Annual Financial Report - 38 of 41

RNS Number : 8713D

HSBC Holdings PLC

30 March 2011

 



41   Contingent liabilities, contractual commitments and guarantees

	HSBC				HSBC Holdings
	2010		2009		2010		2009
	US$m		US$m		US$m		US$m
Guarantees and contingent liabilities
Guarantees and irrevocable letters of credit pledged as collateral security ...........................................................	71,157		73,385		46,988		35,073
Other contingent liabilities .................................................	166		174		-		-
	71,323		73,559		46,988		35,073
Commitments
Documentary credits and short-term trade-related transactions ....................................................................	12,051		9,066		-		-
Forward asset purchases and forward forward deposits placed .......................................................................................	30		192		-		-
Undrawn formal standby facilities, credit lines and other commitments to lend .....................................................	590,432		548,792		2,720		3,240
	602,513		558,050		2,720		3,240

The above table discloses the nominal principal amounts of commitments excluding capital commitments, which are separately disclosed below, guarantees and other contingent liabilities; mainly credit-related instruments including both financial and non-financial guarantees and commitments to extend credit. Contingent liabilities arising from legal proceedings and regulatory matters against the Group are disclosed in Note 44. Nominal principal amounts represent the amounts at risk should contracts be fully drawn upon and clients default. The amount of the loan commitments shown above reflects, where relevant, the expected level of take-up of pre-approved loan offers made by mailshots to personal customers. As a significant portion of guarantees and commitments is expected to expire without being drawn upon, the total of the nominal principal amounts is not representative of future liquidity requirements.

Guarantees

HSBC provides guarantees and similar undertakings on behalf of both third-party customers and other entities within the HSBC Group. These guarantees are generally provided in the normal course of HSBC's banking business. The principal types of guarantees provided, and the maximum potential amount of future payments which HSBC could be required to make at 31 December 2010, were as follows:

	At 31 December 2010				At 31 December 2009
	Guarantees in favour of third parties		Guarantees by HSBC Holdings in favour of other HSBC Group entities		Guarantees in favour of third parties		Guarantees by HSBC Holdings in favour of other HSBC Group entities
	US$m		US$m		US$m		US$m
Guarantee type
Guarantees of indebtedness including financial guarantees1 and guarantees of a capital nature............	21,175		46,988		23,558		35,073
Standby letters of credit that are financial guarantees ...	8,033		-		10,712		-
Other direct credit substitutes2 ......................................	6,555		-		4,676		-
Performance bonds3 .....................................................	15,367		-		14,468		-
Bid bonds3 ....................................................................	927		-		728		-
Standby letters of credit related to particular transactions3 ............................................................	6,263		-		4,944		-
Other transaction-related guarantees3 ...........................	12,746		-		13,577		-
Other items ..................................................................	91		-		722		-
	71,157		46,988		73,385		35,073

1  Financial guarantees are contracts that require the issuer to make specified payments to reimburse the holder for a loss incurred because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument.

2  Other direct credit substitutes include re-insurance letters of credit and trade-related letters of credit issued without provision for the issuing entity to retain title to the underlying shipment.

3  Performance bonds, bid bonds, standby letters of credit and other transaction-related guarantees are undertakings by which the obligation on HSBC to make payment depends on the outcome of a future event.

The amounts disclosed in the above table are nominal principal amounts and reflect HSBC's maximum exposure under a large number of individual guarantee undertakings. The risks and exposures arising from guarantees are captured and managed in accordance with HSBC's overall credit risk management policies and procedures. Approximately half of the above guarantees have a term of less than one year. Guarantees with terms of more than one year are subject to HSBC's annual credit review process.

Financial Services Compensation Scheme

The Financial Services Compensation Scheme ('FSCS') has provided compensation to consumers following the collapse of a number of deposit takers. The compensation paid out to consumers is currently funded through loans from the Bank of England and HM Treasury. HSBC Bank could be liable to pay a proportion of the outstanding borrowings that the FSCS has borrowed from HM Treasury which at 31 March 2010 stood at approximately £20bn (US$30bn). Currently, the levy paid by the bank represents its share of the interest on these borrowings. The accrual at 31 December 2010 was US$144m in respect of the 2010/11 and 2011/12 levy years (2009: US$182m in respect of the 2009/10 and 2010/11 levy years).

The ultimate FSCS levy to the industry as a result of the collapses cannot currently be estimated reliably as it is dependent on various uncertain factors including the potential recoveries of assets by the FSCS and changes in the interest rate, the level of protected deposits and the population of FSCS members at the time.

Commitments

In addition to the commitments disclosed on page 358, at 31 December 2010, HSBC had US$1,071m (2009: US$1,359m) of capital commitments contracted but not provided for and US$287m (2009: US$227m) of capital commitments authorised but not contracted for.

Associates

HSBC's share of associates' contingent liabilities amounted to US$25,640m at 31 December 2010 (2009: US$19,770m). No matters arose where HSBC was severally liable.

42   Lease commitments

Finance lease commitments

HSBC leases land and buildings (including branches) and equipment from third parties under finance lease arrangements to support its operations.

	At 31 December 2010						At 31 December 2009
	Total future    minimum     payments		Future        interest        charges		Present value  of finance lease commitments		Total future       minimum       payments		Future          interest          charges		Present value     of finance lease commitments
	US$m		US$m		US$m		US$m		US$m		US$m
Lease commitments:
- no later than one year ........	107		(20)		87		103		(29)		74
- later than one year and no later than five years	187		(92)		95		249		(116)		133
- later than five years	390		(118)		272		619		(182)		437
	684		(230)		454		971		(327)		644

At 31 December 2010, future minimum sublease payments of US$436m (2009: US$512m) are expected to be received under non-cancellable subleases at the balance sheet date.

Operating lease commitments

At 31 December 2010, HSBC was obligated under a number of non-cancellable operating leases for properties, plant and equipment on which the future minimum lease payments extend over a number of years.

	At 31 December 2010				At 31 December 2009
	Land and buildings		Equipment		Land and buildings		Equipment
	US$m		US$m		US$m		US$m
Future minimum lease payments under non-cancellable operating leases:
- no later than one year ................................................	920		23		846		11
- later than one year and no later than five years ..........	2,663		37		2,253		11
- later than five years ...................................................	2,614		-		2,534		-
	6,197		60		5,633		22

At 31 December 2010, future minimum sublease payments of US$21m (2009: US$21m) are expected to be received under non-cancellable subleases at the balance sheet date.

In 2010, US$888m (2009: US$1,100m; 2008: US$861m) was charged to 'General and administrative expenses' in respect of lease and sublease agreements, of which US$869m (2009: US$833m; 2008: US$635m) related to minimum lease payments, US$18m (2009: US$16m; 2008: US$22m) to contingent rents, and US$1m (2009: US$251m; 2008: US$204m) to sublease payments.

The contingent rent represents escalation payments made to landlords for operating, tax and other escalation expenses.

Finance lease receivables

HSBC leases a variety of assets to third parties under finance leases, including transport assets (such as aircraft), property and general plant and machinery. At the end of lease terms, assets may be sold to third parties or leased for further terms. Lessees may participate in any sales proceeds achieved. Lease rentals arising during the lease terms will either be fixed in quantum or be varied to reflect changes in, for example, tax or interest rates. Rentals are calculated to recover the cost of assets less their residual value, and earn finance income.

	At 31 December 2010						At 31 December 2009
	Total future minimum payments		Unearned finance income		Present value		Total future minimum payments		Unearned finance income		Present value
	US$m		US$m		US$m		US$m		US$m		US$m
Lease receivables:
- no later than one year ..........	3,002		(344)		2,658		2,874		(328)		2,546
- later than one year and no later than five years .........	8,940		(813)		8,127		9,525		(1,061)		8,464
- later than five years ..............	6,629		(1,462)		5,167		6,902		(1,737)		5,165
	18,571		(2,619)		15,952		19,301		(3,126)		16,175

At 31 December 2010, unguaranteed residual values of US$243m (2009: US$230m) had been accrued, and the accumulated allowance for uncollectible minimum lease payments receivable amounted to US$11m (2009: US$21m). During the year, no contingent rents were received (2009: nil) and recognised in the income statement.

Operating lease receivables

HSBC leases a variety of different assets to third parties under operating lease arrangements, including transport assets, property and general plant and machinery.

	At 31 December 2010				At 31 December 2009
	Land and buildings		Equipment		Land and buildings		Equipment
	US$m		US$m		US$m		US$m
Future minimum lease payments under non-cancellable operating leases:
-. no later than one year ................................................	18		17		37		857
-. later than one year and no later than five years ..........	21		22		21		917
-. later than five years ...................................................	14		2		23		447
	53		41		81		2,221

43   Special purpose entities

HSBC enters into certain transactions with customers in the ordinary course of business which involve the establishment of special purpose entities ('SPE's) to facilitate or secure customer transactions. HSBC structures that utilise SPEs are authorised centrally when they are established to ensure appropriate purpose and governance. The activities of SPEs administered by HSBC are closely monitored by senior management.

SPEs are assessed for consolidation in accordance with the accounting policy set out in Note 1f.

Total consolidated assets held by SPEs by balance sheet classification

	Conduits		Securit-       isations		Money        market           funds		Non-money        market investment           funds		Total
	US$bn		US$bn		US$bn		US$bn		US$bn
At 31 December 2010
Cash ............................................................................	1.0		0.7		-		0.3		2.0
Trading assets .............................................................	0.1		0.6		0.4		0.5		1.6
Financial assets designated at fair value........................	0.1		-		-		6.4		6.5
Derivatives .................................................................	-		0.3		-		-		0.3
Loans and advances to banks .......................................	-		1.4		-		-		1.4
Loans and advances to customers ................................	8.4		22.2		-		-		30.6
Financial investments .................................................	30.5		0.1		-		-		30.6
Other assets ................................................................	1.6		0.4		-		0.4		2.4
	41.7		25.7		0.4		7.6		75.4
At 31 December 2009
Cash ............................................................................	-		-		-		0.2		0.2
Trading assets .............................................................	-		0.9		42.8		0.2		43.9
Financial assets designated at fair value .......................	0.1		-		-		5.3		5.4
Derivatives .................................................................	-		1.2		-		-		1.2
Loans and advances to banks .......................................	0.3		-		-		-		0.3
Loans and advances to customers ................................	10.3		35.4		-		-		45.7
Financial investments .................................................	31.4		-		-		-		31.4
Other assets ................................................................	1.6		1.4		0.3		-		3.3
	43.7		38.9		43.1		5.7		131.4

HSBC's maximum exposure to SPEs

The following table shows the total assets of the various types of SPEs and the amount of funding provided by HSBC to these SPEs. The table also shows HSBC's maximum exposure to the SPEs and, within that exposure, the liquidity and credit enhancements provided by HSBC. The maximum exposures to SPEs represent HSBC's maximum possible risk exposure that could occur as a result of the Group's arrangements and commitments to SPEs. The maximum amounts are contingent in nature, and may arise as a result of drawdowns under liquidity facilities, where these have been provided, and any other funding commitments, or as a result of any loss protection provided by HSBC to the SPEs. The conditions under which such exposure might arise differ depending on the nature of each SPE and HSBC's involvement with it.

Total assets of consolidated and unconsolidated SPEs and HSBC's funding and maximum exposure

	Consolidated SPEs								Unconsolidated SPEs
	Total assets		Funding provided by HSBC		Liquidity and credit enchance- ments		HSBC's maximum exposure		Total assets		Funding provided by HSBC		HSBC's maximum exposure
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 31 December 2010
Conduits ..................................	41.7		28.6		38.3		50.5		-		-		-
Securities investment conduits ........................................	32.2		28.6		25.6		37.8		-		-		-
Multi-seller conduits ............	9.5		0.0		12.7		12.7		-		-		-
Securitisations..........................	25.7		1.9		0.1		4.7		9.9		-		-
Money market funds ...............	0.4		0.4		-		0.4		95.8		0.7		0.7
Constant net asset value funds ........................................	-		-		-		-		74.9		0.5		0.5
Other ..................................	0.4		0.4		-		0.4		20.9		0.2		0.2
Non-money market investment funds ...................................	7.6		6.9		-		6.9		274.7		1.7		1.7
	75.4		37.8		38.4		62.5		380.4		2.4		2.4
At 31 December 2009
Conduits ..................................	43.7		32.8		43.5		56.9		-		-		-
Securities investment conduits ........................................	32.8		32.4		29.1		42.5		-		-		-
Multi-seller conduits ............	10.9		0.4		14.4		14.4		-		-		-
Securitisations .........................	38.9		2.9		0.1		7.9		11.1		0.1		0.1
Money market funds ...............	43.1		1.5		-		1.5		55.9		0.3		0.3
Constant net asset value funds ........................................	42.4		0.9		-		0.9		31.2		0.1		0.1
Other ..................................	0.7		0.6		-		0.6		24.7		0.2		0.2
Non-money market investment funds ...................................	5.7		5.4		-		5.4		249.7		1.4		1.4
Other ......................................	-		-		-		-		20.6		8.8		3.2
	131.4		42.6		43.6		71.7		337.3		10.6		5.0

Conduits

HSBC sponsors and manages two types of conduits: securities investment conduits ('SIC's) and multi-seller conduits.

Securities investment conduits

Solitaire, HSBC's principal SIC, purchases highly rated asset-backed securities ('ABS's) to facilitate tailored investment opportunities. At 31 December 2010, Solitaire held US$11.7bn of ABSs (2009: US$11.7bn). These are included within the disclosures of ABS 'held through consolidated SPEs' on page 133. HSBC's other SICs, Mazarin, Barion and Malachite, evolved from the restructuring of HSBC's sponsored structured investment vehicles ('SIV's) in 2008.

Solitaire

Commercial Paper ('CP') issued by Solitaire benefits from a 100% liquidity facility provided by HSBC. At 31 December 2010, US$7.6bn of Solitaire's assets were funded by the draw-down of the liquidity facility (2009: US$7.6bn). HSBC is exposed to credit losses on the drawn amounts.

HSBC's maximum exposure represents the risk that HSBC may be required to fund the vehicle in the event the CP is redeemed without reinvestment from third parties. At 31 December 2010 this amounted to US$16.8bn (31 December 2009: US$18.4bn).

Mazarin

HSBC is exposed to the par value of Mazarin's assets through the provision of a liquidity facility equal to the lesser of the amortised cost of issued senior debt and the amortised cost of non-defaulted assets. At 31 December 2010 this amounted to US$11.6bn (2009: US$13.6bn). First loss protection is provided through the capital notes issued by Mazarin, which are substantially all held by third parties.

At 31 December 2010, HSBC held 1.3% of Mazarin's capital notes (2009: 1.3%) which have a par value of US$17m (2009: US$17m) and a carrying amount of US$0.6m (2009: US$0.6m).

Barion and Malachite

HSBC's primary exposure to these SICs is represented by the amortised cost of the debt required to support the non-cash assets of the vehicles. At 31 December 2010 this amounted to US$9.4bn (2009: US$10.5bn). First loss protection is provided through the capital notes issued by these vehicles, which are substantially all held by third parties.

At 31 December 2010, HSBC held 3.7% of the capital notes issued by these vehicles (2009: 3.8%) which have a par value of US$35m (2009: US$37m) and a carrying amount of US$2m (2009: US$2m).

Multi-seller conduits

These vehicles were established for the purpose of providing access to flexible market-based sources of finance for HSBC's clients.

HSBC's maximum exposure is equal to the transaction-specific liquidity facilities offered to the multi-seller conduits. First loss protection is provided by the originator of the assets, and not by HSBC, through transaction-specific credit enhancements. A layer of secondary loss protection is provided by HSBC in the form of programme-wide enhancement facilities.

The following table sets out the weighted average life of the asset portfolios for the above mentioned conduits.

Weighted average life of portfolios

	Solitaire		Other SICs		Total SICs		Total multi-     seller conduits
Weighted average life (years)
At 31 December 2010 ............................................	5.1		4.0		4.4		1.8
At 31 December 2009 ..............................................	6.3		4.1		4.9		2.4

Securitisations

HSBC uses SPEs to securitise customer loans and advances that it has originated in order to diversify its sources of funding for asset origination and for capital efficiency purposes. The loans and advances are transferred by HSBC to the SPEs for cash, and the SPEs issue debt securities to investors to fund the cash purchases.

HSBC's maximum exposure is the aggregate of any holdings of notes issued by these vehicles and the reserve account positions intended to provide credit support under certain pre-defined circumstances to senior note holders.

In addition, HSBC uses SPEs to mitigate the capital absorbed by some of the customer loans and advances it has originated. Credit derivatives are used to transfer the credit risk associated with these customer loans and advances to an SPE, using securitisations commonly known as synthetic securitisations by which the SPE writes credit default swap protection to HSBC. The SPE is funded by the issuance of notes with the cash held as collateral against the credit default protection. From a UK regulatory perspective, the credit protection issued by the SPE in respect of the customer loans allows the risk weight of the loans to be replaced by the risk weight of the collateral in the SPE and as a result mitigates the capital absorbed by the customer loans. Any notes issued by the SPE and held by HSBC attract the appropriate risk weight under the relevant regulatory regime. These SPEs are consolidated when HSBC is exposed to the majority of risks and rewards of ownership.

Money market funds

HSBC has established and manages a number of money market funds which provide customers with tailored investment opportunities within narrow and well-defined objectives.

The majority of these money market funds are Constant Net Asset Value funds ('CNAV'), which invest in shorter-dated and highly-rated money market securities with the objective of providing investors with a highly liquid and secure investment. In September 2008 during the financial crisis, HSBC consolidated certain of its CNAV funds as a result of a number of actions taken to maintain their AAA rating and mitigate the risks of forced sales of liquid assets to meet potential redemptions. Since consolidation of the CNAV funds, HSBC has not provided any additional support to the funds and letters of indemnity provided in 2008 have all expired. At all times the funds continued to be governed by their prospectuses.

In December 2010, management determined that it would not provide similar support in the future in the light of changes in the application of banking regulations. As a result, any presumption of ongoing support caused by past actions is no longer valid and it is not appropriate to continue to consolidate the CNAV funds.

The effect of deconsolidating the CNAV funds on HSBC's balance sheet was to derecognise US$44.4bn of assets and US$43.9bn of liabilities. The deconsolidation of the CNAV funds did not have a material impact on HSBC's consolidated income statement for the year ended 31 December 2010.

HSBC's maximum exposure to the CNAV funds is represented by HSBC's investment in the units of the funds which at 31 December 2010 amounted to US$0.5bn (2009: US$1.0bn). Investments in units of the funds are included within 'Trading assets'. Prior to deconsolidation, the interest income from the CNAV funds and the expense payable to third‑party holders of units in the funds were presented within 'Net interest income on trading activities'.

HSBC's maximum exposure to money market funds is represented by HSBC's investment in the units of each fund, which at 31 December 2010 amounted to US$1.1bn (2009: US$1.8bn).

Non-money market investment funds

HSBC has established a large number of non-money market investment funds to enable customers to invest in a range of assets, typically equities and debt securities.

HSBC's maximum exposure to non-money market investment funds is represented by its investment in the units of each fund which at 31 December 2010 amounted to US$8.6bn (2009: US$6.8bn).

Other

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

In certain transactions HSBC is exposed to risk often referred to as gap risk. Gap risk typically arises in transactions where the aggregate potential claims against the SPE by HSBC pursuant to one or more derivatives could be greater than the value of the collateral held by the SPE and securing such derivatives. HSBC often mitigates such gap risk by incorporating in the SPE transaction features which allow for deleveraging, a managed liquidation of the portfolio, or other mechanisms including trade restructuring or unwinding the trade. Following the inclusion of such risk reduction mechanisms, HSBC has, in certain circumstances, retained all or a portion of the underlying exposure in the transaction. In these circumstances, HSBC assesses whether the exposure retained causes a requirement under IFRSs to consolidate the SPE. When this retained exposure represents ABSs, it has been included in 'Nature of HSBC's exposures' on page 129.

Third-party sponsored SPEs

Through standby liquidity facility commitments, HSBC has exposure to third-party sponsored SIVs, conduits and securitisations under normal banking arrangements on standard market terms. These exposures are not considered significant to HSBC's operations.

Additional off-balance sheet arrangements and commitments

Additional off-balance sheet commitments such as financial guarantees, letters of credit and commitments to lend are disclosed in Note 41.

Leveraged finance transactions

Loan commitments in respect of leveraged finance transactions are accounted for as derivatives where it is HSBC's intention to sell the loan after origination. Further information is provided on pages 138 and 139.

44   Legal proceedings, investigations and regulatory matters

HSBC is party to legal proceedings, investigations and regulatory matters in a number of jurisdictions including the UK, Hong Kong and the US arising out of its normal business operations. Apart from the matters described below, HSBC considers that none of these matters is material, either individually or in the aggregate. HSBC recognises a provision for a liability in relation to these matters when it is probable that an outflow of economic benefits will be required to settle an 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. While the outcome of these matters is inherently uncertain, management believes that, based on the information available to it, appropriate provisions have been made in respect of legal proceedings, investigations and regulatory matters as at 31 December 2010 (see note 33, Provisions).

Securities litigation

As a result of an August 2002 restatement of previously reported consolidated financial statements and other corporate events, including the 2002 settlement with 46 State Attorneys General relating to real estate lending practices, Household International (now HSBC Finance) and certain former officers were named as defendants in a class action law suit, Jaffe v Household International Inc, et al No 2. C 5893 (N.D.Ill, filed 19 August 2002). The complaint asserted claims under the US Securities Exchange Act of 1934, on behalf of all persons who acquired and disposed of Household International common stock between 30 July 1999 and 11 October 2002. The claims alleged that the defendants knowingly or recklessly made false and misleading statements of material fact relating to Household's Consumer Lending operations, including collections, sales and lending practices, some of which ultimately led to the 2002 State settlement agreement, and facts relating to accounting practices evidenced by the restatement. Following a jury trial concluded in April 2009, which was decided partly in favour of the plaintiffs, the Court issued a ruling on 22 November 2010, within the second phase of the case to determine actual damages, that claim forms should be mailed to class members, and also set out a method for calculating damages for class members who filed claims. At subsequent hearings the Court has allowed HSBC Finance to take limited discovery on the issue of whether investors relied on the 'misleading statements' at the time they made their investments and also reserved on the issue of whether HSBC Finance would ultimately be entitled to a jury trial on the issue of reliance.

Despite the jury verdict and the 22 November 2010 ruling, HSBC continues to believe that it has meritorious defences, and intends to seek an appeal of the Court's rulings. Lead Plaintiffs, in Court filings, have estimated that damages could range 'somewhere between US$2.4bn to US$3.2bn to class members', before pre-judgement interest. The timing and outcome of the resolution of this matter is uncertain. Given the complexity and uncertainties associated with the actual determination of damages, including but not limited to the number of class members that may file valid claims, the number of claims that can be substantiated by class members providing adequate documentation, the reduction of trading losses by any trading gains made over the relevant period, the determination of reliance by class members on the financial statements, and whether any given class member was the beneficial owner of the shares, HSBC is unable at this time to estimate reliably the amount of any damages, or range of possible damages, that could arise, but they could be significant.

Bernard L. Madoff Investment Securities LLC

In December 2008, Bernard L. Madoff ('Madoff') was arrested for running a Ponzi scheme and a trustee was appointed for the liquidation of his firm, Bernard L. Madoff Investment Securities LLC ('Madoff Securities'), an SEC-registered broker-dealer and investment adviser. Since his appointment, the trustee has been recovering assets and processing claims of Madoff Securities customers. Madoff subsequently pleaded guilty to various charges and is serving a 150-year prison sentence. He has acknowledged, in essence, that while purporting to invest his customers' money in securities and, upon request, return their profits and principal, he in fact never invested in securities and used other customers' money to fulfil requests for the return of profits and principal. The relevant US authorities are continuing their investigations into his fraud, and have brought charges against others.

Various non-US HSBC companies provided custodial, administration and similar services to a number of funds incorporated outside the US whose assets were invested with Madoff Securities.

Based on information provided by Madoff Securities, as at 30 November 2008, the purported aggregate value of these funds was US$8.4bn, an amount that includes fictitious profits reported by Madoff. Based on information available to HSBC to date, we estimate that the funds' actual transfers to Madoff Securities minus their actual withdrawals from Madoff Securities during the time that HSBC serviced the funds totalled approximately US$4.3bn.

Plaintiffs (including funds, fund investors, and the Madoff Securities trustee) have commenced Madoff-related proceedings against numerous defendants in a multitude of jurisdictions. Various HSBC companies have been named as defendants in suits in the US, Ireland, Luxembourg, and other jurisdictions. The suits (which include US class actions) allege that the HSBC defendants knew or should have known of Madoff's fraud and breached various duties to the funds and fund investors. In December 2010, the Madoff Securities trustee commenced suits against various HSBC companies in the US bankruptcy court and in the English High Court. The US action (which also names certain funds, investment managers, and other entities and individuals) seeks US$9bn in damages and additional recoveries from HSBC and the various co-defendants. It seeks damages against HSBC for allegedly aiding and abetting Madoff's fraud and breach of fiduciary duty. It also seeks, pursuant to US bankruptcy law, recovery of unspecified amounts received by HSBC from funds invested with Madoff, including amounts that HSBC received when it redeemed units HSBC held in the various funds. HSBC acquired those fund units in connection with financing transactions HSBC had entered into with various clients. The trustee's US bankruptcy law claims also seek recovery of fees earned by HSBC for providing custodial, administration and similar services to the funds. The trustee's English action seeks recovery of unspecified transfers of money from Madoff Securities to or through HSBC, on the ground that the HSBC defendants actually or constructively knew of Madoff's fraud.

Between October 2009 and July 2010, Fairfield Sentry Limited and Fairfield Sigma Limited ('Fairfield'), funds whose assets were directly or indirectly invested with Madoff Securities, commenced multiple suits in the British Virgin Islands and the US against numerous fund shareholders, including various HSBC companies that acted as nominees for clients of HSBC's private banking business and other clients who invested in the Fairfield funds. The Fairfield actions seek restitution of amounts paid to the defendants in connection with share redemptions, on the ground that such payments were made by mistake, based on inflated values resulting from Madoff's fraud.

There are many factors which may affect the range of possible outcomes, and the resulting financial impact, of the various Madoff-related proceedings, including but not limited to the circumstances of the fraud, the multiple jurisdictions in which the proceedings have been brought and the number of different plaintiffs and defendants in such proceedings. The cases where HSBC companies are named as a defendant are at an early stage. For these reasons, among others, it is not practicable at this time for HSBC to estimate reliably the aggregate liabilities, or ranges of liabilities, that might arise as a result of all such claims but they could be significant. In any event, HSBC considers that it has good defences to these claims and will continue to defend them vigorously.

Payment Protection Insurance

Following an extensive period of consultation, on 10 August 2010 the Financial Services Authority ('FSA') published Policy Statement 10/12 ('PS 10/12') on the assessment and redress of Payment Protection Insurance ('PPI') complaints. This included (i) new handbook guidance setting out how complaints are to be handled, and 'redressed fairly' where appropriate; (ii) an explanation of when and why firms should analyse their past complaints to identify if there are serious flaws in sales practices that may have affected complainants and non-complainants; and (iii) an Open Letter setting out common sales failings to help firms identify bad practices.

After extensive consideration, the British Bankers Association ('BBA'), as the representative body of UK banks, sent a formal pre-action protocol letter to the FSA and the Financial Ombudsman Service ('FOS') setting out its concerns and what it considered to be the flaws identified in PS 10/12 and Guidance issued by FOS on the handling of PPI complaints. The letter indicated that, absent a satisfactory reply, it was the BBA's intention to apply to the High Court for a Judicial Review of both PS 10/12 and the FOS Guidance. The FSA and FOS responded on 28 September 2010 denying that they had acted unlawfully in introducing the Policy Statement or relying on the Guidance.

On 8 October 2010, an application for Judicial Review was issued by the BBA seeking an order to quash PS 10/12 and the FOS Guidance. The FSA subsequently issued a statement on 24 November 2010 seeking to clarify aspects of PS 10/12 and the Open Letter. The FSA and FOS filed defences to the Judicial Review application on 10 December 2010. The Judicial Review application was heard by the Court on 25 - 28 January 2011, and judgement is currently awaited.

HSBC believes that the BBA has a strongly arguable case against both the FSA and the FOS. If the Court ultimately concludes, however, after any appeals of the judgement that may follow from any of the parties, that PS 10/12 and the FOS Guidance stand, in whole or in part, then these would need to be taken into consideration when determining complaints alleging the mis-sale of PPI.

If, contrary to HSBC's current assessment, a decision is reached in the case that results in a potential liability for HSBC, a large number of different outcomes is possible, each of which would have a different financial impact. There are many factors affecting the range of possible outcomes, and the resulting financial impact, including the extent to which one or both of PS 10/12 and the FOS Guidance are upheld, and the underlying rationale for each decision; the ways in which PS 10/12 and or the FOS Guidance are found to impose additional requirements over and above the common law and the FSA Conduct of Business rules in force at the time relating to the sale of general insurance products, and in the handling of firms' PPI complaints; the effect of any decision on the nature and volume of customer complaints; and the extent to which, if at all, HSBC might be required to take action, and the nature of any such action, in relation to non-complainants. The extent of any redress that may be required as a result of a decision to uphold PS 10/12 and the FOS Guidance, in whole or in part, would also depend on the facts and circumstances of each individual customer's case. For these reasons, among others, HSBC does not at this time consider it practicable to provide a reliable estimate or range of estimates of the potential financial impact of an adverse decision.

Pending resolution of the dispute, HSBC continues to review all complaints received which allege that PPI has been mis-sold and, where possible, seeks to resolve them. Where HSBC considers it is not in a position to reach a final decision on a complaint until the conclusion of the application for Judicial Review of PS 10/12 and the FOS Guidance and any subsequent appeals, it informs the complainant that this is the case.

In December 2007, the Group decided to cease selling PPI products in the UK and a phased withdrawal was completed across the HSBC, first direct and M&S Money brands during 2008. HFC Bank Ltd ('HFC') ceased selling single premium PPI in 2008 and sales of regular premium PPI will reduce as HFC exits its remaining retail relationships. During the consultation process in 2009, the FSA reported that it had obtained agreement from firms representing 40% of the market for face to face single premium PPI sales to review all such sales since July 2007. No HSBC subsidiary or associate was included in that group of firms.

Regulatory and law enforcement agencies investigations

HSBC Bank USA entered into a consent cease and desist order with the Office of the Comptroller of the Currency and the indirect parent of that company, HSBC North America, entered into a consent cease and desist order with the Federal Reserve Board in the first week of October 2010. These actions require improvements for an effective compliance risk management programme across the Group's US businesses, including US Bank Secrecy Act ('BSA') and Anti Money Laundering ('AML') compliance. Steps continue to be taken to address the requirements of these Orders and to ensure that compliance and effective policies and procedures are maintained.

Various HSBC Group companies are the subject of ongoing investigations, including Grand Jury subpoenas and other requests for information, by US Government agencies, including the US Attorney's Office, the US Department of Justice and the New York County District Attorney's Office. These investigations pertain to, among other matters, HSBC Bank USA's bank note and foreign correspondent banking businesses and its compliance with BSA and AML controls, as well as various HSBC companies' compliance with Office of Foreign Asset Control ('OFAC') requirements, and adherence by certain customers to US tax reporting requirements.

The consent cease and desist orders do not preclude additional enforcement actions against HSBC Bank USA or HSBC North America by bank regulatory or law enforcement agencies, including actions to recover civil money penalties, fines and other financial penalties relating to activities which were the subject of the cease and desist orders. In addition, it is likely that there could be some form of formal enforcement action in respect of some or all of the ongoing investigations. Actual or threatened enforcement actions against other financial institutions for breaches of BSA, AML and OFAC requirements have resulted in settlements involving fines and penalties, some of which have been significant depending on the individual circumstances of each action. The ongoing investigations are at an early stage. Based on the facts currently known, it is not practicable at this time for HSBC to determine the terms on which the ongoing investigations will be resolved or the timing of such resolution or for HSBC to estimate reliably the amounts, or range of possible amounts, of any fines and/or penalties. As matters progress, it is possible that any fines and/or penalties could be significant.

45    Related party transactions

Related parties of the Group and HSBC Holdings include subsidiaries, associates, joint ventures, post-employment benefit plans for HSBC employees, Key Management Personnel, close family members of Key Management Personnel and entities which are controlled, jointly controlled or significantly influenced, or for which significant voting power is held, by Key Management Personnel or their close family members.

Key Management Personnel are defined as those persons having authority and responsibility for planning, directing and controlling the activities of HSBC Holdings, being the Directors and Group Managing Directors of HSBC Holdings.

Compensation of Key Management Personnel

	HSBC
	2010		2009		2008
	US$m		US$m		US$m
Short-term employee benefits ......................................................................	39		22		31
Post-employment benefits ...........................................................................	3		3		5
Other long-term benefits ..............................................................................	1		-		-
Termination benefits ....................................................................................	-		-		-
Share-based payments ...................................................................................	49		27		16
	92		52		52

Transactions, arrangements and agreements involving related parties

Particulars of advances (loans and quasi-loans), credits and guarantees entered into by subsidiaries of HSBC Holdings during 2010 with Directors, disclosed pursuant to section 413 of the Companies Act 2006, are shown below:

	At 31 December
	2010		2009
	US$m		US$m
Advances and credits ...............................................................................................................	9		5

Particulars of transactions with related parties, disclosed pursuant to the requirements of IAS 24, are shown below. The disclosure of the year-end balance and the highest amounts outstanding during the year in the table below is considered to be the most meaningful information to represent the amount of the transactions and the amount of outstanding balances during the year.

	2010				2009
	Balance at 31 December		Highest         amounts    outstanding    during year		Balance at    31 December		Highest           amounts       outstanding       during year
	US$m		US$m		US$m		US$m
Key Management Personnel1
Advances and credits .........................................................	901		1,681		736		1,407
Guarantees ........................................................................	27		31		32		34

1  Includes Key Management Personnel, close family members of Key Management Personnel and entities which are controlled, jointly controlled or significantly influenced, or for which significant voting power is held, by Key Management Personnel or their close family members.

Some of the transactions were connected transactions, as defined by the Rules Governing The Listing of Securities on The Stock Exchange of Hong Kong Limited but were exempt from any disclosure requirements under the provisions of those Rules. The above transactions were made in the ordinary course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with persons of a similar standing or, where applicable, with other employees. The transactions did not involve more than the normal risk of repayment or present other unfavourable features.

Shareholdings, options and other securities of Key Management Personnel

	At 31 December
	2010                   (000s)		2009                   (000s)
Number of options held over HSBC Holdings ordinary shares under employee share plans .......	602		1,033
Number of HSBC Holdings ordinary shares held beneficially and non-beneficially ....................	13,395		19,567
Number of HSBC Holdings preference shares held beneficially and non-beneficially ................	-		8
Number of HSBC Holdings 8.125% Perpetual Subordinated Capital Securities held beneficially and non-beneficially .........................................................................................	-		25
	13,997		20,633

Transactions with other related parties of HSBC

Associates and joint ventures

The Group provides certain banking and financial services to associates and joint ventures, including loans, overdrafts, interest and non-interest bearing deposits and current accounts. Details of the interests in associates and joint ventures are given in Note 21. Transactions and balances during the year with associates and joint ventures were as follows:

	2010				2009
	Highest           balance during          the year1		Balance at 31 December1		Highest   balance during            the year1		Balance at    31 December1
	US$m		US$m		US$m		US$m
Amounts due from joint ventures:
- subordinated ................................................................	5		5		-		-
- unsubordinated .............................................................	514		412		423		378
Amounts due from associates:
- subordinated ................................................................	16		-		17		17
- unsubordinated .............................................................	2,248		1,702		1,343		1,239
	2,783		2,119		1,783		1,634
Amounts due to joint ventures ...........................................	151		134		130		129
Amounts due to associates ..................................................	700		527		1,494		136
	851		661		1,624		265

1  The disclosure of the year-end balance and the highest balance during the year is considered the most meaningful information to represent transactions during the year.

The above outstanding balances arose from the ordinary course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with third-party counterparties.

Post-employment benefit plans

At 31 December 2010, US$4.7bn (2009: US$4.2bn) of HSBC post-employment benefit plan assets were under management by HSBC companies. Fees of US$17m (2009: US$15m) were earned by HSBC companies for these management services provided to its post-employment benefit plans. HSBC's post-employment benefit plans had placed deposits of US$1,840m (2009: US$929m) with its banking subsidiaries, on which interest payable to the schemes amounted to US$4m (2009: US$3m). The above outstanding balances arose from the ordinary course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with third-party counterparties.

HSBC Bank (UK) Pension Scheme entered into swap transactions with HSBC as part of the management of the inflation and interest rate sensitivity of its liabilities. At 31 December 2010, the gross notional value of the swaps was US$22.9bn (2009: US$23.7bn), the swaps had a positive fair value of US$2.2bn (2009: positive fair value of US$1.0bn) to the scheme and HSBC had delivered collateral of US$3.3bn (2009: US$2.8bn) to the scheme in respect of these swaps, on which HSBC earned interest amounting to nil (2009: US$7m). All swaps were executed at prevailing market rates and within standard market bid/offer spreads.

In order to satisfy diversification requirements, there are special collateral provisions for the swap transactions between HSBC and the scheme. The collateral agreement stipulates that the scheme never posts collateral to HSBC. Collateral is posted to the scheme by HSBC at an amount that provides the Trustee with a high level of confidence that would be sufficient to replace the swaps in the event of default by HSBC Bank plc. With the exception of the special collateral arrangements detailed above, all other aspects of the swap transactions between HSBC and the scheme are on substantially the same terms as comparable transactions with third-party counterparties.

On 17 June 2010, HSBC Bank plc made a £1,760m (US$2,638m) special contribution to accelerate the reduction of the deficit of the HSBC Bank (UK) Pension Scheme. On the same day the Scheme used the contribution to acquire debt securities with a fair value of £1,760m (US$2,638m) from HSBC in a transaction at an arm's length value determined by the Scheme's independent third-party advisors.

HSBC International Staff Retirements Benefits Scheme entered into swap transactions with HSBC to manage the inflation and interest rate sensitivity of the liabilities and selected assets. At 31 December 2010, the gross notional value of the swaps was US$1.8bn (2009: US$1.8bn) and the swaps had a net positive fair value of US$77m to the scheme (2009: US$27m). 

HSBC Holdings

Details of HSBC Holdings' principal subsidiaries are shown in Note 26. Transactions and balances during the year with subsidiaries were as follows:

	2010				2009
	Highest           balance during         the year1		Balance at 31 December1		Highest   balance during           the year1		Balance at    31 December1
	US$m		US$m		US$m		US$m
Assets
Cash at bank ................................................................	459		459		443		224
Derivatives ..................................................................	3,219		2,327		3,682		2,981
Loans and advances .....................................................	23,212		21,238		26,156		23,212
Financial investments ..................................................	2,606		2,025		2,629		2,455
Investments in subsidiaries ...........................................	92,899		92,899		90,914		86,247
Total related party assets .............................................	122,395		118,948		123,824		115,119
Liabilities
Amounts owed to HSBC undertakings ..........................	4,580		2,932		5,669		3,711
Derivatives ..................................................................	1,677		827		1,324		362
Subordinated liabilities:
- at amortised cost ...................................................	3,907		2,464		3,907		3,907
- designated at fair value ..........................................	4,507		4,259		4,360		4,360
Total related party liabilities ........................................	14,671		10,482		15,260		12,340
Guarantees ...................................................................	46,988		46,988		47,341		35,073
Commitments ..............................................................	3,240		2,720		3,241		3,240

1  The disclosure of the year-end balance and the highest balance during the year is considered the most meaningful information to represent transactions during the year. The above outstanding balances arose in the ordinary course of business and are on substantially the same terms, including interest rates and security, as for comparable transactions with third-party counterparties, with the exception of US$160m (2009: US$160m) in respect of loans to HSBC subsidiaries from HSBC Holdings and US$506m (2009: US$529m) in respect of loans from HSBC subsidiaries to HSBC Holdings made at an agreed zero per cent interest rate.

Some employees of HSBC Holdings are members of the HSBC Bank (UK) Pension Scheme, which is sponsored by a separate Group company. HSBC Holdings incurs a charge for these employees equal to the contributions paid into the scheme on their behalf. Disclosure in relation to the scheme is made in Note 7 to the accounts.

46   Events after the balance sheet date

A fourth interim dividend for 2010 of US$0.12 per ordinary share (a distribution of approximately US$2,125m) was declared by the Directors after 31 December 2010.

These accounts were approved by the Board of Directors on 28 February 2011 and authorised for issue.

 

END

 

 

ACSUKSWRAWAOUAR