	-	470
Shares issued in lieu of dividends and amounts arising thereon⁴ .........	118	(121)	-	3,596		-	-	-	-	3,593
Capital securities issued⁸	-	-	2,133			-	-	-	-	2,133
Dividends to shareholders	-	-	-	(11,301)		-	-	-	-	(11,301)
Own shares adjustment ..	-	-	-	(647)		-	-	-	-	(647)
Exercise and lapse of share options and vesting of share awards ..............	-	-	-	-		-	137	(75)	-	62
Cost of share-based payment arrangements	-	-	-	-		-	-	14	-	14
Income taxes on share- based payments .........	-	-	-	(2)		-	-	-	-	(2)
Equity investments granted to employees of subsidiaries under employee share plans	-	-	-	-		-	-	87	-	87
Other movements .........	-	-	-	(6)		-	-	1	-	(5)
Transfers⁷ .....................	-	-	-	3,601		-	-	-	(3,601)	-

At 31 December ............	6,053	8,463	2,133	17,094		190	1,318	1,995	25,341	62,587

Dividends per ordinary share at 31 December 2009 were US$0.34 (2008: US$0.93; 2007: US$0.87).

For footnotes, see 364.

Footnotes to Financial Statements

1 The effect of the bonus element within the rights issue has been included within the calculation of basic and diluted earnings per share for the period, through an adjustment to the weighted average number of ordinary and dilutive potential ordinary shares outstanding. Comparative data has been restated on this basis.

2 Adjustment to bring changes between opening and closing balance sheet amounts to average rates. This is not done on a line-by-line basis, as details cannot be determined without unreasonable expense.

3 Cumulative goodwill amounting to US$5,138 million has been charged against reserves in respect of acquisitions of subsidiaries prior to 1 January 1998, including US$3,469 million charged against the merger reserve arising on the acquisition of HSBC Bank plc. The balance of US$1,669 million has been charged against retained earnings.

4 Share premium includes the deduction of US$1 million in respect of issuance costs incurred during the year (2008: US$3 million; 2007: US$3 million).

5 Retained earnings include 179,964,968 (US$2,572 million) of own shares held within HSBC's insurance business, retirement funds for the benefit of policyholders or beneficiaries within employee trusts for the settlement of shares expected to be delivered under employee share schemes or bonus plans, and the market-making activities in Global Markets (2008: 194,751,829 (US$3,094 million); 2007: 158,706,463 (US$2,649 million)).

6 Amounts transferred to the income statement in respect of cash flow hedges include US$502 million (2008: US$152 million; 2007: US$57 million) taken to 'Net interest income' and US$306 million (2008: US$1,602 million; 2007: US$1,829 million) taken to 'Net trading income'.

7 Statutory share premium relief under Section 131 of the Companies Act 1985 (the 'Act') was taken in respect of the acquisition of HSBC Bank plc in 1992, HSBC France in 2000 and HSBC Finance Corporation in 2003 and the shares issued were recorded at their nominal value only. In HSBC's consolidated financial statements the fair value differences of US$8,290 million in respect of HSBC France and US$12,768 million in respect of HSBC Finance Corporation were recognised in the merger reserve. The merger reserve created on the acquisition of HSBC Finance Corporation subsequently became attached to HSBC Overseas Holdings (UK) Limited ('HOHU'), following a number of inter-group reorganisations. At 31 December 2009, an amount of US$5,945 million (2008: US$3,601 million) was transferred from this reserve to retained earnings as a result of impairment in HSBC Holdings' investment in HOHU. During 2009, pursuant to section 131 of the Companies Act 1985, statutory share premium relief was taken in respect of the rights issue and US$15,796 million was recognised in the merger reserve. The merger reserve includes the deduction of US$614 million in respect of costs relating to the rights issue, of which US$149 million was subsequently transferred to the income statement. Of this US$149 million, US$121 million was a loss arising from accounting for the agreement with the underwriters as a contingent forward contract. The merger reserve excludes the loss of US$344 million on a forward foreign exchange contract associated with hedging the proceeds of the rights issue. For further details see Note 41 on the Financial Statements.

8 In April 2008, HSBC Holdings issued US$2,200 million of Perpetual Subordinated Capital Securities, including US$67 million of issuance costs, which are classified as equity under IFRSs.

9 Retained earnings include 38,446,053 (US$562 million) of own shares held to fund employee share plans (2008: 36,995,330 (US$562 million)).

1 Basis of preparation

(a) Compliance with International Financial Reporting Standards

The consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings have been prepared in accordance with International Financial Reporting Standards ('IFRSs') as issued by the International Accounting Standards Board ('IASB') and as endorsed by the EU. EU-endorsed IFRSs may differ from IFRSs as issued by the IASB if, at any point in time, new or amended IFRSs have not been endorsed by the EU. At 31 December 2009, there were no unendorsed standards effective for the year ended 31 December 2009 affecting these consolidated and separate financial statements, and there was no difference between IFRSs endorsed by the EU and IFRSs issued by the IASB in terms of their application to HSBC. Accordingly, HSBC's financial statements for the year ended 31 December 2009 are prepared in accordance with IFRSs as issued by the IASB.

IFRSs comprise accounting standards issued by the IASB and its predecessor body as well as interpretations issued by the International Financial Reporting Interpretations Committee ('IFRIC') and its predecessor body.

During 2009, HSBC adopted the following significant standards and amendments to standards:

· 'Classification of Rights Issues - Amendment to IAS 32', ('the amendment') which is effective for annual periods beginning on or after 1 February 2010, with early adoption permitted. HSBC has elected to adopt the amendment in advance of the effective date and, as required by IAS 8, has applied the amendment retrospectively. The amendment requires that rights issues, options or warrants to acquire a fixed number of the entity's own equity instruments for a fixed amount of any currency are equity instruments if the entity offers the rights issues, options or warrants pro rata to all of its existing owners of the same class of its own non-derivative equity instruments. The offer of rights by HSBC Holdings plc to its shareholders on 20 March 2009 was accounted for as an equity instrument, as required by the amendment, in the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings.

· IFRS 8 'Operating Segments' ('IFRS 8'), which replaced IAS 14 'Segment Reporting' requires an entity to disclose information about its segments which enables users to evaluate the nature and financial effects of its business activities and the economic environments in which it operates. HSBC's operating segments are organised into six geographical regions; Europe, Hong Kong, Rest of Asia-Pacific, Middle East, North America and Latin America. Due to the nature of the Group, HSBC's chief operating decision-maker regularly reviews operating activity on a number of bases, including by geographical region, customer group and global business, and retail businesses by geographical region. HSBC's IFRS 8 operating segments were determined to be geographical regions because the chief operating decision-maker primarily uses information on geographical regions in order to make decisions about allocating resources and assessing performance.

IFRS 8 requires segment financial information to be reported using the same measures reported to the chief operating decision-maker for the purpose of making decisions about allocating resources to the operating segments and assessing their performance. Information provided to the chief operating decision-maker of HSBC to make decisions about allocating resources and assessing performance of operating segments is measured in accordance with IFRSs.

· IAS 1 'Presentation of Financial Statements' ('IAS 1') (Revised 2007) aims to improve users' ability to analyse and compare information given in financial statements. The adoption of the revised standard had no effect on the results reported in HSBC's consolidated financial statements or the separate financial statements of HSBC Holdings. It did, however, result in certain presentational changes in HSBC's consolidated financial statements, including:

- the presentation of all items of income and expenditure in two financial statements, the 'Consolidated income statement' and the 'Consolidated statement of comprehensive income'; and

- the presentation of the 'Consolidated statement of changes in equity' as a financial statement replaces the previous 'Equity' note on the financial statements.

· An amendment to IFRS 7 'Financial Instruments: Disclosures - Improving Disclosures about Financial Instruments'. The most significant additional disclosures required by this amendment in the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings include tables of fair

value measurements disclosing the source of inputs using a three level fair value hierarchy, and reconciliations of the movements between opening and closing balances of Level 3 financial instruments, being those measured at fair value using a valuation technique with significant unobservable inputs.

During 2009, in addition to the above, HSBC adopted a number of standards, interpretations and amendments thereto which had an insignificant effect on the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings.

(b) Differences between IFRSs and Hong Kong Financial Reporting Standards

There are no significant differences between IFRSs and Hong Kong Financial Reporting Standards in terms of their application to HSBC and consequently there would be no significant differences had the financial statements been prepared in accordance with Hong Kong Financial Reporting Standards. The Notes on the Financial Statements, taken together with the Report of the Directors, include the aggregate of all disclosures necessary to satisfy IFRSs and Hong Kong reporting requirements.

Disclosures under IFRS 4 'Insurance Contracts' ('IFRS 4') and IFRS 7 concerning the nature and extent of risks relating to insurance contracts and financial instruments have been included in the audited sections of the 'Report of the Directors: Risk' on pages 196 to 293.

Capital disclosures under IAS 1 have been included in the audited sections of 'Capital management and allocation' on pages 285 to 291.

Disclosures relating to the effect of the recent market turmoil on HSBC's securitisation activities and structured products, and disclosures under IFRS 7 relating to the fair value of financial instruments, have been included in the audited section of 'Report of the Directors: Impact of Market Turmoil' on pages 151 to 195.

In publishing the parent company financial statements here together with the Group financial statements, HSBC Holdings has taken advantage of the exemption in section 408(3) of the Companies Act 2006 not to present its individual income statement and related notes that form a part of these financial statements.

HSBC's consolidated financial statements are presented in US dollars which is also HSBC Holdings' functional currency. HSBC Holdings' functional currency is the US dollar because the US dollar and currencies linked to it are the most significant currencies relevant to the underlying transactions, events and conditions of its subsidiaries, as well as representing a significant proportion of its funds generated from financing activities. HSBC uses the US dollar as its presentation currency in its consolidated financial statements because the US dollar and currencies linked to it form the major currency bloc in which HSBC transacts and funds its business.

(d) Comparative information

As required by US public company reporting requirements, these consolidated financial statements include two years of comparative information for the consolidated income statement, consolidated statement of comprehensive income, consolidated statement of cash flows, consolidated statement of changes in equity and related notes on the financial statements.

(e) Use of estimates and assumptions

The preparation of financial information requires the use of estimates and assumptions about future conditions. The use of available information and the application of judgement are inherent in the formation of estimates; actual results in the future may differ from estimates upon which financial information is prepared. Management believes that HSBC's critical accounting policies where judgement is necessarily applied are those which relate to impairment of loans and advances, goodwill impairment, the valuation of financial instruments, the impairment of available-for-sale financial assets and deferred tax assets (see 'Critical Accounting Policies' on pages 61 to 65, which form an integral part of these financial statements).

Further information about key assumptions concerning the future, and other key sources of estimation uncertainty, are set out in the notes on the financial statements.

(f) Consolidation

The consolidated financial statements of HSBC comprise the financial statements of HSBC Holdings and its subsidiaries made up to 31 December, with the exception of the banking and insurance subsidiaries of HSBC Bank Argentina, whose financial statements are made up to 30 June annually to comply with local regulations. Accordingly, HSBC uses their audited interim financial statements, drawn up to 31 December annually.

Subsidiaries are consolidated from the date that HSBC gains control. The purchase method of accounting is used to account for the acquisition of subsidiaries by HSBC. The cost of an acquisition is measured at the fair value of the consideration given at the date of exchange, together with costs directly attributable to that acquisition. The acquired identifiable assets, liabilities and contingent liabilities are measured at their fair values at the date of acquisition. Any excess of the cost of acquisition over the fair value of HSBC's share of the identifiable assets, liabilities and contingent liabilities acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of HSBC's share of the identifiable assets, liabilities and contingent liabilities of the business acquired, the difference is recognised immediately in the income statement.

Entities that are controlled by HSBC are consolidated until the date that control ceases.

In the context of Special Purpose Entities ('SPE's), the following circumstances may indicate a relationship in which, in substance, HSBC controls and consequently consolidates an SPE:

- the activities of the SPE are being conducted on behalf of HSBC according to its specific business needs so that HSBC obtains benefits from the SPE's operation;

- HSBC has the decision-making powers to obtain the majority of the benefits of the activities of the SPE or, by setting up an 'autopilot' mechanism, HSBC has delegated these decision-making powers;

- HSBC has rights to obtain the majority of the benefits of the SPE and therefore may be exposed to risks incident to the activities of the SPE; or

- 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.

HSBC performs a re-assessment of consolidation whenever there is a change in the substance of the relationship between HSBC and an SPE.

All intra-HSBC transactions are eliminated on consolidation.

The consolidated financial statements of HSBC also include the attributable share of the results and reserves of joint ventures and associates. These are based on financial statements made up to 31 December, with the exception of the Bank of Communications, Ping An Insurance and Industrial Bank which are included on the basis of financial statements made up for the twelve months to 30 September. These are equity accounted three months in arrears in order to meet the requirements of the Group's reporting timetable. HSBC has taken into account the effect of significant transactions or events that occur between the period from 1 October to 31 December that would have a material effect on its results.

(g) Future accounting developments

At 31 December 2009, a number of standards and interpretations, and amendments thereto, had been issued by the IASB, which are not effective for HSBC's consolidated financial statements or the separate financial statements of HSBC Holdings as at 31 December 2009. Those which are expected to have a significant effect on HSBC's consolidated financial statements and the separate financial statements of HSBC Holdings are discussed below.

Standards and Interpretations issued by the IASB and endorsed by the EU

A revised IFRS 3 'Business Combinations' and amendments to IAS 27 'Consolidated and Separate Financial Statements' were issued on 10 January 2008. The revisions and amendments to the standards apply prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual financial reporting period beginning on or after 1 July 2009. The main changes under the standards are that:

- acquisition-related costs are recognised as an expense in the income statement in the period in which they are incurred;

- all consideration transferred, including contingent consideration, is recognised and measured at fair value at the acquisition date;

- equity interests held prior to control being obtained are remeasured to fair value at the date of obtaining control, and any gain or loss is recognised in the income statement;

- changes in a parent's ownership interest in a subsidiary that do not result in a change of control are treated as transactions between equity holders and are reported in equity; and

- an option is available, on a transaction-by-transaction basis, to measure any non-controlling (previously referred to as minority) interests in the entity acquired either at fair value, or at the non-controlling interests' proportionate share of the net identifiable assets of the entity acquired.

The effect that the changes will have on HSBC's consolidated financial statements and the separate financial statements of HSBC Holdings will depend on the incidence and timing of business combinations occurring after 31 December 2009.

Standards and Interpretations issued by the IASB but not endorsed by the EU

IFRS 9 'Financial Instruments' introduces new requirements for the classification and measurement of financial assets. The standard is effective for annual periods beginning on or after 1 January 2013 with early adoption permitted. IFRS 9 is required to be applied retrospectively. If the standard is adopted prior to 1 January 2012, an entity will be exempt from the requirement to restate prior period comparative information. IFRS 9 is subject to EU endorsement, the timing of which is uncertain. Accordingly, HSBC is unable to provide a date by which it plans to apply IFRS 9.

The main changes to the requirements of IAS 39 are summarised below.

- All financial assets that are currently in the scope of IAS 39 will be classified as either amortised cost or fair value. The available-for-sale and held-to-maturity categories will no longer exist.

- Classification is based on an entity's business model for managing the financial assets and the contractual cash flow characteristics of the financial assets. Reclassifications between the two categories are prohibited unless there is a change in the entity's business model.

- A financial asset is measured at amortised cost if two criteria are met: i) the objective of the business model is to hold the financial asset for the collection of the contractual cash flows; and ii) the contractual cash flows of the instrument are solely payments of principal and interest on the principal outstanding. All other financial assets are measured at fair value. Movements in the fair value of financial assets classified at fair value are recognised in profit or loss, except for equity investments where an entity takes the option to designate an equity instrument that is not held for trading at fair value through other comprehensive income. If this option is taken, all subsequent changes in fair value are recognised in other comprehensive income with no recycling of gains or losses to the income statement. Dividend income would continue to be recognised in the income statement.

- An entity is only permitted to designate a financial asset otherwise meeting the amortised cost criteria at fair value through profit or loss if doing so significantly reduces or eliminates an accounting mismatch. This designation is made on initial recognition and is irrevocable.

- Financial instruments which contain embedded derivatives are to be classified in their entirety either at fair value or amortised cost depending on whether the contracts as a whole meet the relevant criteria under IFRS 9.

IFRS 9 is the first instalment in the IASB's planned phased replacement of IAS 39 with a less complex and improved standard for financial instruments. The next steps in the IASB's project will address the classification and measurement requirements for financial liabilities, the impairment of financial assets measured at amortised cost and hedge accounting. The IASB has indicated that it aims to finalise the replacement of IAS 39 by the end of 2010. In addition, the IASB is working with the US Financial Accounting Standards Board to reduce inconsistencies between US GAAP and IFRS in accounting for financial instruments. The impact of IFRS 9 may change as a consequence of further developments resulting from the IASB's financial instruments project. As a result, it is impracticable to quantify the impact of IFRS 9 as at the date of publication of these financial statements.

2 Summary of significant accounting policies

(a) Interest income and expense

Interest income and expense for all financial instruments except for those classified as held for trading or designated at fair value (other than debt securities issued by HSBC and derivatives managed in conjunction with such debt securities issued) are recognised in 'Interest income' and 'Interest expense' in the income statement using the effective interest method. The latter is a way of calculating the amortised cost of a financial asset or a financial liability (or groups of financial assets or financial liabilities) and of allocating the interest income or interest expense over the relevant period.

The effective interest rate is the rate that exactly discounts estimated future cash receipts or payments through the expected life of the financial instrument or, where appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, HSBC estimates cash flows considering all contractual terms of the financial instrument but excluding future credit losses. The calculation includes all amounts paid or received by HSBC that are an integral part of the effective interest rate of a financial instrument, including transaction costs and all other premiums or discounts.

Interest on impaired financial assets is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss.

(b) Non-interest income

Fee income is earned from a diverse range of services provided by HSBC to its customers. Fee income is accounted for as follows:

- income earned on the execution of a significant act is recognised as revenue when the act is completed (for example, fees arising from negotiating, or participating in the negotiation of, a transaction for a third party, such as an arrangement for the acquisition of shares or other securities);

- income earned from the provision of services is recognised as revenue as the services are provided (for example, asset management, portfolio and other management advisory and service fees); and

- income which forms an integral part of the effective interest rate of a financial instrument is recognised as an adjustment to the effective interest rate (for example, certain loan commitment fees) and recorded in 'Interest income' (Note 2a).

Net trading income comprises all gains and losses from changes in the fair value of financial assets and financial liabilities held for trading, together with the related interest income, expense and dividends.

Net income from financial instruments designated at fair value includes all gains and losses from changes in the fair value of financial assets and financial liabilities designated at fair value through profit or loss. Interest income and expense and dividend income arising on these financial instruments are also included in 'Net income from financial instruments designated at fair value', except for interest arising from debt securities issued, and derivatives managed in conjunction with those debt securities, which is recognised in 'Interest expense' (Note 2a).

Dividend income is recognised when the right to receive payment is established. This is the ex-dividend date for listed equity securities, and usually the date when shareholders have approved the dividend for unlisted equity securities.

HSBC's operating segments are organised into six geographical regions; Europe, Hong Kong, Rest of Asia-Pacific, Middle East, North America and Latin America. Due to the nature of the Group, HSBC's chief operating decision-maker regularly reviews operating activity on a number of bases, including by geographical region, customer group and global business, and retail businesses by geographical region. HSBC's operating segments were determined to be geographical regions because the chief operating decision-maker primarily uses information on geographical regions in order to make decisions about allocating resources and assessing performance.

Measurement of segmental assets, liabilities, income and expenses is in accordance with the Group's accounting policies. Segmental income and expenses include transfers between segments and these transfers are conducted on arm's length terms and conditions. Shared costs are included in segments on the basis of the actual recharges made.

(d) Determination of fair value

All financial instruments are recognised initially at fair value. In the normal course of business, the fair value of a financial instrument on initial recognition is the transaction price (that is, the fair value of the consideration given or received). In certain circumstances, however, the fair value will be based on other observable current market transactions in the same instrument, without modification or repackaging, or on a valuation technique whose variables include only data from observable markets, such as interest rate yield curves, option volatilities and currency rates. When such evidence exists, HSBC recognises a trading gain or loss on inception of the financial instrument, being the difference between the transaction price and the fair value. When unobservable market data have a significant impact on the valuation of financial instruments, the entire initial difference in fair value indicated by the valuation model from the transaction price is not recognised immediately in the income statement but is recognised over the life of the transaction on an appropriate basis, or when the inputs become observable, or the transaction matures or is closed out, or when HSBC enters into an offsetting transaction.

Subsequent to initial recognition, the fair values of financial instruments measured at fair value that are quoted in active markets are based on bid prices for assets held and offer prices for liabilities issued. When independent prices are not available, fair values are determined by using valuation techniques which refer to observable market data. These include comparison with similar instruments where market observable prices exist, discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants. Fair values of financial instruments may be determined in whole or in part using valuation techniques based on assumptions that are not supported by prices from current market transactions or observable market data, where current prices or observable market data are not available.

Valuation techniques incorporate assumptions about factors that other market participants would use in their valuations, including interest rate yield curves, exchange rates, volatilities, and prepayment and default rates. If there are additional factors that are not incorporated within the valuation model but would be considered by market participants, further fair value adjustments are applied to model calculated fair values. These fair value adjustments include adjustments for bid-offer spread, model uncertainty, credit risk and model limitation. Where a financial instrument has a quoted price in an active market and it is part of a portfolio, the fair value of the portfolio is calculated as the product of the number of units and quoted price and no block discounts are made.

If the fair value of a financial asset measured at fair value becomes negative, the financial instrument is recorded as a financial liability until the fair value becomes positive, at which time the financial instrument is recorded as a financial asset.

The fair values of financial liabilities are measured using quoted market prices where available, or using valuation techniques. These fair values include market participants' assessments of the appropriate credit spread to apply to HSBC's liabilities. The amount of change during the period, and cumulatively, in the fair value of designated financial liabilities and loans and advances that is attributable to changes in their credit spread is determined as the amount of change in the fair value that is not attributable to changes in market conditions that give rise to market risk.

(e) Reclassification of financial assets

Non-derivative financial assets (other than those designated at fair value through profit or loss upon initial recognition) may be reclassified out of the fair value through profit or loss category in the following circumstances:

- financial assets that would have met the definition of loans and receivables at initial recognition (if the financial asset had not been required to be classified as held for trading) may be reclassified out of the fair value through profit or loss category if there is the intention and ability to hold the financial asset for the foreseeable future or until maturity; and

- financial assets (except financial assets that would have met the definition of loans and receivables at initial recognition) may be reclassified out of the fair value through profit or loss category and into another category in rare circumstances.

When a financial asset is reclassified as described in the above circumstances, the financial asset is reclassified at its fair value on the date of reclassification. Any gain or loss already recognised in the income statement is not reversed. The fair value of the financial asset on the date of reclassification becomes its new cost or amortised cost, as applicable.

(f) Loans and advances to banks and customers

Loans and advances to banks and customers include loans and advances originated by HSBC which are not classified either as held for trading or designated at fair value. Loans and advances are recognised when cash is advanced to a borrower. They are derecognised when either the borrower repays its obligations, or the loans are sold or written off, or substantially all the risks and rewards of ownership are transferred. They are initially recorded at fair value plus any directly attributable transaction costs and are subsequently measured at amortised cost using the effective interest method, less any impairment losses. Where exposures are hedged by derivatives designated and qualifying as fair value hedges, the carrying value of the loans and advances so hedged includes a fair value adjustment for the hedged risk only.

HSBC may commit to underwrite loans on fixed contractual terms for specified periods of time, where the drawdown of the loan is contingent upon certain future events outside the control of HSBC. Where the loan arising from the lending commitment is expected to be held for trading, the commitment to lend is recorded as a derivative and measured at fair value through profit or loss. On drawdown, the loan is classified as held for trading and measured at fair value through profit or loss. Where it is not HSBC's intention to trade but hold the loan, a provision on the loan commitment is only recorded where it is probable that HSBC will incur a loss. This may occur, for example, where a loss of principal is probable or the interest rate charged on the loan is lower than the cost of funding. On inception, the loan to be held is recorded at its fair value and subsequently measured at amortised cost using the effective interest method. However, where the initial fair value is lower than the cash amount advanced (for example, due to the rate of interest charged on the loan being below the market rate of interest), the write-down is charged to the income statement. The write-down will be recovered over the life of the loan, through the recognition of interest income using the effective interest method, unless the loan becomes impaired. The write-down is recorded as a reduction to other operating income.

Financial assets which have been reclassified out of the fair value through profit or loss category into the loans and receivables category are initially recorded at the fair value at the date of reclassification. The reclassified assets are subsequently measured at amortised cost, using the effective interest rate determined at the date of reclassification.

(g) Impairment of loans and advances

Losses for impaired loans are recognised promptly when there is objective evidence that impairment of a loan or portfolio of loans has occurred. Impairment allowances are calculated on individual loans and on groups of loans assessed collectively. Impairment losses are recorded as charges to the income statement. The carrying amount of impaired loans on the balance sheet is reduced through the use of impairment allowance accounts. Losses expected from future events are not recognised.

Individually assessed loans and advances

For all loans that are considered individually significant, HSBC assesses on a case-by-case basis at each balance sheet date whether there is any objective evidence that a loan is impaired. For those loans where objective evidence of impairment exists, impairment losses are determined considering the following factors:

- HSBC's aggregate exposure to the customer;

- the viability of the customer's business model and their capacity to trade successfully out of financial difficulties and generate sufficient cash flow to service debt obligations;

- the amount and timing of expected receipts and recoveries;

- the likely dividend available on liquidation or bankruptcy;

- the extent of other creditors' commitments ranking ahead of, or pari passu with, HSBC and the likelihood of other creditors continuing to support the company;

- the complexity of determining the aggregate amount and ranking of all creditor claims and the extent to which legal and insurance uncertainties are evident;

- the realisable value of security (or other credit mitigants) and likelihood of successful repossession;

- the likely deduction of any costs involved in recovery of amounts outstanding;

- the ability of the borrower to obtain, and make payments in, the currency of the loan if not denominated in local currency; and

- when available, the secondary market price of the debt.

Impairment losses are calculated by discounting the expected future cash flows of a loan at its original effective interest rate, and comparing the resultant present value with the loan's current carrying amount.

Collectively assessed loans and advances

Impairment is assessed on a collective basis in two circumstances:

- to cover losses which have been incurred but have not yet been identified on loans subject to individual assessment; and

- for homogeneous groups of loans that are not considered individually significant.

Incurred but not yet identified impairment

Individually assessed loans for which no evidence of loss has been specifically identified on an individual basis are grouped together according to their credit risk characteristics for the purpose of calculating an estimated collective loss. This reflects impairment losses that HSBC has incurred as a result of events occurring before the balance sheet date, which HSBC is not able to identify on an individual loan basis, and that can be reliably estimated. These losses will only be individually identified in the future. As soon as information becomes available which identifies losses on individual loans within the group, those loans are removed from the group and assessed on an individual basis for impairment.

The collective impairment allowance is determined after taking into account:

- historical loss experience in portfolios of similar credit risk characteristics (for example, by industry sector, loan grade or product);

- the estimated period between impairment occurring and the loss being identified and evidenced by the establishment of an appropriate allowance against the individual loan; and

- management's experienced judgement as to whether current economic and credit conditions are such that the actual level of inherent losses at the balance sheet date is likely to be greater or less than that suggested by historical experience.

The period between a loss occurring and its identification is estimated by local management for each identified portfolio.

Homogeneousgroups of loans and advances

Statistical methods are used to determine impairment losses on a collective basis for homogeneous groups of loans that are not considered individually significant, because individual loan assessment is impracticable. Losses in these groups of loans are recorded on an individual basis when individual loans are written off, at which point they are removed from the group. Two alternative methods are used to calculate allowances on a collective basis:

− When appropriate empirical information is available, HSBC utilises roll rate methodology. This methodology employs statistical analyses of historical data and experience of delinquency and default to estimate the amount of loans that will eventually be written off as a result of the events occurring before the balance sheet date which HSBC is not able to identify on an individual loan basis, and that can be reliably estimated. Under this methodology, loans are grouped into ranges according to the number of days past due, and statistical analysis is used to estimate the likelihood that loans in each range will progress through the various stages of delinquency and ultimately prove irrecoverable. Current economic conditions are also evaluated when calculating the appropriate level of allowance required to cover inherent loss. The estimated loss is the difference between the present value of expected future cash flows, discounted at the original effective interest rate of the portfolio, and the carrying amount of the portfolio. In certain highly developed markets, sophisticated models also take into account behavioural and account management trends as revealed in, for example, bankruptcy and rescheduling statistics.

− When the portfolio size is small or when information is insufficient or not reliable enough to adopt a roll rate methodology, HSBC adopts a basic formulaic approach based on historical loss rate experience.

In normal circumstances, historical experience provides the most objective and relevant information from which to assess inherent loss within each portfolio. In certain circumstances, historical loss experience provides less relevant information about the inherent loss in a given portfolio at the balance sheet date, for example, where there have been changes in economic, regulatory or behavioural conditions, such that the most recent trends in the portfolio risk factors are not fully reflected in the statistical models.

These additional portfolio risk factors may include recent loan portfolio growth and product mix, unemployment rates, bankruptcy trends, geographic concentrations, loan product features (such as the ability of borrowers to repay adjustable-rate loans where reset interest rates give rise to increases in interest charges), economic conditions such as national and local trends in housing markets and interest rates, portfolio seasoning, account management policies and practices, current levels of write-offs, changes in laws and regulations and other items which can affect customer payment patterns on outstanding loans, such as natural disasters. These risk factors, where relevant, are taken into account when calculating the appropriate level of impairment allowances by adjusting the impairment allowances derived solely from historical loss experience.

Roll rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual outcomes to ensure they remain appropriate.

Write-off of loans and advances

Loans (and the related impairment allowance accounts) are normally written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, this is generally after receipt of any proceeds from the realisation of security. In circumstances where the net realisable value of any collateral has been determined and there is no reasonable expectation of further recovery, write off may be earlier.

Reversals of impairment

If the amount of an impairment loss decreases in a subsequent period, and the decrease can be related objectively to an event occurring after the impairment was recognised, the excess is written back by reducing the loan impairment allowance account accordingly. The write-back is recognised in the income statement.

Reclassified loans and advances

Where financial assets have been reclassified out of the fair value through profit or loss category to the loans and receivables category, the effective interest rate determined at the date of reclassification is used to calculate any impairment losses.

Following reclassification, where there is a subsequent increase in the estimates of future cash receipts as a result of increased recoverability of those cash receipts, the effect of that increase is recognised as an adjustment to the effective interest rate from the date of change in the estimate rather than as an adjustment to the carrying amount of the asset at the date of change in the estimate.

Assets acquired in exchange for loans

Non-financial assets acquired in exchange for loans as part of an orderly realisation are recorded as assets held for sale and reported in 'Other assets'. The asset acquired is recorded at the lower of its fair value (less costs to sell) and the carrying amount of the loan (net of impairment allowance) at the date of exchange. No depreciation is charged in respect of assets held for sale. Any subsequent write-down of the acquired asset to fair value less costs to sell is recognised in the income statement, in 'Other operating income'. Any subsequent increase in the fair value less costs to sell, to the extent this does not exceed the cumulative write-down, is also recognised in 'Other operating income', together with any realised gains or losses on disposal.

Renegotiated loans

Loans subject to collective impairment assessment whose terms have been renegotiated are no longer considered past due, but are treated as up to date loans for measurement purposes once the minimum number of payments required under the new arrangements have been received. These renegotiated loans are segregated from other parts of the loan portfolio for the purposes of collective impairment assessment, to reflect their risk profile. Loans subject to individual impairment assessment, whose terms have been renegotiated, are subject to ongoing review to determine whether they remain impaired or should be considered past due. The carrying amount of loans that have been classified as renegotiated retain this classification until maturity or derecognition.

(h) Trading assets and trading liabilities

Treasury bills, debt securities, equity securities, loans, deposits, debt securities in issue, and short positions in securities are classified as held for trading if they have been acquired or incurred principally for the purpose of selling or repurchasing in the near term, or they form part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent pattern of short-term profit-taking. These financial assets or financial liabilities are recognised on trade date, when HSBC enters into contractual arrangements with counterparties to purchase or sell the financial instruments, and are normally derecognised when either sold (assets) or extinguished (liabilities). Measurement is initially at fair value, with transaction costs taken to the income statement. Subsequently, the fair values are remeasured, and gains and losses from changes therein are recognised in the income statement in 'Net trading income'.

(i) Financial instruments designated at fair value

Financial instruments, other than those held for trading, are classified in this category if they meet one or more of the criteria set out below, and are so designated by management. HSBC may designate financial instruments at fair value when the designation:

- eliminates or significantly reduces measurement or recognition inconsistencies that would otherwise arise from measuring financial assets or financial liabilities, or recognising gains and losses on them, on different bases. Under this criterion, the main classes of financial instruments designated by HSBC are:

Long-term debt issues. The interest payable on certain fixed rate long-term debt securities issued has been matched with the interest on 'receive fixed/pay variable' interest rate swaps as part of a documented interest rate risk management strategy. An accounting mismatch would arise if the debt securities issued were accounted for at amortised cost, because the related derivatives are measured at fair value with changes in the fair value recognised in the income statement. By designating the long-term debt at fair value, the movement in the fair value of the long-term debt will also be recognised in the income statement.

Financial assets and financial liabilities under investment contracts. Liabilities to customers under linked contracts are determined based on the fair value of the assets held in the linked funds, with changes recognised in the income statement. If no designation was made for the assets relating to the customer liabilities they would be classified as available-for-sale and the changes in fair value would be recorded in other comprehensive income. These financial instruments are managed on a fair value basis and management information is also prepared on this basis. Designation at fair value of the financial assets and liabilities under investment contracts allows the changes in fair values to be recorded in the income statement and presented in the same line.

- applies to groups of financial assets, financial liabilities or combinations thereof that are managed, and their performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy, and where information about the groups of financial instruments is reported to management on that basis. Under this criterion, certain financial assets held to meet liabilities under insurance contracts are the main class of financial instrument so designated. HSBC has documented risk management and investment strategies designed to manage such assets at fair value, taking into consideration the relationship of assets to liabilities in a way that mitigates market risks. Reports are provided to management on the fair value of the assets. Fair value measurement is also consistent with the regulatory reporting requirements under the appropriate regulations for these insurance operations.

- relates to financial instruments containing one or more embedded derivatives that significantly modify the cash flows resulting from those financial instruments, including certain debt issues and debt securities held.

The fair value designation, once made, is irrevocable. Designated financial assets and financial liabilities are recognised when HSBC enters into the contractual provisions of the arrangements with counterparties, which is generally on trade date, and are normally derecognised when either sold (assets) or extinguished (liabilities). Measurement is initially at fair value, with transaction costs taken to the income statement. Subsequently, the fair values are remeasured, and gains and losses from changes therein are recognised in the income statement in 'Net income from financial instruments designated at fair value'.

(j) Financial investments

Treasury bills, debt securities and equity securities intended to be held on a continuing basis, other than those designated at fair value, are classified as available-for-sale or held-to-maturity. Financial investments are recognised on trade date when HSBC enters into contractual arrangements with counterparties to purchase securities, and are normally derecognised when either the securities are sold or the borrowers repay their obligations.

(i) Available-for-sale financial assets are initially measured at fair value plus direct and incremental transaction costs. They are subsequently remeasured at fair value, and changes therein are recognised in other comprehensive income in 'Available-for-sale investments - fair value gains/(losses)' until the financial assets are either sold or become impaired. When available-for-sale financial assets are sold, cumulative gains or losses previously recognised in other comprehensive income are recognised in the income statement as 'Gains less losses from financial investments'.

Interest income is recognised on available-for-sale debt securities using the effective interest rate, calculated over the asset's expected life. Premiums and/or discounts arising on the purchase of dated investment securities are included in the calculation of their effective interest rates. Dividends are recognised in the income statement when the right to receive payment has been established.

At each balance sheet date an assessment is made of whether there is any objective evidence of impairment in the value of a financial asset. Impairment losses are recognised if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the financial asset (a 'loss event') and that loss event (or events) has an impact on the estimated future cash flows of the financial asset that can be reliably estimated.

If the available-for-sale financial asset is impaired, the difference between the financial asset's acquisition cost (net of any principal repayments and amortisation) and the current fair value, less any previous impairment loss recognised in the income statement, is removed from other comprehensive income and recognised in the income statement.

Impairment losses for available-for-sale debt securities are recognised within 'Loan impairment charges and other credit risk provisions' in the income statement and impairment losses for available-for-sale equity securities are recognised within 'Gains less losses from financial investments' in the income statement.

Once an impairment loss has been recognised on an available-for-sale financial asset, the subsequent accounting treatment for changes in the fair value of that asset differs depending on the nature of the available-for-sale financial asset concerned:

- for an available-for-sale debt security, a subsequent decline in the fair value of the instrument is recognised in the income statement when there is further objective evidence of impairment as a result of further decreases in the estimated future cash flows of the financial asset. Where there is no further objective evidence of impairment, the decline in the fair value of the financial asset is recognised in other comprehensive income. If the fair value of a debt security increases in a subsequent period, and the increase can be objectively related to an event occurring after the impairment loss was recognised in the income statement, the impairment loss is reversed through the income statement to the extent of the increase in fair value;

- for an available-for-sale equity security, all subsequent increases in the fair value of the instrument are treated as a revaluation and are recognised in other comprehensive income. Impairment losses recognised on the equity security are not reversed through the income statement. Subsequent decreases in the fair value of the available-for-sale equity security are recognised in the income statement, to the extent that further cumulative impairment losses have been incurred in relation to the acquisition cost of the equity security.

(ii) Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that HSBC positively intends, and is able, to hold to maturity. Held-to-maturity investments are initially recorded at fair value plus any directly attributable transaction costs, and are subsequently measured at amortised cost using the effective interest rate method, less any impairment losses.

(k) Sale and repurchase agreements (including stock lending and borrowing)

When securities are sold subject to a commitment to repurchase them at a predetermined price ('repos'), they remain on the balance sheet and a liability is recorded in respect of the consideration received. Securities purchased under commitments to sell ('reverse repos') are not recognised on the balance sheet and the consideration paid is recorded in 'Loans and advances to banks' or 'Loans and advances to customers' as appropriate. The difference between the sale and repurchase price is treated as interest and recognised over the life of the agreement.

Securities lending and borrowing transactions are generally secured, with collateral taking the form of securities or cash advanced or received. The transfer of securities to counterparties under these agreements is not normally reflected on the balance sheet. Cash collateral advanced or received is recorded as an asset or a liability respectively.

Securities borrowed are not recognised on the balance sheet. If they are sold on to third parties, an obligation to return the securities is recorded as a trading liability and measured at fair value, and any gains or losses are included in 'Net trading income'.

(l) Derivatives and hedge accounting

Derivatives are recognised initially, and are subsequently remeasured, at fair value. Fair values of exchange-traded derivatives are obtained from quoted market prices. Fair values of over-the-counter derivatives are obtained using valuation techniques, including discounted cash flow models and option pricing models.

Derivatives may be embedded in other financial instruments, for example, a convertible bond with an embedded conversion option. Embedded derivatives are treated as separate derivatives when their economic characteristics and risks are not clearly and closely related to those of the host contract; the terms of the embedded derivative would meet the definition of a stand-alone derivative if they were contained in a separate contract; and the combined contract is not held for trading or designated at fair value. These embedded derivatives are measured at fair value with changes therein recognised in the income statement.

Derivatives are classified as assets when their fair value is positive, or as liabilities when their fair value is negative. Derivative assets and liabilities arising from different transactions are only offset if the transactions are with the same counterparty, a legal right of offset exists, and the parties intend to settle the cash flows on a net basis.

The method of recognising fair value gains and losses depends on whether derivatives are held for trading or are designated as hedging instruments, and if the latter, the nature of the risks being hedged. All gains and losses from changes in the fair value of derivatives held for trading are recognised in the income statement. When derivatives are designated as hedges, HSBC classifies them as either: (i) hedges of the change in fair value of recognised assets or liabilities or firm commitments ('fair value hedges'); (ii) hedges of the variability in highly probable future cash flows attributable to a recognised asset or liability, or a forecast transaction ('cash flow hedges'); or (iii) a hedge of a net investment in a foreign operation ('net investment hedges'). Hedge accounting is applied to derivatives designated as hedging instruments in a fair value, cash flow or net investment hedge provided certain criteria are met.

Hedge accounting

At the inception of a hedging relationship, HSBC documents the relationship between the hedging instruments and the hedged items, its risk management objective and its strategy for undertaking the hedge. HSBC also requires a documented assessment, both at hedge inception and on an ongoing basis, of whether or not the hedging instruments, primarily derivatives, that are used in hedging transactions are highly effective in offsetting the changes attributable to the hedged risks in the fair values or cash flows of the hedged items. Interest on designated qualifying hedges is included in 'Net interest income'.

Fair value hedge

Changes in the fair value of derivatives that are designated and qualify as fair value hedging instruments are recorded in the income statement, along with changes in the fair value of the hedged assets, liabilities or group thereof that are attributable to the hedged risk.

If a hedging relationship no longer meets the criteria for hedge accounting, the cumulative adjustment to the carrying amount of the hedged item is amortised to the income statement based on a recalculated effective interest rate over the residual period to maturity, unless the hedged item has been derecognised, in which case, it is released to the income statement immediately.

Cash flow hedge

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other comprehensive income within the 'Cash flow hedges - fair value gains/(losses)'. Any gain or loss in fair value relating to an ineffective portion is recognised immediately in the income statement.

The accumulated gains and losses recognised in other comprehensive income are reclassified to the income statement in the periods in which the hedged item will affect profit or loss. However, when the forecast transaction that is hedged results in the recognition of a non-financial asset or a non-financial liability, the gains and losses previously recognised in other comprehensive income are removed from equity and included in the initial measurement of the cost of the asset or liability.

When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss recognised in other comprehensive income at that time remains in equity until the forecast transaction is eventually recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was recognised in other comprehensive income is immediately reclassified to the income statement.

Net investment hedge

Hedges of net investments in foreign operations are accounted for in a similar way to cash flow hedges. A gain or loss on the effective portion of the hedging instrument is recognised in other comprehensive income; a gain or loss on the ineffective portion is recognised immediately in the income statement. Gains and losses previously recognised in other comprehensive income are reclassified to the income statement on the disposal of the foreign operation.

Hedge effectiveness testing

To qualify for hedge accounting, HSBC requires that at the inception of the hedge and throughout its life, each hedge must be expected to be highly effective (prospective effectiveness), and demonstrate actual effectiveness (retrospective effectiveness) on an ongoing basis.

The documentation of each hedging relationship sets out how the effectiveness of the hedge is assessed. The method adopted by an entity to assess hedge effectiveness will depend on its risk management strategy.

For prospective effectiveness, the hedging instrument must be expected to be highly effective in offsetting changes in fair value or cash flows attributable to the hedged risk during the period for which the hedge is designated. For actual effectiveness to be achieved, the changes in fair value or cash flows must offset each other in the range of 80 per cent to 125 per cent.

Hedge ineffectiveness is recognised in the income statement in 'Net trading income'.

Derivatives that do not qualify for hedge accounting

All gains and losses from changes in the fair values of derivatives that do not qualify for hedge accounting are recognised immediately in the income statement. These gains and losses are reported in 'Net trading income', except where derivatives are managed in conjunction with financial instruments designated at fair value (other than derivatives managed in conjunction with debt securities issued by the Group), in which case gains and losses are reported in 'Net income from financial instruments designated at fair value'. The interest on derivatives managed in conjunction with debt securities issued by the Group which are designated at fair value is recognised in 'Interest expense'. All other gains and losses on these derivatives are reported in 'Net income from financial instruments designated at fair value'.

(m) Derecognition of financial assets and liabilities

Financial assets are derecognised when the contractual right to receive cash flows from the assets has expired; or when HSBC has transferred its contractual right to receive the cash flows of the financial assets, and either:

- substantially all the risks and rewards of ownership have been transferred; or

- HSBC has neither retained nor transferred substantially all the risks and rewards, but has not retained control.

Financial liabilities are derecognised when they are extinguished, that is when the obligation is discharged, is cancelled, or expires.

(n) Offsetting financial assets and financial liabilities

Financial assets and financial liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously.

(o) Subsidiaries, associates and joint ventures

HSBC classifies investments in entities which it controls as subsidiaries. Where HSBC is a party to a contractual arrangement whereby, together with one or more parties, it undertakes an economic activity that is subject to joint control, HSBC classifies its interest in the venture as a joint venture. HSBC classifies investments in entities over which it has significant influence, and that are neither subsidiaries nor joint ventures, as associates. For the purpose of determining this classification, control is considered to be the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

HSBC Holdings' investments in subsidiaries are stated at cost less any impairment losses. An impairment loss recognised in prior periods shall be reversed through the income statement if, and only if, there has been a change in the estimates used to determine the investment in subsidiary's recoverable amount since the last impairment loss was recognised.

Investments in associates and interests in joint ventures are recognised using the equity method. Under this method, such investments are initially stated at cost, including attributable goodwill, and are adjusted thereafter for the post-acquisition change in HSBC's share of net assets.

Profits on transactions between HSBC and its associates and joint ventures are eliminated to the extent of HSBC's interest in the respective associates or joint ventures. Losses are also eliminated to the extent of HSBC's interest in the associates or joint ventures unless the transaction provides evidence of an impairment of the asset transferred.

(p) Goodwill and intangible assets

(i) Goodwill arises on business combinations, including the acquisition of subsidiaries, and on the acquisition of interests in joint ventures and associates, when the cost of acquisition exceeds the fair value of HSBC's share of the identifiable assets, liabilities and contingent liabilities acquired. If HSBC's interest in the fair value of the identifiable assets, liabilities and contingent liabilities of an acquired business is greater than the cost of acquisition, the excess is recognised immediately in the income statement.

Intangible assets are recognised separately from goodwill when they are separable or arise from contractual or other legal rights, and their fair value can be measured reliably.

Goodwill is allocated to cash-generating units for the purpose of impairment testing, which is undertaken at the lowest level at which goodwill is monitored for internal management purposes. Impairment testing is performed at least annually, and whenever there is an indication that the cash-generating unit may be impaired, by comparing the recoverable amount from a cash-generating unit with the carrying amount of its net assets, including attributable goodwill. The recoverable amount of an asset is the higher of its fair value less cost to sell, and its value in use. Value in use is the present value of the expected future cash flows from a cash-generating unit. If the recoverable amount is less than the carrying value, an impairment loss is charged to the income statement. Goodwill is stated at cost less accumulated impairment losses.

Goodwill on acquisitions of interests in joint ventures and associates is included in 'Interests in associates and joint ventures' and is not tested separately for impairment.

At the date of disposal of a business, attributable goodwill is included in HSBC's share of net assets in the calculation of the gain or loss on disposal.

(ii) Intangible assets include the present value of in-force long-term insurance business, computer software, trade names, mortgage servicing rights, customer lists, core deposit relationships, credit card customer relationships and merchant or other loan relationships. Intangible assets are subject to impairment review if there are events or changes in circumstances that indicate that the carrying amount may not be recoverable. Where:

- intangible assets have an indefinite useful life, or are not yet ready for use, they are tested for impairment annually. This impairment test may be performed at any time during the year, provided it is performed at the same time every year. An intangible asset recognised during the current period is tested before the end of the current year; and

- intangible assets have a finite useful life, except for the present value of in-force long-term insurance business, they are stated at cost less amortisation and accumulated impairment losses and are amortised over their estimated useful lives. Estimated useful life is the lower of legal duration and expected useful life. The amortisation of mortgage servicing rights is included within 'Net fee income'.

For the accounting policy governing the present value of in-force long-term insurance business (see Note 2y).

(iii) Intangible assets with finite useful lives are amortised, generally on a straight-line basis, over their useful lives as follows:

Trade names ...........................................................................................................	10 years
Mortgage servicing rights ........................................................................................	generally between 5 and 12 years
Internally generated software ..................................................................................	between 3 and 5 years
Purchased software .................................................................................................	between 3 and 5 years
Customer/merchant relationships ............................................................................	between 3 and 10 years
Other ......................................................................................................................	generally 10 years

(q) Property, plant and equipment

Land and buildings are stated at historical cost, or fair value at the date of transition to IFRSs ('deemed cost'), less any impairment losses and depreciation calculated to write-off the assets over their estimated useful lives as follows:

- freehold land is not depreciated;

- freehold buildings are depreciated at the greater of two per cent per annum on a straight-line basis or over their remaining useful lives; and

- leasehold buildings are depreciated over the unexpired terms of the leases, or over their remaining useful lives.

Equipment, fixtures and fittings (including equipment on operating leases where HSBC is the lessor) are stated at cost less any impairment losses and depreciation calculated on a straight-line basis to write-off the assets over their useful lives, which run to a maximum of 35 years but are generally between 5 years and 20 years.

Property, plant and equipment is subject to an impairment review if there are events or changes in circumstances which indicate that the carrying amount may not be recoverable.

HSBC holds certain properties as investments to earn rentals or for capital appreciation, or both. Investment properties are included in the balance sheet at fair value with changes therein recognised in the income statement in the period of change. Fair values are determined by independent professional valuers who apply recognised valuation techniques.

(r) Finance and operating leases

Agreements which transfer to counterparties substantially all the risks and rewards incidental to the ownership of assets, but not necessarily legal title, are classified as finance leases. When HSBC is a lessor under finance leases the amounts due under the leases, after deduction of unearned charges, are included in 'Loans and advances to banks' or 'Loans and advances to customers' as appropriate. The finance income receivable is recognised in 'Net interest income' over the periods of the leases so as to give a constant rate of return on the net investment in the leases.

When HSBC is a lessee under finance leases, the leased assets are capitalised and included in 'Property, plant and equipment' and the corresponding liability to the lessor is included in 'Other liabilities'. A finance lease and its corresponding liability are recognised initially at the fair value of the asset or, if lower, the present value of the minimum lease payments. Finance charges payable are recognised in 'Net interest income' over the period of the lease based on the interest rate implicit in the lease so as to give a constant rate of interest on the remaining balance of the liability.

All other leases are classified as operating leases. When acting as lessor, HSBC includes the assets subject to operating leases in 'Property, plant and equipment' and accounts for them accordingly. Impairment losses are recognised to the extent that residual values are not fully recoverable and the carrying value of the assets is thereby impaired. When HSBC is the lessee, leased assets are not recognised on the balance sheet. Rentals payable and receivable under operating leases are accounted for on a straight-line basis over the periods of the leases and are included in 'General and administrative expenses' and 'Other operating income', respectively.

(s) Income tax

Income tax comprises current tax and deferred tax. Income tax is recognised in the income statement except to the extent that it relates to items recognised in other comprehensive income or directly in equity, in which case it is recognised in the same statement in which the related item appears.

Current tax is the tax expected to be payable on the taxable profit for the year, calculated using tax rates enacted or substantively enacted by the balance sheet date, and any adjustment to tax payable in respect of previous years. Current tax assets and liabilities are offset when HSBC intends to settle on a net basis and the legal right to offset exists.

Deferred tax is recognised on temporary differences between the carrying amounts of assets and liabilities in the balance sheet and the amounts attributed to such assets and liabilities for tax purposes. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that future taxable profits will be available against which deductible temporary differences can be utilised.

Deferred tax is calculated using the tax rates expected to apply in the periods in which the assets will be realised or the liabilities settled, based on tax rates and laws enacted, or substantively enacted, by the balance sheet date. Deferred tax assets and liabilities are offset when they arise in the same tax reporting group and relate to income taxes levied by the same taxation authority, and when HSBC has a legal right to offset.

Deferred tax relating to actuarial gains and losses on post-employment benefits is recognised in other comprehensive income. Deferred tax relating to share-based payment transactions is recognised directly in equity to the extent that the amount of the estimated future tax deduction exceeds the amount of the related cumulative remuneration expense. Deferred tax relating to fair value re-measurements of available-for-sale investments and cash flow hedging instruments which are charged or credited directly to other comprehensive income, is also charged or credited to other comprehensive income and is subsequently recognised in the income statement when the deferred fair value gain or loss is recognised in the income statement.

(t) Pension and other post-employment benefits

HSBC operates a number of pension and other post-employment benefit plans throughout the world. These plans include both defined benefit and defined contribution plans and various other post-employment benefits such as post-employment healthcare.

Payments to defined contribution plans and state-managed retirement benefit plans, where HSBC's obligations under the plans are equivalent to a defined contribution plan, are charged as an expense as they fall due.

The defined benefit pension costs and the present value of defined benefit obligations are calculated at the reporting date by the schemes' actuaries using the Projected Unit Credit Method. The net charge to the income statement mainly comprises the current service cost, plus the unwinding of the discount rate on plan liabilities, less the expected return on plan assets, and is presented in operating expenses. Past service costs are charged immediately to the income statement to the extent that the benefits have vested, and are otherwise recognised on a straight-line basis over the average period until the benefits vest. Actuarial gains and losses comprise experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred), as well as the effects of changes in actuarial assumptions. Actuarial gains and losses are recognised in other comprehensive income in the period in which they arise.

The defined benefit liability recognised in the balance sheet represents the present value of defined benefit obligations adjusted for unrecognised past service costs and reduced by the fair value of plan assets. Any net defined benefit surplus is limited to unrecognised past service costs plus the present value of available refunds and reductions in future contributions to the plan.

The cost of obligations arising from other post-employment defined benefit plans, such as defined benefit health-care plans, are accounted for on the same basis as defined benefit pension plans.

(u) Share-based payments

The cost of share-based payment arrangements with employees is measured by reference to the fair value of equity instruments on the date they are granted, and recognised as an expense on a straight-line basis over the vesting period, with a corresponding credit to the 'Share-based payment reserve'. The vesting period is the period during which all the specified vesting conditions of a share-based payment arrangement are to be satisfied. The fair value of equity instruments that are made available immediately, with no vesting period attached to the award, are expensed immediately.

Fair value is determined by using appropriate valuation models, taking into account the terms and conditions upon which the equity instruments were granted. Vesting conditions include service conditions and performance conditions; any other features of a share-based payment arrangement are non-vesting conditions. Market performance conditions and non-vesting conditions are taken into account when estimating the fair value of equity instruments at the date of grant, so that an award is treated as vesting irrespective of whether the market performance condition or non-vesting condition is satisfied, provided all other vesting conditions are satisfied.

Vesting conditions, other than market performance conditions, are not taken into account in the initial estimate of the fair value at the grant date. They are taken into account by adjusting the number of equity instruments included in the measurement of the transaction, so that the amount recognised for services received as consideration for the equity instruments granted shall be based on the number of equity instruments that eventually vest. On a cumulative basis, no expense is recognised for equity instruments that do not vest because of a failure to satisfy non-market performance or service conditions.

Where an award has been modified, as a minimum, the expense of the original award continues to be recognised as if it had not been modified. Where the effect of a modification is to increase the fair value of an award or increase the number of equity instruments, the incremental fair value of the award or incremental fair value of the extra equity instruments is recognised in addition to the expense of the original grant, measured at the date of modification, over the modified vesting period.

A cancellation that occurs during the vesting period is treated as an acceleration of vesting, and recognised immediately for the amount that would otherwise have been recognised for services over the vesting period.

Where HSBC Holdings enters into share-based payment arrangements involving employees of subsidiaries, the cost is recognised in 'Investment in subsidiaries' and credited to the 'Share-based payment reserve' over the vesting period. Where a subsidiary funds the share-based payment arrangement, 'Investment in subsidiaries' is reduced by the fair value of equity instruments.

(v) Foreign currencies

Items included in the financial statements of each of HSBC's entities are measured using the currency of the primary economic environment in which the entity operates ('the functional currency'). HSBC's consolidated financial statements are presented in US dollars which is also HSBC Holdings' functional currency.

Transactions in foreign currencies are recorded in the functional currency at the rate of exchange prevailing on the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into the functional currency at the rate of exchange ruling at the balance sheet date. Any resulting exchange differences are included in the income statement. Non-monetary assets and liabilities that are measured at historical cost in a foreign currency are translated into the functional currency using the rate of exchange at the date of the initial transaction. Non-monetary assets and liabilities measured at fair value in a foreign currency are translated into the functional currency using the rate of exchange at the date the fair value was determined. Any exchange component of a gain or loss on a non-monetary item is recognised in other comprehensive income if the gain or loss on the non-monetary item is recognised in other comprehensive income. Any exchange component of a gain or loss on a non-monetary item is recognised in the income statement if the gain or loss on the non-monetary item is recognised in the income statement.

In the consolidated financial statements, the assets, including related goodwill where applicable, and liabilities of branches, subsidiaries, joint ventures and associates whose functional currency is not US dollars, are translated into the Group's presentation currency at the rate of exchange ruling at the balance sheet date. The results of branches, subsidiaries, joint ventures and associates whose functional currency is not US dollars are translated into US dollars at the average rates of exchange for the reporting period. Exchange differences arising from the retranslation of opening foreign currency net assets, and exchange differences arising from retranslation of the result for the reporting period from the average rate to the exchange rate prevailing at the period end, are recognised in other comprehensive income. Exchange differences on a monetary item that is part of a net investment in a foreign operation are recognised in the income statement of the separate financial statements. In consolidated financial statements these exchange differences are recognised in other comprehensive income. On disposal of a foreign operation, exchange differences relating thereto and previously recognised in other comprehensive income are recognised in the income statement.

(w) Provisions

Provisions are recognised when it is probable that an outflow of economic benefits will be required to settle a current legal or constructive obligation, which has arisen as a result of past events, and for which a reliable estimate can be made of the amount of the obligation.

Contingent liabilities, which include certain guarantees and letters of credit pledged as collateral security, are possible obligations that arise from past events whose existence will be confirmed only by the occurrence, or non-occurrence, of one or more uncertain future events not wholly within the control of HSBC; or are present obligations that have arisen from past events but are not recognised because it is not probable that settlement will require the outflow of economic benefits, or because the amount of the obligations cannot be reliably measured. Contingent liabilities are not recognised in the financial statements but are disclosed unless the probability of settlement is remote.

(x) Financial guarantee contracts

Liabilities under financial guarantee contracts which are not classified as insurance contracts are recorded initially at their fair value, which is generally the fee received or receivable. Subsequently, financial guarantee liabilities are measured at the higher of the initial fair value, less cumulative amortisation, and the best estimate of the expenditure required to settle the obligations.

HSBC Holdings has issued financial guarantees and similar contracts to other Group entities. Where it has previously asserted explicitly that it regards such contracts as insurance contracts and has used accounting applicable to insurance contracts, HSBC may elect to account for guarantees as an insurance contract. This election is made on a contract by contract basis, but the election for each contract is irrevocable. Where these guarantees have been classified as insurance contracts, they are measured and recognised as insurance liabilities.

(y) Insurance contracts

Through its insurance subsidiaries, HSBC issues contracts to customers that contain insurance risk, financial risk or a combination thereof. A contract under which HSBC accepts significant insurance risk from another party by agreeing to compensate that party on the occurrence of a specified uncertain future event, is classified as an insurance contract. An insurance contract may also transfer financial risk, but is accounted for as an insurance contract if the insurance risk is significant.

While investment contracts with discretionary participation features are financial instruments, they continue to be treated as insurance contracts as permitted by IFRS 4.

Insurance contracts are accounted for as follows:

Premiums

Gross insurance premiums for non-life insurance business are reported as income over the term of the insurance contracts based on the proportion of risks borne during the accounting period. The unearned premium (the proportion of the business underwritten in the accounting year relating to the period of risk after the balance sheet date) is calculated on a daily or monthly pro rata basis.

Premiums for life insurance contracts are accounted for when receivable, except in unit-linked insurance contracts where premiums are accounted for when liabilities are established.

Reinsurance premiums are accounted for in the same accounting period as the premiums for the direct insurance contracts to which they relate.

Claims and reinsurance recoveries

Gross insurance claims for non-life insurance contracts include paid claims and movements in outstanding claims liabilities.

Gross insurance claims for life insurance contracts reflect the total cost of claims arising during the year, including claim handling costs and any policyholder bonuses allocated in anticipation of a bonus declaration. Claims arising during the year include maturities, surrenders and death claims.

Maturity claims are recognised when due for payment. Surrenders are recognised when paid or at an earlier date on which, following notification, the policy ceases to be included within the calculation of the related insurance liabilities. Death claims are recognised when notified.

Reinsurance recoveries are accounted for in the same period as the related claim.

Liabilities under insurance contracts

Outstanding claims liabilities for non-life insurance contracts are based on the estimated ultimate cost of all claims incurred but not settled at the balance sheet date, whether reported or not, together with related claim-handling costs and a reduction for the expected value of salvage and other recoveries. Liabilities for claims incurred but not reported are made on an estimated basis, using appropriate statistical techniques.

Liabilities under non-linked life insurance contracts are calculated by each life insurance operation based on local actuarial principles.

Liabilities under unit-linked life insurance contracts are at least equivalent to the surrender or transfer value which is calculated by reference to the value of the relevant underlying funds or indices.

A liability adequacy test is carried out on insurance liabilities to ensure that the carrying amount of the liabilities is sufficient in the light of current estimates of future cash flows. When performing the liability adequacy test, all contractual cash flows are discounted and compared with the carrying value of the liability. When a shortfall is identified it is charged immediately to the income statement.

Present value of in-force long-term insurance business

The value placed on insurance contracts that are classified as long-term insurance business or long-term investment contracts with discretionary participating features ('DPF') and are in force at the balance sheet date is recognised as an asset. The asset represents the present value of the shareholders' interest in the profits expected to emerge from these contracts written at the balance sheet date.

The present value of in-force long-term insurance business and long-term investment contracts with DPF, referred to as 'PVIF', is determined by discounting the shareholders' interest in future profits expected to emerge from business currently in force using appropriate assumptions in assessing factors such as future mortality, lapse rates and levels of expenses and a risk discount rate that reflects the risk premium attributable to the respective contracts. The PVIF incorporates allowances for both non-market risk and the value of financial options and guarantees. The PVIF asset is presented gross of attributable tax in the balance sheet and movements in the PVIF asset are included in 'Other operating income' on a gross of tax basis.

Future profit participation

Where contracts provide discretionary profit participation benefits to policyholders, liabilities for these contracts include provisions for the future discretionary benefits to policyholders. These provisions reflect actual performance of the investment portfolio to date and management expectation on the future performance in connection with the assets backing the contracts, as well as other experience factors such as mortality, lapses and operational efficiency, where appropriate. This benefit may arise from the contractual terms, regulation, or past distribution policy.

In the case of net unrealised investment gains on contracts whose discretionary benefits principally reflect the actual performance of the investment portfolio, the corresponding increase in the liabilities is recognised in either the income statement or other comprehensive income, following the treatment of the unrealised gains on the relevant assets. In the case of net unrealised losses, a deferred participating asset is recognised only to the extent that its recoverability is highly probable. Movements in the liabilities arising from realised gains and losses on relevant assets are recognised in the income statement.

Investment contracts

Customer liabilities under linked and certain non-linked investment contracts and the corresponding financial assets are designated at fair value. Movements in fair value are recognised in 'Net income from financial investments designated at fair value'. Premiums receivable and amounts withdrawn are accounted for as increases or decreases in the liability recorded in respect of investment contracts.

Liabilities under linked investment contracts are at least equivalent to the surrender or transfer value which is calculated by reference to the value of the relevant underlying funds or indices.

Investment management fees receivable are recognised in the income statement over the period of the provision of the investment management services, in 'Net fee income'.

The incremental costs directly related to the acquisition of new investment contracts or renewing existing investment contracts are deferred and amortised over the period during which the investment management services are provided.

(z) Debt securities issued and deposits by customers and banks

Financial liabilities are recognised when HSBC enters into the contractual provisions of the arrangements with counterparties, which is generally on trade date, and initially measured at fair value, which is normally the consideration received net of directly attributable transaction costs incurred. Subsequent measurement of financial liabilities, other than those measured at fair value through profit or loss and financial guarantees, is at amortised cost, using the effective interest method to amortise the difference between proceeds received, net of directly attributable transaction costs incurred, and the redemption amount over the expected life of the instrument.

(aa) Share capital

Shares are classified as equity when there is no contractual obligation to transfer cash or other financial assets. Incremental costs directly attributable to the issue of equity instruments are shown in equity as a deduction from the proceeds, net of tax.

HSBC Holdings plc shares held by HSBC are recognised in equity as a deduction from retained earnings until they are cancelled. When such shares are subsequently sold, reissued or otherwise disposed of, any consideration received is included in equity, net of any directly attributable incremental transaction costs and related income tax effects.

(ab) Cash and cash equivalents

For the purpose of the statement of cash flows, cash and cash equivalents include highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of change in

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