Annual Financial Report -43 of 48

RNS Number : 3939B

HSBC Holdings PLC

03 April 2013

14 Trading assets

	2012	2011
	US$m	US$m
Trading assets:
- not subject to repledge or resale by counterparties ...........................................................	305,312	235,916
- which may be repledged or resold by counterparties .........................................................	103,499	94,535

	408,811	330,451

Treasury and other eligible bills ...............................................................................................	26,282	34,309
Debt securities .........................................................................................................................	144,677	130,487
Equity securities ......................................................................................................................	41,634	21,002

Trading assets at fair value ......................................................................................................	212,593	185,798
Loans and advances to banks ...................................................................................................	78,271	75,525
Loans and advances to customers ............................................................................................	117,947	69,128

	408,811	330,451

Trading assets valued at fair value¹

	Fair value
	2012	2011
	US$m	US$m

US Treasury and US Government agencies² .............................................................................	28,405	15,686
UK Government .....................................................................................................................	11,688	12,917
Hong Kong Government .........................................................................................................	6,228	8,844
Other government ..................................................................................................................	91,498	90,816
Asset-backed securities³ ...........................................................................................................	2,896	2,913
Corporate debt and other securities .........................................................................................	30,244	33,620
Equity securities ......................................................................................................................	41,634	21,002

	212,593	185,798

1 Included within these figures are debt securities issued by banks and other financial institutions of US$20,274m (2011: US$24,956m), of which US$3,469m (2011: US$5,269m) are guaranteed by various governments.

2 Includes securities that are supported by an explicit guarantee issued by the US Government.

3 Excludes asset-backed securities included under US Treasury and US Government agencies.

Trading assets listed on a recognised exchange and unlisted

	Treasury and other eligible bills	Debt securities	Equity securities	Total
	US$m	US$m	US$m	US$m
Fair value at 31 December 2012
Listed on a recognised exchange¹ .......................................	606	82,732	39,945	123,283
Unlisted² ............................................................................	25,676	61,945	1,689	89,310

	26,282	144,677	41,634	212,593

Fair value at 31 December 2011
Listed on a recognised exchange¹ .......................................	789	78,760	19,994	99,543
Unlisted² ............................................................................	33,520	51,727	1,008	86,255

	34,309	130,487	21,002	185,798

1 Included within listed investments are US$2,828m (2011: US$2,836m) of investments listed in Hong Kong.

2 Unlisted treasury and other eligible bills primarily comprise treasury bills not listed on a recognised exchange but for which there is a liquid market.

Loans and advances to banks held for trading

	2012	2011
	US$m	US$m

Reverse repos ..........................................................................................................................	45,015	45,490
Settlement accounts ................................................................................................................	6,324	7,555
Stock borrowing ......................................................................................................................	5,361	5,531
Other ......................................................................................................................................	21,571	16,949

	78,271	75,525

Loans and advances to customers held for trading

	2012	2011
	US$m	US$m

Reverse repos .......................................................................................................................	73,666	34,358
Settlement accounts .............................................................................................................	8,186	5,804
Stock borrowing ...................................................................................................................	10,710	3,928
Other ...................................................................................................................................	25,385	25,038

	117,947	69,128

15 Fair values of financial instruments carried at fair value

The classification of financial instruments is determined in accordance with the accounting policies set out in Note 2. The use of assumptions and estimation in valuing financial instruments is described on page 56.

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

Financial instruments carried at fair value and bases of valuation¹

		Valuation techniques
	Quoted market price Level 1	Using observable inputs Level 2	With significant unobservable inputs Level 3	Total
	US$m	US$m	US$m	US$m
At 31 December 2012
Assets
Trading assets ..............................................................	198,843	205,590	4,378	408,811
Financial assets designated at fair value ........................	25,575	7,594	413	33,582
Derivatives ..................................................................	1,431	352,960	3,059	357,450
Financial investments: available for sale ......................	253,246	135,931	8,511	397,688

Liabilities
Trading liabilities .........................................................	116,550	180,543	7,470	304,563
Financial liabilities designated at fair value ...................	10,703	77,017	-	87,720
Derivatives ..................................................................	1,506	354,375	3,005	358,886

At 31 December 2011
Assets
Trading assets ..............................................................	180,043	145,628	4,780	330,451
Financial assets designated at fair value ........................	22,496	7,644	716	30,856
Derivatives ..................................................................	1,262	340,668	4,449	346,379
Financial investments: available for sale ......................	217,788	151,936	9,121	378,845

Liabilities
Trading liabilities .........................................................	98,208	159,157	7,827	265,192
Financial liabilities designated at fair value ...................	27,461	57,696	567	85,724
Derivatives ..................................................................	1,991	340,260	3,129	345,380

1 The above table does not include financial instruments within the Assets held for sale and Liabilities of disposal groups held for sale categorisations.

The increase in Level 1 trading assets and liabilities reflects an increase in equity securities and settlement account balances, the latter varying considerably in proportion with the level of trading activity. The increase in Level 2 assets reflects higher reverse repo balances used to cover short positions and an increase in repo balances contributed to the growth in Level 2 liabilities.

As described on page 446, HSBC Holdings transferred financial liabilities designated at fair value from Level 1 to Level 2. There were no other material transfers between Level 1 and Level 2 in the year. An analysis of the movements of Level 3 financial instruments is provided on page 447.

Control framework

Fair values are subject to a control framework designed to ensure that they are either determined or validated by a function independent of the risk‑taker.

For all financial instruments where fair values are determined by reference to externally quoted prices or observable pricing inputs to models, independent price determination or validation is utilised. In inactive markets, direct observation of a traded price may not be possible. In these circumstances, HSBC will source alternative market information to validate the financial instrument's fair value, with greater weight given to information that is considered to be more relevant and reliable. The factors that are considered in this regard are, inter alia:

· the extent to which prices may be expected to represent genuine traded or tradeable prices;

· the degree of similarity between financial instruments;

· the degree of consistency between different sources;

· the process followed by the pricing provider to derive the data;

· the elapsed time between the date to which the market data relates and the balance sheet date; and

· the manner in which the data was sourced.

For fair values determined using a valuation model, the control framework may include, as applicable, development or validation by independent support functions of (i) the logic within valuation models; (ii) the inputs to those models; (iii) any adjustments required outside the valuation models; and (iv) where possible, model outputs. Valuation models are subject to a process of due diligence and calibration before becoming operational and are calibrated against external market data on an ongoing basis.

The fair value governance structure is as follows:

Determination of fair value

Fair values are determined according to the following hierarchy:

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

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

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

The best evidence of fair value is a quoted price in an actively traded market. The fair values of financial instruments that are quoted in active markets are based on bid prices for assets held and offer prices for liabilities issued. 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. In the event that the market for a financial instrument is not active, a valuation technique is used.

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

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. For swaps with collateralised counterparties and in significant major currencies, HSBC uses a discounting curve that reflects the overnight interest rate ('OIS discounting').

The majority of valuation techniques employ only observable market data. However, certain financial instruments are valued on the basis of valuation techniques that feature one or more significant market inputs that are unobservable, and for them the measurement of fair value is more judgemental. An instrument in its entirety is classified as valued using significant unobservable inputs if, in the opinion of management, a significant proportion of the instrument's inception profit ('day 1 gain or loss') or greater than 5% of the instrument's carrying value is driven by unobservable inputs. 'Unobservable' in this context means that there is little or no current market data available from which to determine the price at which an arm's length transaction would be likely to occur. It generally does not mean that there is no data available at all upon which to base a determination of fair value (consensus pricing data may, for example, be used).

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

Structured notes issued and certain other hybrid instrument liabilities are included within trading liabilities and are measured at fair value. The credit spread applied to these instruments is derived from the spreads at which HSBC issues structured notes.

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

Fair value adjustments

Fair value adjustments are adopted when HSBC considers that there are additional factors that would be considered by a market participant that are not incorporated within the valuation model. The magnitude of fair value adjustments depends upon many entity-specific factors, and therefore fair value adjustments may not be comparable across the banking industry.

HSBC classifies fair value adjustments as either 'risk-related' or 'model-related'. The majority of these adjustments relate to GB&M.

Movements in the level of fair value adjustments do not necessarily result in the recognition of profits or losses within the income statement. For example, as models are enhanced, fair value adjustments may no longer be required. Similarly, fair value adjustments will decrease when the related positions are unwound, but this may not result in profit or loss.

Global Banking and Markets fair value adjustments

	At 31 December
	2012	2011
	US$m	US$m
Type of adjustment
Risk-related .............................................................................................................................	2,013	1,899
Bid-offer .............................................................................................................................	638	695
Uncertainty .........................................................................................................................	142	154
Credit valuation adjustment .................................................................................................	1,747	1,050
Debit valuation adjustment ..................................................................................................	(518)	-
Other ..................................................................................................................................	4	-

Model-related ..........................................................................................................................	162	567
Model limitation .................................................................................................................	161	567
Other ..................................................................................................................................	1	-

Inception profit (Day 1 P&L reserves) (Note 19) ...................................................................	181	200

	2,356	2,666

The increase in credit valuation adjustment and debit valuation adjustment reflects a refinement in methodology, described on page 441. The decrease in model limitation adjustments reflects the inclusion of OIS discounting within the modelled value of many interest rate derivatives such that an adjustment is no longer required outside the model, in addition to market movements and the unwind or maturity of certain legacy credit structures.

Risk-related adjustments

Bid-offer

IAS 39 requires that financial instruments are marked at bid or offer, as appropriate. Valuation models will typically generate mid-market values. The bid-offer adjustment reflects the cost that would be incurred if substantially all residual net portfolio market risks were closed using available hedging instruments or by disposing of or unwinding the actual position.

Uncertainty

Certain model inputs may be less readily determinable from market data, and/or the choice of model itself may be more subjective. In these circumstances, there exists a range of possible values that the financial instrument or market parameter may assume and an adjustment may be necessary to reflect the likelihood that in estimating the fair value of the financial instrument, market participants would adopt more conservative values for uncertain parameters and/or model assumptions than those used in the valuation model.

Credit valuation adjustment

The credit valuation adjustment is an adjustment to the valuation of OTC derivative contracts to reflect within fair value the possibility that the counterparty may default and that HSBC may not receive the full market value of the transactions.

Debit valuation adjustment

The debit valuation adjustment is an adjustment to the valuation of OTC derivative contracts to reflect within fair value the possibility that HSBC may default, and that HSBC may not pay full market value of the transactions.

Model-related adjustments

Model limitation

Models used for portfolio valuation purposes may be based upon a simplifying set of assumptions that do not capture all material market characteristics. Additionally, markets evolve, and models that were adequate in the past may require development to capture all material market characteristics in current market conditions. In these circumstances, model limitation adjustments are adopted. As model development progresses, model limitations are addressed within the valuation models and a model limitation adjustment is no longer needed.

Inception profit (Day 1 P&L reserves)

Inception profit adjustments are adopted where the fair value estimated by a valuation model is based on one or more significant unobservable inputs. The accounting for inception profit adjustments is discussed on page 388. An analysis of the movement in the deferred Day 1 P&L reserve is provided on page 454.

Credit valuation adjustment/debit valuation adjustment methodology

HSBC calculates a separate credit valuation adjustment ('CVA') and debit valuation adjustment ('DVA') for each HSBC legal entity, and within each entity for each counterparty to which the entity has exposure. The calculation of the monoline CVA is described on page 189.

HSBC calculates the CVA by applying the probability of default ('PD') of the counterparty conditional on the non-default of HSBC, to the expected positive exposure of HSBC to the counterparty, and multiplying the result by the loss expected in the event of default. Conversely, HSBC calculates the DVA by applying the PD of HSBC, conditional on the non-default of the counterparty, to the expected positive exposure of the counterparty to HSBC, and multiplying by the loss expected in the event of default. Both calculations are performed over the life of the potential exposure.

As set out on page 383, from 31 December 2012 HSBC revised its methodology for estimating the CVA and the DVA for derivatives. The CVA calculation maximises the use of PD based on relevant, observable market data, such as credit default swap ('CDS') spreads. Where CDS spreads are not available, PDs are estimated having regard to market practice, considering relevant data including both CDS indices and historical rating transition matrices. HSBC aligned its methodology for estimating the DVA to be consistent with that applied for the CVA as at 31 December 2012. Historically, HSBC considered that a zero spread was appropriate in respect of own credit risk and consequently did not adjust derivative liabilities for its own credit risk.

For most products, to calculate the expected positive exposure to a counterparty, HSBC uses a simulation methodology to incorporate the range of potential exposures across the portfolio of transactions with the counterparty over the life of an instrument. The simulation methodology includes credit mitigants such as counterparty netting agreements and collateral agreements with the counterparty. A standard loss given default assumption of 60% is generally adopted for developed market exposures, and 75% for emerging market exposures. Alternative loss given default assumptions may be adopted where both the nature of the exposure and the available data support this.

For certain types of exotic derivatives where the products are not currently supported by the simulation, or for derivative exposures in smaller trading locations where the simulation tool is not yet available, HSBC adopts alternative methodologies. These may involve mapping to the results for similar products from the simulation tool or where such a mapping approach is not appropriate, a simplified methodology is used, generally following the same principles as the simulation methodology. The calculation is applied at a trade level, with more limited recognition of credit mitigants such as netting or collateral agreements than used in the simulation methodology described previously.

The methodologies do not, in general, account for 'wrong-way risk'. Wrong-way risk arises where the underlying value of the derivative prior to any CVA is positively correlated to the probability of default of the counterparty. Where there is significant wrong-way risk, a trade-specific approach is applied to reflect the wrong-way risk within the valuation.

With the exception of certain central clearing parties, HSBC includes all third-party counterparties in the CVA and DVA calculations and does not net these calculations across HSBC Group entities.

Fair value valuation bases

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

	Assets					Liabilities
	Available for sale	Held for trading	Designated at fair value through profit or loss		Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m	US$m		US$m	US$m	US$m		US$m	US$m
At 31 December 2012
Private equity including strategic investments .............................	3,582	92		377	-	-		-	-
Asset-backed securities ................	2,288	652		-	-	-		-	-
Loans held for securitisation .......	-	547		-	-	-		-	-
Structured notes ..........................	-	23		-	-	6,987		-	-
Derivatives with monolines .........	-	-		-	630	-		-	-
Other derivatives ........................	-	-		-	2,429	-		-	3,005
Other portfolios ..........................	2,641	3,064		36	-	483		-	-

	8,511	4,378		413	3,059	7,470		-	3,005

At 31 December 2011
Private equity including strategic investments .............................	4,565	88		432	-	-		-	-
Asset-backed securities ................	2,584	710		-	-	-		-	-
Loans held for securitisation .......	-	682		-	-	-		-	7
Structured notes ..........................	-	92		-	-	7,340		-	-
Derivatives with monolines .........	-	-		-	940	-		-	-
Other derivatives ........................	-	-		-	3,509	-		-	3,122
Other portfolios ..........................	1,972	3,208		284	-	487		567	-

	9,121	4,780		716	4,449	7,827		567	3,129

Private equity and strategic investments

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

Asset-backed securities

While quoted market prices are generally used to determine the fair value of these securities, valuation models are used to substantiate the reliability of the limited market data available and to identify whether any adjustments to quoted market prices are required. For ABSs including residential MBSs, the valuation uses an industry standard model and the assumptions relating to prepayment speeds, default rates and loss severity based on collateral type, and performance, as appropriate. The valuations output is benchmarked for consistency against observable data for securities of a similar nature.

Loans, including leveraged finance and loans held for securitisation

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

Structured notes

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

Trading liabilities valued using a valuation technique with significant unobservable inputs principally comprised equity-linked structured notes, which are issued by HSBC and provide the counterparty with a return that is linked to the performance of certain equity securities, and other portfolios. The notes are classified as Level 3 due to the unobservability of parameters such as long-dated equity volatilities and correlations between equity prices, between equity prices and interest rates and between interest rates and foreign exchange rates.

Derivatives

OTC (i.e. non-exchange traded) derivatives are valued using valuation models. Valuation models calculate the present value of expected future cash flows, based upon 'no-arbitrage' principles. For many vanilla derivative products, such as interest rate swaps and European options, the modelling approaches used are standard across the industry. For more complex derivative products, there may be some differences in market practice. Inputs to valuation models are determined from observable market data wherever possible, including prices available from exchanges, dealers, brokers or providers of consensus pricing. Certain inputs may not be observable in the market directly, but can be determined from observable prices via model calibration procedures or estimated from historical data or other sources. Examples of inputs that may be unobservable include volatility surfaces, in whole or in part, for less commonly traded option products, and correlations between market factors such as foreign exchange rates, interest rates and equity prices. The valuation of derivatives with monolines is discussed on page 189.

Derivative products valued using valuation techniques with significant unobservable inputs included certain types of correlation products, such as foreign exchange basket options, equity basket options, foreign exchange interest rate hybrid transactions and long-dated option transactions. Examples of the latter are equity options, interest rate and foreign exchange options and certain credit derivatives. Credit derivatives include certain tranched CDS transactions.

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

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

Movement in Level 3 financial instruments

	Assets					Liabilities
	Available for sale	Held for trading	Designated at fair value through profit or loss		Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m	US$m		US$m	US$m	US$m		US$m	US$m
2012
At 1 January ...............................	9,121	4,780		716	4,449	7,827		567	3,129
Total gains/(losses) recognised in profit or loss ...........................	(414)	356		10	(974)	319		-	10
Total gains/(losses) recognised in other comprehensive income¹ .	472	78		(32)	92	143		-	84
Purchases ....................................	1,738	942		113	-	(368)		-	-
New issuances ..............................	-	-		-	-	2,852		-	-
Sales ............................................	(840)	(1,408)		(69)	-	-		-	-
Settlements .................................	(367)	(617)		(25)	(14)	(1,604)		-	18
Transfers out ..............................	(2,944)	(298)		(350)	(571)	(1,901)		(567)	(291)
Transfers in ................................	1,745	545		50	77	202		-	55

At 31 December ..........................	8,511	4,378		413	3,059	7,470		-	3,005

Total gains/(losses) recognised in profit or loss relating to assets and liabilities held on 31 December:	166	339		9	(1,294)	384		-	(395)
- net interest income .............	44	-		-	-	-		-	-
- trading income excluding net interest income .............	-	326		-	(1,294)	396		-	(395)
- net interest income on trading activities ..................	-	13		-	-	(12)		-	-
- net income from other financial instruments designated at fair value ........	-	-		9	-	-		-	-
- dividend income ..................	122	-		-	-	-		-	-

Movement in Level 3 financial instruments (continued)

	Assets						Liabilities
	Available for sale	Held for trading	Designated at fair value through profit or loss			Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m	US$m		US$m		US$m	US$m		US$m	US$m
2011
At 1 January ........................	8,237	5,689		587		3,961	11,393		570	3,806
Total gains/(losses) recognised in profit or loss ....................	222	(330)		11		767	36		8	628
Total gains/(losses) recognised in other comprehensive income¹ ............................	(179)	(12)		(15)		(16)	11		(11)	-
Purchases .............................	1,858	1,483		242		-	(1,843)		-	-
New issuances .......................	-	-		-		-	4,569		-	-
Sales .....................................	(756)	(2,578)		(69)	(	-	-		-	-
Settlements ..........................	(1,088)	(199)		(7)		(33)	(1,528)		-	(1,083)
Transfers out .......................	(1,891)	(569)		(173)		(410)	(5,266)		-	(608)
Transfers in .........................	2,718	1,296		140		180	455		-	386

At 31 December ...................	9,121	4,780		716		4,449	7,827		567	3,129

Total gains/(losses) recognised in profit or loss relating to assets and liabilities held on 31 December:	134	(237)		36		617	101		8	80
- net interest income ......	105	-		-		-	-		-	-
- trading income/(expense) excluding net interest income .........................	-	(265)		-		617	119		-	80
- net interest income/(expense) on trading activities ......	-	28		-		-	(18)		-	-
- net income from other financial instruments designated at fair value .	-	-		36		-	-		8	-
- dividend income ...........	29	-		-		-	-		-	-

1 Included in 'Available-for-sale investments: Fair value gains/losses' and 'Exchange differences' in the consolidated statement of comprehensive income.

Available-for-sale securities: Purchases of Level 3 AFS assets relate principally to Emerging Market corporate bonds. Sales of Level 3 AFS assets relate principally to private equity disposals. Transfers in and out of Level 3 relate principally to ABS securities, and the excess of transfers out over transfers in reflects some improvement in ABS liquidity over the year.

Derivatives: The reduction in Level 3 derivative assets predominantly reflected reductions in the fair value of legacy structured credit assets as credit spreads narrowed and the unwind or maturity of certain other structured derivatives.

Trading liabilities: Movements in Level 3 trading liability balances primarily reflect issue and redemption of structured notes, particularly equity-linked notes. Transfers out reflect structured notes, particularly equity linked notes, becoming observable as their residual maturity decreased.

Effect of changes in significant unobservable assumptions to reasonably possible alternatives

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

Sensitivity of fair values to reasonably possible alternative assumptions

	Reflected in profit or loss		Reflected in other comprehensive income
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m
At 31 December 2012
Derivatives, trading assets and trading liabilities¹ ................	465	(384)	-	-
Financial assets and liabilities designated at fair value .........	41	(41)	-	-
Financial investments: available for sale .............................	-	-	680	(710)

	506	(425)	680	(710)

	Reflected in profit or loss		Reflected in other comprehensive income
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m
At 31 December 2011
Derivatives, trading assets and trading liabilities¹ ................	369	(436)	-	-
Financial assets and liabilities designated at fair value .........	72	(72)	-	-
Financial investments: available for sale .............................	-	-	814	(818)

	441	(508)	814	(818)

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

In derivatives, trading assets and trading liabilities greater pricing certainty has arisen during the year in respect of legacy structured credit assets, as narrowing credit spreads have reduced exposures. This has been offset by greater pricing uncertainty in some other areas, most notably in certain interest rate derivative products and the pricing of the derivative representing the forward sale of Ping An.

The reduction in pricing uncertainty in available-for-sale securities reflects greater liquidity in the ABS market.

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

	Reflected in profit or loss		Reflected in other comprehensive income
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m
At 31 December 2012
Private equity investments .................................................	62	(62)	353	(353)
Asset-backed securities .......................................................	41	(27)	143	(139)
Loans held for securitisation ..............................................	3	(3)	-	-
Structured notes .................................................................	4	(5)	-	-
Derivatives with monolines ................................................	36	(20)	-	-
Other derivatives ...............................................................	320	(267)	-	-
Other portfolios .................................................................	40	(41)	184	(218)

	506	(425)	680	(710)

At 31 December 2011
Private equity investments .................................................	123	(83)	451	(451)
Asset-backed securities .......................................................	3	(3)	183	(175)
Loans held for securitisation ..............................................	4	(4)	-	-
Structured notes .................................................................	6	(6)	-	-
Derivatives with monolines ................................................	76	(178)	-	-
Other derivatives ...............................................................	145	(154)	-	-
Other portfolios .................................................................	84	(80)	180	(192)

	441	(508)	814	(818)

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

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

In respect of private equity investments, in many of the methodologies, the principal assumption is the valuation multiple to be applied to the main financial indicators. This may be determined with reference to multiples for comparable listed companies and includes discounts for marketability.

For ABSs, the principal assumptions in the models are based on benchmark information about prepayment speeds, default rates, loss severities and the historical performance of the underlying assets.

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

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

HSBC Holdings

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

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

		Valuation techniques
	Quoted market price	Using observable inputs	With significant unobservable inputs
	Level 1	Level 2	Level 3	Total
	US$m	US$m	US$m	US$m
At 31 December 2012
Assets
Derivatives .....................................................................	-	3,768	-	3,768
Available for sale ............................................................	-	1,208	-	1,208

Liabilities
Designated at fair value ..................................................	-	23,195	-	23,195
Derivatives .....................................................................	-	760	-	760

At 31 December 2011
Assets
Derivatives .....................................................................	-	3,568	-	3,568
Available for sale ............................................................	-	-	1,078	1,078

Liabilities
Designated at fair value ..................................................	17,196	3,955	-	21,151
Derivatives .....................................................................	-	1,067	-	1,067

Liabilities designated at fair value: Transfers out of Level 1 were to bring these instruments in line with the classification methodology adopted for other corporate bonds within the Group.

Available for sale securities: Transfers out of Level 3 reflect increased observability in prices and improved market liquidity for these financial investments.

Financial instruments measured at fair value - Level 3

Financial investments measured using a valuation technique with significant unobservable inputs (Level 3) comprise fixed-rate preferred securities and senior notes purchased from HSBC undertakings. The unobservable elements of the valuation technique include the use of implied credit spreads and simplified bond pricing assumptions.

Movement in Level 3 financial instruments available for sale

	2012	2011
	US$m	US$m

At 1 January ...........................................................................................................................	1,078	2,025
Total gains or losses:
- recognised in profit or loss ..................................................................................................	-	55
- recognised in other comprehensive income .........................................................................	130	(61)
Settlements .............................................................................................................................	-	(941)
Transfers out ..........................................................................................................................	(1,208)	-

At 31 December ......................................................................................................................	-	1,078

Total gains or losses recognised in profit or loss relating to those assets and liabilities held on 31 December ...........................................................................................................	-	18

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

Effect of changes in significant unobservable assumptions to reasonably possible alternatives

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

At 31 December 2012 ...........................................................................................................	-	-
At 31 December 2011 .............................................................................................................	69	(77)

16 Fair values of financial instruments not carried at fair value

The classification of financial instruments is determined in accordance with the accounting policies set out in Note 2.

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

	At 31 December 2012		At 31 December 2011
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Assets and liabilities not held for sale
Assets
Loans and advances to banks ....................................................	152,546	152,823	180,987	181,302
Loans and advances to customers .............................................	997,623	973,741	940,429	914,485
Financial investments: debt securities .......................................	23,413	25,458	21,018	22,500
Financial investments: treasury and other eligible bills ..............	-	-	181	181

Liabilities
Deposits by banks .....................................................................	107,429	107,392	112,822	112,848
Customer accounts ...................................................................	1,340,014	1,340,521	1,253,925	1,254,313
Debt securities in issue ..............................................................	119,461	120,779	131,013	130,914
Subordinated liabilities ..............................................................	29,479	32,159	30,606	29,351

Loans and advances and customer accounts held for sale
Loans and advances to banks and customers .............................	6,632	6,387	35,720	37,832
Customer accounts ...................................................................	2,990	2,990	20,138	19,130

1 Including financial instruments within disposal groups held for sale.

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

Assets

Cash and balances at central banks

Items in the course of collection from other banks

Hong Kong Government certificates of indebtedness

Endorsements and acceptances

Short-term receivables within 'Other assets'

Accrued income

Liabilities

Hong Kong currency notes in circulation

Items in the course of transmission to other banks

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

Endorsements and acceptances

Short-term payables within 'Other liabilities'

Accruals

Analysis of loans and advances to customers by geographical segment

	At 31 December 2012		At 31 December 2011
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Loans and advances to customers
Europe .........................................................................................	463,440	453,382	434,336	426,039
Hong Kong ..................................................................................	173,613	171,926	157,665	154,054
Rest of Asia-Pacific .....................................................................	138,119	138,015	123,868	123,662
Middle East and North Africa .......................................................	28,086	27,954	25,875	25,758
North America .............................................................................	140,756	128,637	142,747	128,608
Latin America ..............................................................................	53,609	53,827	55,938	56,364

	997,623	973,741	940,429	914,485

Valuation

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

The fair values of loans and advances to customers in the US are substantially lower than their carrying amount, reflecting the market conditions at the balance sheet date. The secondary market demand and estimated value for US loans and advances has been heavily influenced by the challenging economic conditions during the past number of years, including house price depreciation, rising unemployment, changes in consumer behaviour, changes in discount rates and the lack of financing options available to support the purchase of loans and advances. Many investors are non-bank financial institutions or hedge funds with high equity levels and a high cost of debt. For certain consumer loans, investors take a more conservative view of future performance than HSBC. As a result, third parties are likely to assume higher charge-off levels and/or slower voluntary prepayment speeds than HSBC believes will ultimately be the case. The investor discount rates reflect this difference in the overall cost of capital as well as the potential volatility in the underlying cash flow assumptions, the combination of which may yield a significant pricing discount from HSBC's intrinsic value.

There was a modest decrease year on year in the fair value of loans and advances to customers in Europe relative to their carrying amount, largely in the UK mortgage portfolio which is sensitive to changes in market pricing between the balance sheet dates given its size and the competitive UK market. We also enhanced fair value estimation processes for mortgage and corporate lending in the UK to reflect risk factors, product characteristics and prepayment estimates at a more granular level. This overall decrease was mitigated by higher valuations of ABSs classified as loans and receivables following improved market appetite for such securities.

The fair values of loans and advances to customers in Latin America are higher than their carrying amount, primarily driven by a decrease in market interest rates, and in particular for the mortgage portfolios.

Fair values of the assets and liabilities set out below are estimated for the purpose of disclosure as follows:

Loans and advances to banks and customers

The fair value of loans and advances is based on observable market transactions, where available. In the absence of observable market transactions, fair value is estimated using valuation models that incorporate a range of input assumptions. These assumptions may include value estimates from third party brokers which reflect over-the-counter trading activity; forward looking discounted cash flow models using assumptions which HSBC believes are consistent with those which would be used by market participants in valuing such loans; and trading inputs from other market participants which includes observed primary and secondary trades.

Loans are grouped, as far as possible, into homogeneous groups and stratified by loans with similar characteristics to improve the accuracy of estimated valuation outputs. The stratification of a loan book considers all material factors, including vintage, origination period, estimates of future interest rates, prepayment speeds, delinquency rates, loan-to-value ratios, the quality of collateral, default probability, and internal credit risk ratings.

Valuation techniques are calibrated on a regular basis and tested for validity using prices from observable current market transactions in the same instrument, without modification or repackaging, or are based on any available observable market data.

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

Financial investments

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

Deposits by banks and customer accounts

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

Debt securities in issue and subordinated liabilities

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

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

HSBC Holdings

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

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

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

	At 31 December 2012		At 31 December 2011
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Assets
Loans and advances to HSBC undertakings .........................	41,675	42,843	28,048	27,562

Liabilities
Amounts owed to HSBC undertakings .................................	12,856	13,133	2,479	2,485
Debt securities in issue ........................................................	2,691	3,188	2,613	2,922
Subordinated liabilities ........................................................	11,907	14,865	12,450	13,052

17 Reclassification of financial assets

In 2008, HSBC reclassified US$15.3bn and US$2.6bn of financial assets from the held-for-trading category to the loans and receivables and available-for-sale classifications, respectively, as permitted by the relevant amendment to IAS 39 and explained in Note 2(e) on the Financial Statements. No further reclassifications were undertaken.

Reclassification of HSBC's financial assets

	At 31 December 2012		At 31 December 2011
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m

Reclassification to loans and receivables .............................	6,378	5,616	7,867	6,651
Reclassification to available for sale ...................................	12	12	33	33

	6,390	5,628	7,900	6,684

The following table shows the fair value gains and losses, income and expense recognised in the income statement in respect of reclassified assets and the gains and losses that would have been recognised if no reclassification had taken place:

Effect of reclassifying and not reclassifying financial assets

	2012	2011	2010
	US$m	US$m	US$m
Reclassification to loans and receivables
Recorded in the income statement¹ ............................................................	179	318	610
Assuming no reclassification² .....................................................................	653	317	1,260

Net income statement effect of reclassification ............................................	(474)	1	(650)

Reclassification to available for sale
Recorded in the income statement¹ ............................................................	-	1	56
Assuming no reclassification² .....................................................................	1	(2)	59

Net income statement effect of reclassification ............................................	(1)	3	(3)

1 'Income and expense' recorded in the income statement include the accrual of the effective interest rate and, for 2012, includes US$84m in respect of impairment (2011: US$69m; 2010: US$6m).

2 Effect on the income statement during the year had the reclassification not occurred.

18 Financial assets designated at fair value

	At 31 December
	2012	2011
	US$m	US$m
Financial assets designated at fair value:
- not subject to repledge or resale by counterparties ...........................................................	33,562	30,738
- which may be repledged or resold by counterparties .........................................................	20	118

	33,582	30,856

Treasury and other eligible bills ...............................................................................................	54	123
Debt securities .........................................................................................................................	12,551	11,834
Equity securities ......................................................................................................................	20,868	17,930

Securities designated at fair value .............................................................................................	33,473	29,887
Loans and advances to banks ...................................................................................................	55	119
Loans and advances to customers ............................................................................................	54	850

	33,582	30,856

Securities designated at fair value¹

	At 31 December
	2012	2011
	US$m	US$m

Fair value
US Treasury and US Government agencies² ............................................................................	37	35
UK Government ....................................................................................................................	625	812
Hong Kong Government ........................................................................................................	135	151
Other government .................................................................................................................	4,508	3,964
Asset-backed securities³ .........................................................................................................	158	201
Corporate debt and other securities ........................................................................................	7,142	6,794
Equities ..................................................................................................................................	20,868	17,930

	33,473	29,887

1 Included within these figures are debt securities issued by banks and other financial institutions of US$3,509m (2011: US$3,497m), of which US$5m (2011: US$40m) are guaranteed by various governments.

2 Includes securities that are supported by an explicit guarantee issued by the US Government.

3 Excludes asset-backed securities included under US Treasury and US Government agencies.

Securities listed on a recognised exchange and unlisted

	Treasury and other eligible bills	Debt securities	Equity securities	Total
	US$m	US$m	US$m	US$m
Fair value at 31 December 2012
Listed on a recognised exchange¹ .......................................	-	3,007	14,063	17,070
Unlisted .............................................................................	54	9,544	6,805	16,403

	54	12,551	20,868	33,473

Fair value at 31 December 2011
Listed on a recognised exchange¹ .......................................	4	3,607	11,859	15,470
Unlisted .............................................................................	119	8,227	6,071	14,417

	123	11,834	17,930	29,887

1 Included within listed investments are US$931m of investments listed in Hong Kong (2011: US$631m).

19 Derivatives

Fair values of derivatives by product contract type held by HSBC

	Assets			Liabilities
	Trading	Hedging	Total	Trading	Hedging	Total
	US$m	US$m	US$m	US$m	US$m	US$m
At 31 December 2012
Foreign exchange ........................................	68,277	1,227	69,504	70,944	239	71,183
Interest rate ................................................	628,162	2,417	630,579	618,808	6,491	625,299
Equity .........................................................	15,413	-	15,413	19,889	-	19,889
Credit ..........................................................	12,740	-	12,740	13,508	-	13,508
Commodity and other .................................	1,443	-	1,443	1,236	-	1,236

Gross total fair values ..................................	726,035	3,644	729,679	724,385	6,730	731,115

Netting ........................................................			(372,229)			(372,229)

Total ...........................................................			357,450			358,886

At 31 December 2011
Foreign exchange ........................................	74,958	1,026	75,984	75,077	371	75,448
Interest rate ................................................	510,652	2,439	513,091	502,906	6,221	509,127
Equity .........................................................	15,262	-	15,262	19,363	-	19,363
Credit ..........................................................	25,694	-	25,694	25,800	-	25,800
Commodity and other .................................	2,198	-	2,198	1,492	-	1,492

Gross total fair values ..................................	628,764	3,465	632,229	624,638	6,592	631,230

Netting ........................................................			(285,850)			(285,850)

Total ...........................................................			346,379			345,380

The 3% increase in the fair value of derivative assets during 2012 was driven by increased interest rate derivative fair values as major currency yield curves continued to decline, in particular, the euro. This drove both the increase in gross fair values and the increase in the netting adjustment.

Fair values of derivatives by product contract type held by HSBC Holdings with subsidiaries

	At 31 December 2012		At 31 December 2011
	Trading	Trading	Trading	Trading
	assets	liabilities	assets	liabilities
	US$m	US$m	US$m	US$m

Foreign exchange ...............................................................	1,636	760	1,546	1,067
Interest rate .......................................................................	2,132	-	2,022	-

	3,768	760	3,568	1,067

Derivatives are financial instruments that derive their value from the price of underlying items such as equities, bonds, interest rates, foreign exchange, credit spreads, commodities and equity or other indices. Derivatives enable users to increase, reduce or alter exposure to credit or market risks.

Derivatives are carried at fair value and shown in the balance sheet as separate totals of assets and liabilities. A description of how the fair value of derivatives is derived is set out on page 443. Derivative assets and liabilities on different transactions are only set off (netted) if the transactions are with the same counterparty, a legal right of set-off exists and the cash flows are intended to be settled on a net basis.

Use of derivatives

HSBC transacts derivatives for three primary purposes: to create risk management solutions for clients, to manage the portfolio risks arising from client business and to manage and hedge HSBC's own risks. Derivatives (except for derivatives which are designated as effective hedging instruments as defined in IAS 39) are held for trading. Within the held-for-trading classification are two types of derivatives: those used in sales and trading activities, and those used for risk management purposes but which for various reasons do not meet the qualifying criteria for hedge accounting. The second category includes derivatives managed in conjunction with financial instruments designated at fair value. These activities are described more fully below.

HSBC's derivative activities give rise to significant open positions in portfolios of derivatives. These positions are managed constantly to ensure that they remain within acceptable risk levels. When entering into derivative transactions, HSBC employs the same credit risk management framework to assess and approve potential credit exposures that is used for traditional lending.

Trading derivatives

Most of HSBC's derivative transactions relate to sales and trading activities. Sales activities include the structuring and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or expected risks. Trading activities in derivatives are entered into principally for the purpose of generating profits from short-term fluctuations in price or margin and for the risk management of exposure arising from customer activities. Positions may be traded actively or be held over a period of time to benefit from expected changes in exchange rates, interest rates, equity prices or other market parameters. Trading includes market-making, positioning and arbitrage activities. Market-making entails quoting bid and offer prices to other market participants for the purpose of generating revenues based on spread and volume; positioning means managing market risk positions in the expectation of benefiting from favourable movements in prices, rates or indices; arbitrage involves identifying and profiting from price differentials between markets and products.

As mentioned above, other derivatives classified as held for trading include non-qualifying hedging derivatives, ineffective hedging derivatives and the components of hedging derivatives that are excluded from assessing hedge effectiveness. Non-qualifying hedging derivatives are entered into for risk management purposes but do not meet the criteria for hedge accounting. Trading derivatives also include derivatives managed in conjunction with financial instruments designated at fair value.

Gains and losses from changes in the fair value of derivatives, including the contractual interest, that do not qualify for hedge accounting are reported in 'Net trading income' except for derivatives managed in conjunction with financial instruments designated at fair value, where gains and losses are reported in 'Net income from financial instruments designated at fair value' together with the gains and losses on the economically hedged items. Where the derivatives are managed with debt securities in issue, the contractual interest is shown in 'Interest expense' together with the interest payable on the issued debt. Substantially all of HSBC Holdings' derivatives entered into with HSBC undertakings are managed in conjunction with financial liabilities designated at fair value.

The notional contract amounts of derivatives held for trading purposes indicate the nominal value of transactions outstanding at the balance sheet date; they do not represent amounts at risk. The 9% increase in the notional contract amounts of HSBC's derivatives during 2012 was primarily driven by an increase in the trading volumes of interest rate contracts.

Notional contract amounts of derivatives held for trading purposes by product type

	HSBC		HSBC Holdings
	At 31 December 2012	At 31 December 2011	At 31 December 2012	At 31 December 2011
	US$m	US$m	US$m	US$m

Foreign exchange ...............................................................	4,435,729	3,945,774	17,576	18,942
Interest rate .......................................................................	21,355,749	19,788,710	11,554	10,954
Equity ................................................................................	495,668	265,577	-	-
Credit .................................................................................	901,507	1,049,147	-	-
Commodity and other ........................................................	80,219	76,487	-	-

	27,268,872	25,125,695	29,130	29,896

Credit derivatives

HSBC trades credit derivatives through its principal dealing operations and acts as a principal counterparty to a broad range of users, structuring transactions to produce risk management products for its customers, or making markets in certain products. Risk is typically controlled through entering into offsetting credit derivative contracts with other counterparties.

HSBC manages the credit risk arising on buying and selling credit derivative protection by including the related credit exposures within its overall credit limit structure for the relevant counterparty. Trading of credit derivatives is restricted to a small number of offices within the major centres which have the control infrastructure and market skills to manage effectively the credit risk inherent in the products.

Credit derivatives are also deployed to a limited extent for the risk management of the Group's loan portfolios. The notional contract amount of credit derivatives of US$901,507m (2011: US$1,049,147m) consisted of protection bought of US$446,410m (2011: US$517,737m) and protection sold of US$455,097m (2011: US$531,410m). The credit derivative business operates within the market risk management framework described on page 265.

Derivatives valued using models with unobservable inputs

The difference between the fair value at initial recognition (the transaction price) and the value that would have been derived had valuation techniques used for subsequent measurement been applied at initial recognition, less subsequent releases, is as follows:

Unamortised balance of derivatives valued using models with significant unobservable inputs

	2012	2011
	US$m	US$m

Unamortised balance at 1 January ...........................................................................................	200	250
Deferral on new transactions ...................................................................................................	149	234
Recognised in the income statement during the period:
- amortisation .....................................................................................................................	(112)	(143)
- subsequent to unobservable inputs becoming observable ....................................................	(1)	(71)
- maturity, termination or offsetting derivative ..................................................................	(46)	(60)
- risk hedged .......................................................................................................................	(11)	(8)
Exchange differences ..............................................................................................................	2	(2)

Unamortised balance at 31 December¹ ....................................................................................	181	200

1 This amount is yet to be recognised in the consolidated income statement.

Hedge accounting derivatives

HSBC uses derivatives (principally interest rate swaps) for hedging purposes in the management of its own asset and liability portfolios and structural positions. This enables HSBC to optimise the overall cost to the Group of accessing debt capital markets, and to mitigate the market risk which would otherwise arise from structural imbalances in the maturity and other profiles of its assets and liabilities.

The accounting treatment of hedge transactions varies according to the nature of the instrument hedged and the type of hedge transactions. Derivatives may qualify as hedges for accounting purposes if they are fair value hedges, cash flow hedges, or hedges of net investment in foreign operations. These are described under the relevant headings below.

The notional contract amounts of derivatives held for hedge accounting purposes indicate the nominal value of transactions outstanding at the balance sheet date; they do not represent amounts at risk.

Notional contract amounts of derivatives held for hedge accounting purposes by product type

	At 31 December 2012		At 31 December 2011
	Cash flow hedge	Fair value hedge	Cash flow hedge	Fair value hedge
	US$m	US$m	US$m	US$m

Foreign exchange ................................................	16,716	112	12,078	1,363
Interest rate ........................................................	182,688	75,505	228,052	76,950

	199,404	75,617	240,130	78,313

Fair value hedges

HSBC's fair value hedges principally consist of interest rate swaps that are used to protect against changes in the fair value of fixed-rate long-term financial instruments due to movements in market interest rates. For fair value hedges, all changes in the fair value of the derivative and in the fair value of the item in relation to the risk being hedged are recognised in the income statement. If the hedge relationship is terminated, the fair value adjustment to the hedged item continues to be reported as part of the basis of the item and is amortised to the income statement as a yield adjustment over the remainder of the hedging period.

Fair value of derivatives designated as fair value hedges

	At 31 December 2012		At 31 December 2011
	Assets	Liabilities	Assets	Liabilities
	US$m	US$m	US$m	US$m

Foreign exchange ...........................................	-	-	77	1
Interest rate ...................................................	199	4,450	369	4,331

	199	4,450	446	4,332

Gains or losses arising from fair value hedges

	2012	2011	2010
	US$m	US$m	US$m
Gains/(losses):
- on hedging instruments .............................................................................	(898)	(4,082)	(830)
- on the hedged items attributable to the hedged risk ...................................	871	3,858	868

	(27)	(224)	38

The gains and losses on ineffective portions of fair value hedges are recognised immediately in 'Net trading income'.

Cash flow hedges

HSBC's cash flow hedges consist principally of interest rate swaps, futures and cross-currency swaps that are used to protect against exposures to variability in future interest cash flows on non-trading assets and liabilities which bear interest at variable rates or which are expected to be re-funded or reinvested in the future. The amounts and timing of future cash flows, representing both principal and interest flows, are projected for each portfolio of financial assets and liabilities on the basis of their contractual terms and other relevant factors, including estimates of prepayments and defaults. The aggregate principal balances and interest cash flows across all portfolios over time form the basis for identifying gains and losses on the effective portions of derivatives designated as cash flow hedges of forecast transactions. Gains and losses are initially recognised in other comprehensive income, and accumulated in the cash flow hedging reserve, and are transferred to the income statement when the forecast cash flows affect the income statement.

Fair value of derivatives designated as cash flow hedges

	At 31 December 2012		At 31 December 2011
	Assets	Liabilities	Assets	Liabilities
	US$m	US$m	US$m	US$m

Foreign exchange ...........................................	1,230	200	949	370
Interest rate ...................................................	2,218	2,041	2,070	1,890

	3,448	2,241	3,019	2,260

Forecast principal balances on which interest cash flows are expected to arise

	3 months or less	More than 3 months but less than 1 year	5 years or less but more than 1 year	More than 5 years
	US$m	US$m	US$m	US$m
At 31 December 2012
Assets ...........................................................................	112,846	93,072	72,557	5,055
Liabilities .....................................................................	(68,534)	(43,800)	(29,401)	(4,777)

Net cash inflows exposure ............................................	44,312	49,272	43,156	278

At 31 December 2011
Assets ...........................................................................	139,701	110,960	66,383	4,460
Liabilities .....................................................................	(77,898)	(50,480)	(36,296)	(4,693)

Net cash inflows/(outflows) exposure ............................	61,803	60,480	30,087	(233)

This table reflects the interest rate repricing profile of the underlying hedged items.

The gains and losses on ineffective portions of such derivatives are recognised immediately in 'Net trading income'. During the year to 31 December 2012 a gain of US$35m (2011: gain of US$26m; 2010: loss of US$9m) was recognised due to hedge ineffectiveness.

Hedges of net investments in foreign operations

The Group applies hedge accounting in respect of certain consolidated net investments. Hedging is undertaken using forward foreign exchange contracts or by financing with currency borrowings.

At 31 December 2012, the fair values of outstanding financial instruments designated as hedges of net investments in foreign operations were assets of US$3m (2011: US$121m) and liabilities of US$50m (2011: US$36m) and notional contract values of US$2,654m (2011: US$3,920m).

The ineffectiveness recognised in 'Net trading income' in the year ended 31 December 2012 that arose from hedges in foreign operations was nil (2011 and 2010: nil).

20 Financial investments

	At 31 December
	2012	2011
	US$m	US$m
Financial investments:
- not subject to repledge or resale by counterparties ...........................................................	399,613	364,906
- which may be repledged or resold by counterparties .........................................................	21,488	35,138

	421,101	400,044

Carrying amount and fair value of financial investments

	At 31 December 2012		At 31 December 2011
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m

Treasury and other eligible bills ..........................................	87,550	87,550	65,223	65,223
-. available for sale .........................................................	87,550	87,550	65,042	65,042
-. held to maturity .........................................................	-	-	181	181

Debt securities ....................................................................	327,762	329,807	327,611	329,093
-. available for sale .........................................................	304,349	304,349	306,593	306,593
-. held to maturity .........................................................	23,413	25,458	21,018	22,500

Equity securities .................................................................	5,789	5,789	7,210	7,210
-. available for sale .........................................................	5,789	5,789	7,210	7,210


Total financial investments ...............................................	421,101	423,146	400,044	401,526

Financial investments at amortised cost and fair value

	Amortised cost¹	Fair value²
	US$m	US$m
At 31 December 2012
US Treasury ............................................................................................................................	60,657	61,925
US Government agencies³ .......................................................................................................	22,579	23,500
US Government sponsored entities³ ........................................................................................	5,262	5,907
UK Government .....................................................................................................................	17,018	17,940
Hong Kong Government .........................................................................................................	42,687	42,711
Other government ..................................................................................................................	146,507	149,179
Asset-backed securities⁴ ...........................................................................................................	29,960	26,418
Corporate debt and other securities .........................................................................................	86,099	89,777
Equities ...................................................................................................................................	4,284	5,789

	415,053	423,146

	Amortised cost¹	Fair value²
	US$m	US$m
At 31 December 2011
US Treasury ............................................................................................................................	43,848	45,283
US Government agencies³ .......................................................................................................	25,079	26,093
US Government sponsored entities³ ........................................................................................	4,425	5,056
UK Government .....................................................................................................................	32,165	33,603
Hong Kong Government .........................................................................................................	33,359	33,374
Other government ..................................................................................................................	125,623	127,049
Asset-backed securities⁴ ...........................................................................................................	35,096	28,625
Corporate debt and other securities .........................................................................................	94,110	95,233
Equities ...................................................................................................................................	5,122	7,210

	398,827	401,526

At 31 December 2010
US Treasury ............................................................................................................................	37,380	37,255
US Government agencies³ .......................................................................................................	20,895	21,339
US Government sponsored entities³ ........................................................................................	5,029	5,267
UK Government .....................................................................................................................	31,069	31,815
Hong Kong Government .........................................................................................................	29,770	29,793
Other government ..................................................................................................................	108,947	109,806
Asset-backed securities⁴ ...........................................................................................................	39,845	33,175
Corporate debt and other securities .........................................................................................	124,704	125,311
Equities ...................................................................................................................................	5,605	7,983

	403,244	401,744

1 Represents the amortised cost or cost basis of the financial investment.

2 Included within these figures are debt securities issued by banks and other financial institutions of US$59,908m (2011: US$68,334m; 2010: US$99,733m), of which US$6,916m (2011: US$17,079m; 2010: US$38,862m) are guaranteed by various governments. The fair value of the debt securities issued by banks and other financial institutions was US$60,616m (2011: US$68,765m; 2010: US$100,070m).

3 Includes securities that are supported by an explicit guarantee issued by the US Government.

4 Excludes asset-backed securities included under US Government agencies and sponsored entities.

Financial investments listed on a recognised exchange and unlisted

	Treasury and other eligible bills available for sale	Treasury and other eligible bills held to maturity	Debt securities available for sale	Debt securities held to maturity	Equity securities available for sale	Total
	US$m	US$m	US$m	US$m	US$m	US$m
Carrying amount at 31 December 2012
Listed on a recognised exchange¹ .................	3,284	-	113,399	5,599	536	122,818
Unlisted² .....................................................	84,266	-	190,950	17,814	5,253	298,283

	87,550	-	304,349	23,413	5,789	421,101
Carrying amount at 31 December 2011
Listed on a recognised exchange¹ .................	4,077	-	121,303	4,370	535	130,285
Unlisted² .....................................................	60,965	181	185,290	16,648	6,675	269,759

	65,042	181	306,593	21,018	7,210	400,044

1 The fair value of listed held-to-maturity debt securities as at 31 December 2012 was US$6,123m (2011: US$4,641m). Included within listed investments were US$3,512m (2011: US$3,544m) of investments listed in Hong Kong.

2 Unlisted treasury and other eligible bills available for sale primarily comprise treasury bills not listed on a recognised exchange but for which there is a liquid market.

Maturities of investments in debt securities at their carrying amount

	At 31 December
	2012	2011
	US$m	US$m
Remaining contractual maturity of total debt securities:
1 year or less .......................................................................................................................	67,268	87,080
5 years or less but over 1 year .............................................................................................	157,075	128,192
10 years or less but over 5 years ..........................................................................................	47,123	52,251
Over 10 years ......................................................................................................................	56,296	60,088

	327,762	327,611
Remaining contractual maturity of debt securities available for sale:
1 year or less .......................................................................................................................	65,500	85,821
5 years or less but over 1 year .............................................................................................	149,195	120,763
10 years or less but over 5 years ..........................................................................................	39,498	44,946
Over 10 years ......................................................................................................................	50,156	55,063

	304,349	306,593
Remaining contractual maturity of debt securities held to maturity:
1 year or less .......................................................................................................................	1,768	1,259
5 years or less but over 1 year .............................................................................................	7,880	7,429
10 years or less but over 5 years ..........................................................................................	7,625	7,305
Over 10 years ......................................................................................................................	6,140	5,025

	23,413	21,018

Contractual maturities and weighted average yields of investment debt securities at 31 December 2012

	Within one year		After one year but within five years		After five years but within ten years		After ten years
	Amount	Yield	Amount	Yield	Amount	Yield	Amount	Yield
	US$m	%	US$m	%	US$m	%	US$m	%
Available for sale
US Treasury ......................................	12,306	0.4	30,334	0.5	6,113	2.0	2,237	3.5
US Government agencies ...................	6	2.6	7	5.3	94	1.9	22,128	2.9
US Government-sponsored agencies ..	5	2.0	360	2.6	2,968	3.1	807	3.7
UK Government ................................	162	0.2	13,793	1.5	1,286	5.9	634	5.1
Hong Kong Government ...................	946	0.5	686	2.0	-	-	-	-
Other governments ...........................	38,327	2.5	60,048	2.7	10,198	4.4	2,112	3.8
Asset-backed securities ......................	336	0.1	2,682	0.4	7,643	0.2	19,181	0.2
Corporate debt and other securities ....	13,312	3.2	39,667	2.5	8,123	3.5	3,325	5.1

Total amortised cost .........................	65,400		147,577		36,425		50,424

Total carrying value ..........................	65,500		149,195		39,498		50,156

Held to maturity
US Treasury ......................................	22	4.2	21	4.4	50	4.8	143	4.4
US Government agencies ...................	-	-	1	7.6	3	7.7	338	6.5
US Government-sponsored agencies ..	1	8.1	6	7.8	1	7.8	1,113	6.2
Hong Kong Government ...................	-	-	30	0.4	10	4.1	3	1.2
Other governments ...........................	71	2.8	480	3.8	254	5.2	562	5.1
Asset-backed securities ......................	-	-	-	-	-	-	118	6.3
Corporate debt and other securities ....	1,674	4.4	7,342	3.8	7,307	4.2	3,863	4.2

Total amortised cost .........................	1,768		7,880		7,625		6,140

Total carrying value ..........................	1,768		7,880		7,625		6,140

The maturity distributions of asset-backed securities are presented in the above table on the basis of contractual maturity dates. The weighted average yield for each range of maturities is calculated by dividing the annualised interest income for the year ended 31 December 2012 by the book amount of available-for-sale debt securities at that date. The yields do not include the effect of related derivatives.

21 Transfers of financial assets

HSBC enters into transactions in the normal course of business by which it transfers financial assets to third parties including SPEs. Depending on the circumstances these transfers may either result in these financial assets being derecognised or continuing to be recognised.

· Full derecognition occurs when HSBC transfers its contractual right to receive cash flows from the financial assets, or retains the right but assumes an obligation to pass on the cash flows from the asset, and transfers substantially all the risks and rewards of ownership. The risks include credit, interest rate, foreign currency, prepayment and other price risks.

· Derecognition does not occur when HSBC transfers its contractual right to receive cash flows from the financial assets, or retains the right but assumes an obligation to pass on the cash flows from the asset, but either:

i) retains substantially all of the risks and rewards of ownership of the transferred asset; or

ii) neither retains nor transfers substantially all of the risks and rewards of ownership but has retained control of the financial asset. In this situation the financial assets are recognised on the balance sheet to the extent of HSBC's continuing involvement.

The majority of transferred financial assets that do not qualify for derecognition are (i) debt securities held by counterparties as collateral under repurchase agreements or (ii) equity securities lent under securities lending agreements.

As the substance of these transactions is secured borrowings the asset collateral continues to be recognised in full and the related liability reflecting the Group's obligation to repurchase the transferred assets for a fixed price at a future date is recognised in deposits from banks or customers as appropriate. As a result of these transactions, the Group is unable to use, sell or pledge the transferred assets for the duration of the transaction. The Group remains exposed to interest rate risk and credit risk on these pledged instruments. The counterparty's recourse is not limited to the transferred assets.

Other transactions where the counterparty's recourse is only to the transferred asset includes a Canadian government sponsored securitisation programme, where HSBC Bank Canada assigns ownership and its right to sell or pledge residential mortgages. HSBC Bank Canada remains exposed to credit and interest rate risk on the assigned residential mortgages, which continue to be recorded as loans and advances. Third party funds received by HSBC Bank Canada under the programme are accounted for as secured borrowings and presented as debt securities in issue on the consolidated balance sheet.

In a small number of securitisation transactions, HSBC has neither transferred nor retained substantially all the risks and rewards of ownership of the transferred assets, and has retained control of the transferred assets. Circumstances in which HSBC has continuing involvement in the transferred assets may include retention of servicing rights over the transferred assets, entering into a derivative transaction with the securitisation vehicle or retaining an interest in the securitisation vehicle. Where HSBC has continuing involvement it continues to recognise the transferred assets to the extent of its continuing involvement and recognises an associated liability. The net carrying amount of the transferred assets and associated liabilities reflects the rights and obligations that HSBC has retained.

The following table analyses the carrying amount of financial assets that did not qualify for derecognition and their associated financial liabilities, including those that are recognised to the extent of HSBC's continuing involvement and the associated liabilities.

Financial assets not qualifying for full derecognition and associated financial liabilities¹

	Carrying amount of assets before transfer	Carrying amount of transferred assets	Carrying amount of associated liabilities	Fair value of transferred assets	Fair value of associated liabilities	Net position
	US$m	US$m	US$m	US$m	US$m	US$m
At 31 December 2012
Repurchase agreements ................................		122,130	121,589
Securities lending agreements .......................		5,891	5,820
Other sales (recourse to transferred asset only) .................................................................		9,727	9,733	9,767	9,856	(89)
Securitisations recognised to the extent of continuing involvement ...........................	17,427	12	6	12	6	6

1 The disclosure for 2012 reflects amendments made to IFRS 7 that are effective prospectively for annual reporting periods beginning on or after 1 July 2011.

At 31 December 2011, the carrying amount of transferred assets and associated liabilities for repurchase agreements were US$124,982m and US$124,413m respectively, and for securities lending agreements were US$7,129m and US$7,039m, respectively.

At 31 December 2011, the carrying amount of transferred assets and associated liabilities for securitisations recognised to the extent of continuing involvement were US$22m and US$11m, respectively. The carrying amount of these assets before transfer was US$17,427m.

Financial assets qualifying for full derecognition and associated financial liabilities¹

At 31 December 2012

2012

Carrying amount

Gain or

Income/

of continuing

Fair value of

loss

Income/

(expenses)

involvement in

continuing

Maximum

recognised

(expenses)

recognised

the balance sheet

involvement

exposure

at transfer

recognised

cumulat-

Assets

Liabilities

Assets

Liabilities

to loss

date

in year

ively

US$m

Type of continuing involvement

Interest in SPEs ...................

393

354

393

1 The disclosure for 2012 reflects amendments made to IFRS 7 that are effective prospectively for annual reporting periods beginning on or after 1 July 2011.

The assets in the table above represent our continuing involvement in securitisations where HSBC has transferred assets to an unconsolidated SPE, but has retained some of the notes issued by the SPE. These notes are reported in loans and advances to customers. The maximum exposure to loss is the carrying amount of the notes.

22 Interests in associates and joint ventures

Associates

Principal associates of HSBC

	At 31 December 2012		At 31 December 2011
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Listed
Bank of Communications Co., Limited ..............................	11,770	10,633	8,507	8,234
Industrial Bank Co., Limited ..............................................	2,851	3,665	2,214	2,743
Ping An Insurance (Group) Company of China, Limited ....	-	-	6,373	8,110
The Saudi British Bank .......................................................	2,135	3,189	1,886	3,256

	16,756	17,487	18,980	22,343

	At 31 December 2012
	Country of incorporation	HSBC's interest in equity capital	Issued equity capital
Listed
Bank of Communications Co., Limited ...............................................	PRC¹	19.03%	RMB74,263m
Industrial Bank Co., Limited ...............................................................	PRC¹	12.80%	RMB10,786m
The Saudi British Bank .......................................................................	Saudi Arabia	40.00%	SR10,000m

Unlisted
Barrowgate Limited² ...........................................................................	Hong Kong	24.64%	-
Vietnam Technological and Commercial Joint Stock Bank .................	Vietnam	19.48%	VND8,848,079m
Yantai Bank Co., Limited³ ..................................................................	PRC¹	20.00%	RMB2,000m

1 People's Republic of China.

2 Issued equity capital is less than HK$1m.

3 The investment is held through Hang Seng Bank Limited, a 62.14% owned subsidiary of HSBC.

All the above investments in associates are owned by subsidiaries of HSBC Holdings.

Details of all HSBC associates and joint ventures, as required under Section 409 Companies Act 2006, will be annexed to the next Annual Return of HSBC Holdings filed with the UK Registrar of Companies.

HSBC had US$11,770m (2011: US$14,880m) of investments in associates and joint ventures listed in Hong Kong.

For the year ended 31 December 2012, HSBC's share of associates and joint ventures' tax on profit was US$959m (2011: US$890m), which is included within 'Share of profit in associates and joint ventures' in the income statement.

Summarised aggregate financial information on associates

	At 31 December
	2012	2011
	US$m	US$m
HSBC's share of:
- assets ................................................................................................................................	237,338	249,461
- liabilities ...........................................................................................................................	220,455	230,902
- revenues ...........................................................................................................................	14,206	12,009
- profit after tax .................................................................................................................	3,521	3,221

HSBC's investment in Bank of Communications Co., Limited ('BoCom') was equity accounted with effect from August 2004. HSBC's significant influence in BoCom was established as a result of representation on the Board of Directors, and in accordance with the Technical Support and Assistance Agreements, HSBC is assisting in the maintenance of financial and operating policies and a number of staff have been seconded to assist in this process. During 2012, the market value of the investment in BoCom was below the carrying amount for a period of approximately ten months. As a result, we performed impairment tests on the carrying amount of the investment in BoCom. The result confirmed that there was no impairment. The impairment test was performed by comparing the recoverable amount of BoCom, determined by a value in use ('VIU') calculation, with its carrying amount. The calculation of VIU used discounted cash flow projections based on management's estimates. Cash flows beyond the next five years were then extrapolated in perpetuity using a long-term growth rate. The discount rate used was based on a cost of capital used to evaluate investments in mainland China. Management judgement is required in estimating the future cash flows of BoCom which are sensitive to the cash flows projected in the short- and medium-term, and also to the key assumptions regarding the long-term sustainable cash flows thereafter. The key assumptions are consistent with external sources of information.

HSBC's investment in Industrial Bank Co., Limited ('Industrial Bank') was equity accounted with effect from May 2004. HSBC's significant influence has been established as a result of representation on the Board of Directors. In January 2013 HSBC was no longer in a position to exercise significant influence over Industrial Bank and ceased to account for it as an associate. For further details, see Note 45.

HSBC's investment in Ping An Insurance (Group) Company of China Limited ('Ping An') was equity accounted with effect from August 2005, reflecting HSBC's significant influence over this associate. HSBC's significant influence was established as a result of representation on the Board of Directors. In June 2011, following a further issue of shares by Ping An to a third party, HSBC's holding was diluted to 15.57% and a dilution gain of US$181m was recognised in 'Other operating income'.

In July 2011, Ping An increased its ownership interest in Shenzhen Development Bank ('SDB') from 29.99% to 52.38%. As a result, the status of its investment in SDB changed from an interest in an associate to an investment in subsidiary. As a result of this transaction, Ping An recognised a re-measurement loss; HSBC's share of this re-measurement loss was US$48m.

In December 2012 approximately 20.8% of HSBC's holding in Ping An was disposed of. Following the disposal, HSBC no longer has significant influence over Ping An and has ceased to account for Ping An as an associate. For further details on investment in Ping An, see Note 26.

The statutory accounting reference date of BoCom, Ping An and Industrial Bank is 31 December. For the year ended 31 December 2012, these companies were included on the basis of financial statements made up for the twelve months to 30 September 2012, taking into account changes in the subsequent period from 1 October 2012 to 31 December 2012 that would have materially affected their results.

HSBC acquired 15% of Vietnam Technological & Commercial Joint Stock Bank in October 2007. This investment was equity accounted from that date due to HSBC's representation on the Board of Directors and involvement in the Technical Support and Assistance Agreement. In December 2007, as a result of a rights issue in which HSBC did not

participate, HSBC's equity interest was diluted to 14.44%. In September 2008, HSBC increased its equity interest to 20%. HSBC's equity interest has been subsequently diluted to below 20% due to the issue of shares by the associate to its own employees.

Joint ventures

Principal interests in joint ventures

	At 31 December 2012
	Country of incorporation	Principal activity	HSBC's interest in equity capital		Issued equity capital

HSBC Saudi Arabia Limited ...............................	Saudi Arabia	Investment banking		49.00%	SR500m
Vaultex UK Limited .........................................	England	Cash management		50.00%	£10m
Hana HSBC Life Insurance Co., Ltd ..................	South Korea	Insurance manufacturing		49.99%	KRW110,201m
Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited ..................	India	Insurance manufacturing		26.00%	INR9,500m

Summarised aggregate financial information on joint ventures

	At 31 December
	2012	2011
	US$m	US$m
HSBC's share of:
- current assets ....................................................................................................................	1,964	1,556
- non-current assets ............................................................................................................	202	196
- current liabilities ...............................................................................................................	924	747
- non-current liabilities .......................................................................................................	961	715
- income .............................................................................................................................	347	383
- expenses ...........................................................................................................................	311	339

In December 2011, following the issue of shares by HSBC Saudi Arabia Limited to a third party, HSBC's holding was diluted from 60% to 49% and a dilution gain of US$27m was recognised in 'Other operating income'.

Associates and joint ventures

Movements in investments in associates and joint ventures

	2012	2011
	US$m	US$m

At 1 January ...........................................................................................................................	20,399	17,198
Additions ................................................................................................................................	1,804	90
Disposals .................................................................................................................................	(7,580)	(25)
Share of results ........................................................................................................................	3,557	3,264
Dividends ................................................................................................................................	(489)	(304)
Exchange differences ..............................................................................................................	60	681
Share of other comprehensive income/(expense) of associates and joint ventures ...................	311	(710)
Other movements ...................................................................................................................	(228)	205

At 31 December ......................................................................................................................	17,834	20,399

Goodwill included in carrying amount of associates and joint ventures

	2012	2011
	US$m	US$m
Gross amount
At 1 January ...........................................................................................................................	1,551	1,518
Disposals .................................................................................................................................	(874)	-
Exchange differences ..............................................................................................................	3	57
Other changes .........................................................................................................................	(10)	(24)

At 31 December¹ ....................................................................................................................	670	1,551

1 Includes the carrying amount of goodwill arising from joint ventures of US$30m (2011: US$31m).

23 Goodwill and intangible assets

	At 31 December
	2012	2011
	US$m	US$m

Goodwill ..................................................................................................................................	21,390	21,338
Present value of in-force long-term insurance business ('PVIF')¹ ............................................	4,847	4,092
Other intangible assets ............................................................................................................	3,616	3,604

	29,853	29,034

1 Disclosures on PVIF are provided on page 243.

Goodwill

Reconciliation of goodwill

	Europe	Hong Kong	Rest of Asia- Pacific	MENA	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m	US$m
Gross amount
At 1 January 2012 .............	14,433	124	1,063	63	8,747	3,765	28,195
Disposals ............................	(2)	(4)	(5)	-	-	(21)	(32)
Exchange differences .........	229	(6)	(38)	(3)	-	23	205
Reclassified to held for sale	-	-	-	-	(408)	(121)	(529)

At 31 December 2012 ........	14,660	114	1,020	60	8,339	3,646	27,839

Accumulated impairment losses
At 1 January 2012 .............	-	-	-	-	(6,857)	-	(6,857)
Reclassified to held for sale	-	-	-	-	408	-	408

At 31 December 2012 ........	-	-	-	-	(6,449)	-	(6,449)

Net carrying amount at 31 December 2012 .........	14,660	114	1,020	60	1,890	3,646	21,390

Gross amount
At 1 January 2011 .............	14,885	124	1,115	65	12,465	4,316	32,970
Disposals ............................	(3)	-	-	-	-	(46)	(49)
Exchange differences .........	(449)	-	(35)	(2)	(1)	(272)	(759)
Reclassified to held for sale	-	-	-	-	(3,717)	(231)	(3,948)
Other changes ....................	-	-	(17)	-	-	(2)	(19)

At 31 December 2011 ........	14,433	124	1,063	63	8,747	3,765	28,195

Accumulated impairment losses
At 1 January 2011 .............	-	-	-	-	(10,564)	-	(10,564)
Reclassified to held for sale	-	-	-	-	3,707	-	3,707

At 31 December 2011 ........	-	-	-	-	(6,857)	-	(6,857)

Net carrying amount at 31 December 2011 .........	14,433	124	1,063	63	1,890	3,765	21,338

Impairment testing

Timing of impairment testing

HSBC's impairment test in respect of goodwill allocated to each cash-generating unit ('CGU') is performed as at 1 July each year. In line with the accounting policy set out in Note 2(p), goodwill is also retested for impairment whenever there is an indication that it may be impaired. For the purpose of impairment testing, the Group's CGUs are based on geographical regions subdivided by global business. The CGUs represent the lowest level at which goodwill is monitored for internal management purposes. The GB&M-Europe CGU experienced significantly reduced profitability in the second half of 2012 and was retested for impairment as at 31 December 2012. For other CGUs there was no indication of impairment in the period to 31 December 2012 and therefore goodwill has not been retested since 1 July 2012.

Basis of the recoverable amount - value in use or fair value less costs to sell

The recoverable amount of all CGUs to which goodwill has been allocated was equal to its VIU at each respective testing date for 2011 and 2012.

For each significant CGU, the VIU is calculated by discounting management's cash flow projections for the CGU. The discount rate used is based on the cost of capital HSBC allocates to investments in the countries within which the CGU operates. The long-term growth rate is used to extrapolate the cash flows in perpetuity because of the long‑term perspective within the Group of the business units making up the CGUs. In 2012, management's cash flow projections until the end of 2014 were used.

Key assumptions in VIU calculation and management's approach to determining the values assigned to each key assumption

	2012			2011
	Goodwill at 3 1 July 2 2012	Discount rate	Nominal growth rate beyond initial cash flow projections	Goodwill at 1 July 2011	Discount rate	Nominal growth rate beyond initial cash flow projections
	US$m	%	%	US$m	%	%
Cash-generating unit
Retail Banking and Wealth Management - Europe ...............................................	4,054	10.0	3.9	4,794	10.0	4.7
Commercial Banking - Europe .................	2,968	10.2	3.7	3,574	10.1	4.5
Global Private Banking - Europe ..............	4,139	9.1	3.2	4,456	10.0	4.3
Global Banking and Markets - Europe ......	3,016	10.2	3.5	3,139	10.2	4.4
Retail Banking and Wealth Management - Latin America ....................................	1,994	15.3	8.7	2,537	16.0	9.3

Total goodwill in the CGUs listed above ....	16,171			18,500

At 1 July 2012, aggregate goodwill of US$4,741m (1 July 2011: US$5,091m) had been allocated to CGUs that were not considered individually significant. These CGUs do not carry on their balance sheets any significant intangible assets with indefinite useful lives, other than goodwill.

Nominal long-term growth rate: this growth rate reflects GDP and inflation for the countries within which the CGU operates. The rates are based on IMF forecast growth rates as these rates are regarded as the most relevant estimate of likely future trends. The rates used for 2011 and 2012 do not exceed the long-term growth rate for the countries within which the CGU operates.

Discount rate: the discount rate used to discount the cash flows is based on the cost of capital assigned to each CGU, which is derived using a Capital Asset Pricing Model ('CAPM'). The CAPM depends on inputs reflecting a number of financial and economic variables including the risk-free rate and a premium to reflect the inherent risk of the business being evaluated. These variables are based on the market's assessment of the economic variables and management's judgement. In addition, for the purposes of testing goodwill for impairment, management supplements this process by comparing the discount rates derived using the internally generated CAPM with cost of capital rates produced by external sources. HSBC uses externally-sourced cost of capital rates where, in management's judgement, those rates reflect more accurately the current market and economic conditions. For 2012 and 2011, internal costs of capital rates were consistent with externally-sourced rates.

Management's judgement in estimating the cash flows of a CGU: the cash flow projections for each CGU are based on plans approved by the Group Management Board. The key assumptions in addition to the discount rate and nominal long-term growth rate for each significant CGU are discussed below.

Retail Banking and Wealth Management - Europe and Commercial Banking - Europe: the assumptions included in the cash flow projections for RBWM - Europe and CMB - Europe reflect the economic environment and financial outlook of the European countries within these two CGUs. Key assumptions include the level of interest rates and the level and change in unemployment rates. While current economic conditions in Europe continue to be challenging, management's cash flow projections are based primarily on these prevailing conditions. Risks include a further recession in the UK and an uncertain regulatory environment. RBWM - Europe specifically, is sensitive to further customer remediation costs in relation to PPI. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions described above would not cause an impairment to be recognised in respect of RBWM - Europe or CMB - Europe.

Global Private Banking - Europe: the revenues in GPB - Europe are predominately generated through HSBC's client relationships. The cash flow forecast reflects current economic conditions and key assumptions include the level of interest rates and client risk appetite. Further economic deterioration could result in a decrease in assets under management and a reduction in fee and trading income through increased client risk aversion. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions described above would not cause an impairment to be recognised in respect of GPB - Europe.

Global Banking and Markets - Europe: the key assumption included in the cash flow projection for GB&M - Europe is that European markets will continue to recover during 2013. Accordingly, European revenues are forecast to recover in 2013 and this recovery is assumed to continue over the projection period into 2014. Our ability to achieve the forecast cash flows for GB&M - Europe could be adversely impacted by regulatory change during the forecast period including but not limited to the extent that the recommendations set out in the Final Report by the Independent Commission on Banking are implemented.

Based on management's value in use calculation, GB&M - Europe has an excess of recoverable amount over carrying amount ('headroom') of US$2.3bn as at 1 July 2012. Headroom was US$2.3bn as at 31 December 2012 based on goodwill at that point of US$3.1bn. The change in carrying value between 1 July 2012 and 31 December 2012 arises from retranslating goodwill into the presentation currency of the group. The same assumptions were used in the impairment tests as at 1 July 2012 and 31 December 2012. The following changes to the key assumptions used in the value in use calculation would be necessary in order to reduce headroom to nil:

Key assumption	Change to key assumption to reduce headroom to nil
Discount rate ...........................................................................................	Increase by 64 basis points
Nominal growth rate beyond initial cash flow projection .........................	Decrease by 69 basis points
Revenue compound annual growth rate ....................................................	Decrease from 10.3% to 8.3%

Retail Banking and Wealth Management - Latin America: the assumptions included in the cash flow projections for RBWM - Latin America reflect the economic environment and financial outlook of the countries within this segment, with Brazil and Mexico being two of the largest countries included within this segment. Key assumptions include the growth in lending and deposit volumes and the credit quality of the loan portfolios. Mexico and Panama in particular are sensitive to economic conditions in the US which could constrain demand. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions described above would not cause an impairment to be recognised in respect of RBWM - Latin America.

Other intangible assets

Movement of intangible assets excluding goodwill and the PVIF

	Trade names	Mortgage servicing rights	Internally generated software	Purchased software	Customer/ merchant relation- ships	Other	Total
	US$m	US$m	US$m	US$m	US$m	US$m	US$m
Cost
At 1 January 2012 ..........................	60	591	5,598	856	1,354	454	8,913
Additions¹ .......................................	1	30	765	78	120	48	1,042
Disposals ........................................	-	(123)	(32)	(61)	(5)	-	(221)
Amount written off ........................	-	-	(680)	(21)	(39)	-	(740)
Exchange differences ......................	-	-	62	-	(48)	12	26
Reclassified to held for sale .............	-	-	(26)	(15)	(7)	(14)	(62)
Other changes .................................	-	-	16	78	(8)	4	90

At 31 December 2012 ....................	61	498	5,703	915	1,367	504	9,048

Movement of intangible assets excluding goodwill and the PVIF (continued)

	Trade names		Mortgage servicing rights		Internally generated software		Purchased software		Customer/ merchant relation- ships		Other		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m
Accumulated amortisation
At 1 January 2012 ..........	(51)		(369)		(3,437)		(672)		(649)		(131)		(5,309)
Charge for the year² ........	(5)		(78)		(645)		(103)		(127)		(21)		(979)
Impairment .....................	-		-		(63)		(3)		-		(2)		(68)
Disposals .........................	2		123		28		53		5		-		211
Amount written off .........	-		-		680		21		39		-		740
Exchange differences ......	-		(2)		(47)		1		15		(1)		(34)
Reclassified to held for sale ..............................	-		-		24		9		5		10		48
Other changes .................	(1)		-		(9)		(41)		8		2		(41)

At 31 December 2012 .....	(55)		(326)		(3,469)		(735)		(704)		(143)		(5,432)

Net carrying amount at 31 December 2012 ......	6		172		2,234		180		663		361		3,616

Cost
At 1 January 2011 ..........	68		636		5,202		1,065		1,987		503		9,461
Additions¹ .......................	-		40		1,129		102		379		6		1,656
Disposals .........................	-		(91)		(44)		(102)		(181)		(1)		(419)
Amount written off .........	-		-		(365)		(133)		-		(2)		(500)
Exchange differences ......	(6)		-		(109)		(40)		(79)		(14)		(248)
Reclassified to held for sale ..............................	(2)		-		(197)		(22)		(746)		(46)		(1,013)
Other changes .................	-		6		(18)		(14)		(6)		8		(24)

At 31 December 2011 .....	60		591		5,598		856		1,354		454		8,913

Accumulated amortisation
At 1 January 2011 ..........	(52)		(240)		(2,958)		(848)		(1,143)		(144)		(5,385)
Charge for the year² ........	(4)		(215)		(609)		(106)		(212)		(29)		(1,175)
Impairment .....................	-		-		(386)		(3)		-		(1)		(390)
Disposals .........................	-		91		29		100		111		3		334
Amount written off .........	-		-		365		133		-		2		500
Exchange differences ......	3		-		44		31		29		-		107
Reclassified to held for sale ..............................	2		-		50		18		563		36		669
Other changes .................	-		(5)		28		3		3		2		31

At 31 December 2011 .....	(51)		(369)		(3,437)		(672)		(649)		(131)		(5,309)
There was a modest decrease year on year in the fair value of loans and advances to customers in Europe relative to their carrying amount	Whih was largely a result of pricing the UK mortgage portfolio. We also enhanced the mortgage and corporate lending valuation processes in the UK to reflect risk factors	product characteristics and prepayment estimates at a more granular level. This overall decrease was mitigated by higher valuations of ABSs classified as loans and receivables following improved market appetite for such securities.	There was a modest decrease year on year in the fair value of loans and advances to customers in Europe relative to their carrying amount	which was largely a result of pricing the UK mortgage portfolio. We also enhanced the mortgage and corporate lending valuation processes in the UK to reflect risk factors	product characteristics and prepayment estimates at a more granular level. This overall decrease was mitigated by higher valuations of ABSs classified as loans and receivables following improved market appetite for such securities.	There was a modest decrease year on year in the fair value of loans and advances to customers in Europe relative to their carrying amount	which was largely a result of pricing the UK mortgage portfolio. We also enhanced the mortgage and corporate lending valuation processes in the UK to reflect risk factors	product characteristics and prepayment estimates at a more granular level. This overall decrease was mitigated by higher valuations of ABSs classified as loans and receivables following improved market appetite for such securities.	There was a modest decrease year on year in the fair value of loans and advances to customers in Europe relative to their carrying amount	which was largely a result of pricing the UK mortgage portfolio. We also enhanced the mortgage and corporate lending valuation processes in the UK to reflect risk factors	product characteristics and prepayment estimates at a more granular level. This overall decrease was mitigated by higher valuations of ABSs classified as loans and receivables following improved market appetite for such securities.	There was a modest decrease year on year in the fair value of loans and advances to customers in Europe relative to their carrying amount	which was largely a result of pricing the UK mortgage portfolio. We also enhanced the mortgage and corporate lending valuation processes in the UK to reflect risk factors
Net carrying amount at 31 December 2011 ......	9		222		2,161		184		705		323		3,604

1 At 31 December 2012, HSBC had no contractual commitments (2011: nil) to acquire intangible assets.

2 The amortisation charge for the year is recognised within the income statement under 'Amortisation and impairment of intangible assets', with the exception of the amortisation of mortgage servicing rights which is recognised in 'Net fee income'.

This information is provided by RNS

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