Interim Report - 11 of 21

RNS Number : 3110X

HSBC Holdings PLC

14 August 2009

 



Fair values of financial instruments

This section on fair values of financial instruments forms part of the interim consolidated financial statements.

The accounting policies which determine the classification of financial instruments and the use of assumptions and estimation in valuing them are described on pages 344 to 359 and 63 to 64, respectively, of the Annual Report and Accounts 2008. The following is a description of HSBC's methods of determining fair value and its related control framework, and a quantification of its exposure to financial instruments measured at fair value.

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 measured at fair value on an ongoing basis include trading assets and liabilities, instruments designated at fair value, derivatives and financial investments classified as available for sale (including treasury and other eligible bills, debt securities and equity securities).

Fair values of financial instruments carried at fair value

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. To this end, ultimate responsibility for the determination of fair values lies with Finance, which reports functionally to the Group Finance Director. Finance establishes the accounting policies and procedures governing valuation, and is responsible for ensuring that they comply with all relevant accounting standards.

Further details of the control framework, including details on fair values determined using a valuation model, are included on pages 162 and 163 of the Annual Report and Accounts 2008.

Determination of fair value 

Fair values are determined according to the following hierarchy:

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

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

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

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

The judgement as to whether a market is active may include, but is not restricted to, the consideration of factors such as the magnitude and frequency of trading activity, the availability of prices and the size of bid/offer spreads. In inactive markets, obtaining assurance that the transaction price provides evidence of fair value or determining the adjustments to transaction prices that are necessary to measure the fair value of the instrument requires additional work during the valuation process.

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

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

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

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

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

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

The valuation techniques used when quoted market prices are not available incorporate certain assumptions that HSBC believes would be made by a market participant to establish fair value. When HSBC considers that there are additional considerations not included within the valuation model, appropriate adjustments may be made. Examples of such adjustments are:

• Credit risk adjustment: an adjustment to reflect the creditworthiness of OTC derivative counterparties. 

• Market data/model uncertainty: an adjustment to reflect uncertainties in fair values based on unobservable market data inputs (for example, as a result of illiquidity), or in areas where the choice of valuation model is particularly subjective.

• Inception profit ('day 1 gain or loss'): for financial instruments valued at inception on the basis of one or more significant unobservable inputs, the difference between transaction price and model value, as adjusted, at inception (the day 1 gain or loss) is not recognised in the consolidated income statement, but is deferred. An analysis of the movement in the deferred day 1 gain or loss is provided on page 218.

Transaction costs are not included in the fair value calculation, nor are the future costs of administering the OTC derivative portfolio. These, along with trade origination costs such as brokerage fees and post-trade costs, are included either in fee expense or in operating expenses.

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

• Private equity

HSBC's private equity positions 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. The exercise of judgement is required because of uncertainties inherent in estimating fair value for private equity investments.

• Debt securities, treasury and other eligible bills, and equities 

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

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

In the absence of quoted market prices, fair value is determined using valuation techniques based on the calculation of the present value of expected future cash flows of the assets. The inputs to these valuation techniques are derived from observable market data and, where relevant, assumptions in respect of unobservable inputs. In respect of ABSs and mortgages, the assumptions may include prepayment speeds, default rates and loss severity based on collateral type, and performance as appropriate. The output from the valuation techniques is benchmarked for consistency against observable data. 

• Derivatives 

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

• Loans including leveraged loans and loans held for securitisation

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

• Structured notes 

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

Fair value valuation bases

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

The main drivers of the movement in the balances of assets and liabilities measured at fair value with significant unobservable inputs were attributable to a decrease in the fair value of derivative assets, loans held for securitisation and the disposal of securities in other portfolios. At 30 June 2009, financial instruments measured at fair value using a valuation technique with significant unobservable inputs represented 2 per cent of total assets and liabilities measured at fair value (31 December 2008: 2 per cent).

Bases of valuing 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 30 June 2009
Assets
Trading assets	272,812		134,897		6,649		414,358
Financial assets designated at fair value	20,550		12,218		593		33,361
Derivatives	7,304		296,242		7,250		310,796
Financial investments: available for sale	145,558		182,075		9,521		337,154
Liabilities
Trading liabilities	134,641		122,941		6,980		264,562
Financial liabilities designated at fair value	26,848		50,465		-		77,314
Derivatives	9,288		285,726		3,862		298,876
At 31 December 2008
Assets
Trading assets	234,399		185,369		7,561		427,329
Financial assets designated at fair value	14,590		13,483		460		28,533
Derivatives	8,495		476,498		9,883		494,876
Financial investments: available for sale	103,949		173,157		9,116		286,222
Liabilities
Trading liabilities	105,584		135,559		6,509		247,652
Financial liabilities designated at fair value	23,311		51,276		-		74,587
Derivatives	9,896		473,359		3,805		487,060

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

	Assets								Liabilities
	Available      for sale		Held for     trading	Designated     at fair value     through profit or loss			Derivatives		Held for     trading	Designated      at fair value     through         profit or loss			Derivatives
	US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2009
Private equity investments	2,566		31		235		-		-		-		-
Asset-backed securities	3,977		1,257		-		-		-		-		-
Leveraged finance	-		143		-		-		-		-		40
Loans held for securitisation	-		1,539		-		-		-		-		-
Structured notes	-		138		-		-		4,650		-		-
Derivatives with monolines	-		-		-		2,102		-		-		-
Other derivatives	-		-		-		5,148		-		-		3,822
Other portfolios	2,978		3,541		358		-		2,330		-		-
	9,521		6,649		593		7,250		6,980		-		3,862
At 31 December 2008
Private equity investments	2,689		54		225		-		-		-		-
Asset-backed securities	4,264		882		-		95		-		-		565
Leveraged finance	-		266		-		-		-		-		33
Loans held for securitisation	-		2,133		-		-		-		-		-
Structured notes	-		87		-		-		5,294		-		-
Derivatives with monolines	-		-		-		2,441		-		-		-
Other derivatives	-		-		-		7,347		-		-		3,207
Other portfolios	2,163		4,139		235		-		1,215		-		-
	9,116		7,561		460		9,883		6,509		-		3,805

At 30 June 2009, available-for-sale assets valued using a valuation technique with significant unobservable inputs principally comprised various ABSs, private equity investments and other portfolios, similar to the position at 31 December 2008.

Trading assets valued using a valuation technique with significant unobservable inputs principally comprised asset-backed securities, loans held for securitisation and other portfolios. Other portfolios included holdings in various bonds, preference shares and corporate and mortgage loans. The decrease during the period was due to a reduction in the fair value of loans held for securitisation and disposals of positions within other portfolios.

Derivative products valued using valuation techniques with significant unobservable inputs included certain types of correlation products, such as foreign exchange 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 included tranched CDS transactions. The decrease in derivative assets during the first half of 2009 was mainly due to a decrease in the fair value of structured credit transactions.

Trading liabilities valued using a valuation technique with significant unobservable inputs principally comprised equity-linked structured notes, which are issued by HSBC, and provide the counterparty with a return that is linked to the performance of certain equity securities, and other portfolios. The movement in trading liabilities during the first half of 2009 was primarily due to the issue of new equity derivative linked structures and transfers into level 3 which themselves were attributable to fund and foreign exchange related derivatives. 

The increase in derivative liabilities valued using a valuation technique with significant unobservable inputs at 30 June 2009 was attributable to an increase in structured interest rate option 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:

	Assets								Liabilities
	Available      for sale		Held for     trading	Designated     at fair value     through profit or loss			Derivatives		Held for     trading	Designated      at fair value     through         profit or loss			Derivatives
	US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 1 January 2009	9,116		7,561		460		9,883		6,509		-		3,805
Total gains or losses recognised  in profit or loss	(350)		(714)		1		(2,358)		(283)		-		(100)
Total gains or losses recognised in other comprehensive income	196		110		-		211		171		-		197
Purchases	841		550		138		-		312		-		-
Issues	-		-		-		-		1,001		-		-
Sales	(551)		(1,120)		(7)		-		-		-		-
Settlements	(574)		(199)		-		(113)		(484)		-		(171)
Transfers out	(890)		(481)		-		(715)		(1,196)		-		(475)
Transfers in	1,733		942		1		342		950		-		606
At 30 June 2009	9,521		6,649		593		7,250		6,980		-		3,862
Total gains or losses recognised in profit or loss relating to those assets and liabilities held at the end of the reporting period	(349)		(560)		1		(1,836)		(271)		-		485

For available-for-sale securities and assets held for trading, the unobservability of valuations of asset-backed and other fixed income securities resulted in assets in these categories being transferred into level 3 during the first half of 2009. Transfers out of level 3 also occurred in respect of asset-backed and other fixed income securities. The transfers out of level 3 were due to valuations in these asset categories becoming observable during the first half of 2009.

For derivative assets and liabilities, an increase in the observability of equity volatilities and correlations during the first half of 2009, resulted in transfers out of level 3. In addition, the unobservability of specific asset prices underlying derivative structures resulted in derivative liabilities being transferred into level 3.

For held-for-trading liabilities, transfers into level 3 were primarily due to a reduction in the observability of volatilities and gap risk parameters. Transfers out of level 3 resulted from an increase in the observability of equity correlation.

During the first half of 2009, there were no significant transfers between levels 1 and 2.

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

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

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

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:

	Reflected in profit or loss				Reflected in equity
	Favourable     changes		Unfavourable     changes		Favourable     changes		Unfavourable     changes
	US$m		US$m		US$m		US$m
At 30 June 2009
Derivatives, trading assets and trading liabilities1	1,428		(1,126)		-		-
Financial assets and liabilities designated at fair value	39		(39)		-		-
Financial investments: available for sale	-		-		1,263		(1,288)
At 31 December 2008
Derivatives, trading assets and trading liabilities1	1,266		(703)		-		-
Financial assets and liabilities designated at fair value	30		(30)		-		-
Financial investments: available for sale	-		-		984		(1,005)

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

The small increase in the effect of changes in significant unobservable inputs in relation to derivatives, trading assets and trading liabilities during the first half of 2009 primarily reflected 

Principal assumptions used in the valuation of financial instruments with significant unobservable inputs

	Reflected in profit or loss				Reflected in equity
	Favourable     changes		Unfavourable     changes		Favourable     changes		Unfavourable     changes
	US$m		US$m		US$m		US$m
At 30 June 2009
Private equity investments	26		(26)		267		(292)
Asset-backed securities	124		(103)		709		(708)
Leveraged finance	2		(2)		-		-
Loans held for securitisation	19		(19)		-		-
Structured notes	21		(21)		-		-
Derivatives with monolines	211		(444)		-		-
Other derivatives	895		(397)		-		-
Other portfolios	169		(153)		287		(288)
At 31 December 2008
Private equity investments	28		(28)		234		(261)
Asset-backed securities	90		(91)		667		(660)
Leveraged finance	2		(2)		-		-
Loans held for securitisation	41		(41)		-		-
Structured notes	8		(8)		-		-
Derivatives with monolines	341		(250)		-		-
Other derivatives	652		(224)		-		-
Other portfolios	134		(89)		83		(84)

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

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

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

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

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

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

For structured notes and other derivatives, principal assumptions concern the future volatility of asset values and the future correlation between asset values. These principle 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 correlation from comparable assets for which market data is more readily available, and/or an examination of historical levels.

Changes in fair value recorded in the income statement

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

		Half-year to
	30 June     2009			30 June    2008	31     December     2008
	US$m			US$m		US$m
Recorded profit/ (loss) on:
Derivatives, trading assets and trading liabilities	(2,182)			(1,415)		2,194
Financial assets and liabilities designated at fair value	1			13		96

The loss during the first six months in 2009 included changes in the fair value of structured monoline CDPC-related credit derivatives which use a valuation technique with significant unobservable inputs. Additionally, there was a decline in the fair value of other structured credit derivatives attributable to the tightening of credit spreads during the period. 

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

Assessing available-for-sale assets for impairment

HSBC's policy on impairment of available-for-sale assets is described on page 350 of the Annual Report and Accounts 2008. The following is a description of HSBC's application of that policy.

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

Debt securities

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

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

In addition, when assessing available-for-sale ABSs for objective evidence of impairment, HSBC considers the performance of underlying collateral, the extent and depth of market price declines and changes in credit ratings. The primary indicators of potential impairment are considered to be adverse fair value movements, and the disappearance of an active market for the securities.

At 30 June 2009, the population of available-for-sale ABSs identified as being most at risk of impairment included residential MBSs backed by sub-prime and Alt-A mortgages originated in the US, and CDOs with significant exposure to this sector. The estimated future cash flows of these securities are assessed to determine whether any of their cash flows are unlikely to be recovered as a result of events occurring on or before the reporting date.

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

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

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

Equity securities

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

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

For impairment losses on available-for-sale debt and equity securities, see pages 21 and 19, respectively. Any impairment losses recognised in the income statement relating to ABSs are recorded in the 'Loan impairment charges and other credit risk provisions' line. Impairment losses incurred on assets held by consolidated securities investment conduits (excluding Solitaire) are offset by a credit to the impairment line for the amount of the loss borne by capital note holders.

Fair values of financial instruments not carried at fair value

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

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

As a consequence of the market turmoil, there has been a significant reduction in the secondary market demand for US Consumer Lending assets. Uncertainty over the extent and timing of future credit losses, together with a near absence of liquidity for non-prime ABSs and loans, continued to be reflected in a lack of bid prices at 30 June 2009. It is not possible from the indicative market prices that are available to distinguish between the relative discount to nominal value within the fair value measurement that reflects cash flow impairment due to expected losses to maturity, and the discount that the market is demanding for holding an illiquid and out of favour asset. Under impairment accounting for loans and advances, there is no need nor requirement to adjust carrying amounts to reflect illiquidity as HSBC's intention is to fund assets until the earlier of prepayment, charge-off or repayment on maturity. Market fair values, by contrast, reflect both incurred loss and loss expected through the life of the asset, a discount for illiquidity and a credit spread which reflects the market's current risk preferences. This usually differs from the credit spread applicable in the market at the time the loan was underwritten and funded. 

The estimated fair values at 30 June 2009 and 31 December 2008 of loans and advances to customers in North America reflect the combined effect of these conditions. As a result, the fair values are substantially lower than the carrying amount of customer loans and lower than would otherwise be reported under more normal market conditions. Accordingly, the fair values reported do not reflect HSBC's estimate of the underlying long-term value of the assets.

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

• Loans and advances to banks and customers

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

The fair value of a loan portfolio reflects both loan impairments at the reporting date and estimates of market participants' expectations of credit losses over the life of the loans.

For impaired loans, fair value is estimated by discounting the future cash flows over the time period they are expected to be recovered.

•     Financial investments

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

•     Deposits by banks and customer accounts

For the purpose of estimating fair value, deposits by banks and customer accounts are grouped by residual 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 reporting date. 

• Debt securities in issue and subordinated liabilities

Fair values are determined using quoted market prices at the reporting 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 

For all classes of financial instruments, fair value represents the product of the value of a single instrument, multiplied by the number of instruments held. No block discount or premium adjustments are made. The fair values of intangible assets related to the businesses which originate and hold the financial instruments subject to fair value measurement, such as values placed on portfolios of core deposits, credit card and customer relationships, are not included in the above because they are not classified as financial instruments. Accordingly, an aggregation of fair value measurements does not approximate to the value of the organisation as a going concern.

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

Assets

Cash and balances at central banks

Items in the course of collection from other banks

Hong Kong Government certificates of indebtedness 

Endorsements and acceptances

Short-term receivables within 'Other assets'

Accrued income

Liabilities 

Hong Kong currency notes in circulation 

Items in the course of transmission to other banks

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

Endorsements and acceptances

Short-term payables within 'Other liabilities'

Accruals 

Fair values of financial instruments which are not carried at fair value

	At 30 June 2009				At 30 June 2008				At 31 December 2008
	Carrying     amount		Fair     value		Carrying     amount		Fair     value		Carrying     amount		Fair     value
	US$m		US$m		US$m		US$m		US$m		US$m
Assets
Loans and advances to banks	182,266		181,507		256,981		256,944		153,766		153,363
Loans and advances to customers	924,683		871,973		1,049,200		1,013,869		932,868		876,239
Financial investments: debt securities	16,290		16,571		11,023		11,159		14,013		15,057
Liabilities
Deposits by banks	129,151		129,076		154,152		154,284		130,084		130,129
Customer accounts	1,163,343		1,164,256		1,161,923		1,161,845		1,115,327		1,115,291
Debt securities in issue	156,199		151,295		230,267		226,199		179,693		170,599
Subordinated liabilities	30,134		28,299		31,517		29,942		29,433		28,381

Fair values of financial investments classified as held for sale which are not carried at fair value

	At 30 June 2009				At 30 June 2008				At 31 December 2008
	Carrying     amount		Fair     value		Carrying     amount		Fair     value		Carrying     amount		Fair     value
	US$m		US$m		US$m		US$m		US$m		US$m
Assets classified as held for sale
Loans and advances to banks and customers	846		774		1,852		1,526		11		11

Analysis of loans and advances to customers by geographical segment

	At 30 June 2009				At 30 June 2008				At 31 December 2008
	Carrying     amount		Fair     value		Carrying     amount		Fair     value		Carrying     amount		Fair     value
	US$m		US$m		US$m		US$m		US$m		US$m
Loans and advances to customers
Europe	457,090		445,335		508,960		507,280		426,191		417,256
Hong Kong	97,486		97,052		99,741		99,368		100,220		100,490
Rest of Asia-Pacific1	74,062		74,082		88,753		88,735		80,661		77,391
Middle East1	25,097		24,798		25,004		25,134		27,295		27,296
North America2	226,258		185,826		272,490		239,208		256,214		211,346
Latin America	44,690		44,880		54,252		54,144		42,287		42,460
	924,683		871,973		1,049,200		1,013,869		932,868		876,239

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

2    The reasons for the significant difference between carrying amount and fair value of loans and advances to customers in North America are discussed on page 122.

Special purpose entities

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

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

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

HSBC-sponsored SPEs

HSBC sponsors the formation of entities which are designed to accomplish certain narrow and well-defined objectives, such as securitising financial assets or affecting a lease, and this requires a form of legal structure that restricts the assets and liabilities within the structure to the single purpose for which it was established. HSBC consolidates these SPEs when the substance of the relationship indicates that HSBC controls them. In assessing control, all relevant factors are considered, including qualitative and quantitative aspects as described on pages 173 and 174 of the Annual Report and Accounts 2008.

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

Structured investment vehicles and conduits

Structured investment vehicles 

SIVs are SPEs which invest in diversified portfolios of interest-earning assets, generally funded through issues of commercial paper ('CP'), medium-term notes ('MTN's) and other senior debt to take advantage of the spread differentials between the assets in the SIV and the funding cost. Prior to the implementation of Basel II, it was capital efficient to invest in highly-rated investment securities in this way. HSBC sponsored two SIVs, Cullinan Finance Limited ('Cullinan') and Asscher Finance Limited ('Asscher') which are now in the process of voluntary liquidation following completion of the transfer of their portfolios of investment securities and derivatives to the new SICs during the first half of 2009.

At 30 June 2009, all the capital notes in Cullinan and Asscher had been redeemed and replaced by capital notes in the new SICs (31 December 2008: 8.7 per cent of Asscher's capital notes remained outstanding). 

Conduits

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

Securities investment conduits 

Solitaire, HSBC's principal securities investment conduit, purchases highly rated ABSs to facilitate tailored investment opportunities. HSBC's other SICs, Mazarin, Barion and Malachite, evolved from the restructuring of HSBC's sponsored SIVs as stated above and discussed in more detail on pages 173 and 174 of the Annual Report and Accounts 2008. 

Multi-seller conduits 

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

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

An analysis of the assets held by HSBC's SIVs and conduits is set out below:

Ratings analysis of assets

	Solitaire		Other     SICs		Total      SICs		Total      multi-seller     conduits	Total      SICs	Total     SIVs
	US$bn		US$bn		US$bn		US$bn	US$bn	US$bn
S&P ratings at 30 June 2009
AAA	7.0		8.7		15.7		5.8		-
AA	1.2		2.1		3.3		0.2		-
A	0.7		5.1		5.8		3.4		-
BBB	1.2		1.1		2.3		1.0		-
BB	0.3		0.5		0.8		0.8		-
B	0.4		0.5		0.9		-		-
CCC	0.2		0.3		0.5		-		-
CC	0.1		0.1		0.2		-		-
Total investments	11.1		18.4		29.5		11.2		-
Cash and other investments	0.5		0.2		0.7		0.4		-
	11.6		18.6		30.2		11.6		-

	Solitaire		Other     SICs		Total      SICs		Total      multi-seller     conduits	Total      SICs	Total     SIVs
	US$bn		US$bn		US$bn		US$bn	US$bn	US$bn
S&P ratings at 31 December 2008
AAA	8.1		12.0		20.1		6.1	20.1	0.3
AA	0.7		1.4		2.1		1.8	2.1	-
A	1.0		4.7		5.7		1.6	5.7	-
BBB	0.8		1.0		1.8		1.2	1.8	-
BB	0.3		0.4		0.7		0.2	0.7	-
B	0.1		0.2		0.3		0.5	0.3	-
CCC	0.2		0.2		0.4		1.8	0.4	-
D	-		-		-		0.3	0.0	-
Total investments	11.2		19.9		31.1		13.5	31.1	0.3
Cash and other investments	0.9		0.3		1.2		0.4	1.2	0.1
	12.1		20.2		32.3		13.9	32.3	0.4

The migration to lower ratings during the first half of 2009 is a result of the performance of the underlying assets being outside the parameters of the original securitisations, and changes to the ratings methodology of the principal ratings agencies.

At 30 June 2009, 11.9 per cent of the SICs' exposures to sub-prime and US Alt-A mortgages, which in aggregate amounted to US$0.7 billion, remained AAA rated (31 December 2008: 62.7 per cent, US$4.2 billion), while 58.7 per cent, which in aggregate amounted to US$3.3 billion, remained investment grade (31 December 2008: 94 per cent, US$6.3 billion). 

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

At 30 June 2009, the SIVs did not hold any CP issued by SICs set up by HSBC (31 December 2008: US$0.3 billion). As described on page 174 of the Annual Report and Accounts 2008, by 31 December 2008 all the original assets held by the SIVs were transferred to the new SICs.

Weighted average life of portfolios

	Solitaire		Other     SICs		Total      SICs		Total      multi-seller     conduits	Total      SICs	Total     SIVs
Weighted average life (years)
At 30 June 2009	5.5		3.8		4.4		3.2		-
At 31 December 2008	5.8		3.9		4.6		1.6		-

Composition of asset portfolio

	Solitaire		Other     SICs		Total      SICs		Total     multi-seller     conduits1	Total      SICs	Total     SIVs
	US$bn		US$bn		US$bn		US$bn	US$bn	US$bn
Asset class at 30 June 2009
Structured finance
Vehicle loans and equipment leases	-		-		-		3.2		-
Consumer receivables	-		-		-		0.7		-
Credit card receivables	0.2		-		0.2		1.4		-
Residential MBSs	3.6		4.8		8.4		0.4		-
Commercial MBSs	2.1		2.7		4.8		-		-
Auto floor plan	-		-		-		1.2		-
Trade receivables	-		-		-		2.6		-
Student loan securities	2.4		1.9		4.3		-		-
Vehicle finance loan securities	0.1		0.2		0.3		-		-
Leverage loan securities	1.8		2.1		3.9		-	-	-
Other ABSs	0.8		1.2		2.0		1.5		-
	11.0		12.9		23.9		11.0		-
Finance
Commercial bank securities and deposits	0.1		4.6		4.7		0.4		-
Investment bank debt securities	-		0.7		0.7		-		-
Finance company debt securities	-		0.2		0.2		0.2		-
Other assets	0.5		0.2		0.7		-		-
	0.6		5.7		6.3		0.6		-
	11.6		18.6		30.2		11.6		-
Sub-prime mortgages	0.7		1.6		2.3		-		-
US Alt-A	1.7		1.7		3.4		-		-
	2.4		3.3		5.7		-		-
Asset class at 31 December 2008
Structured finance
Vehicle loans and equipment leases	-		-		-		3.9		-
Consumer receivables	-		-		-		0.7		-
Credit card receivables	0.2		-		0.2		1.4		-
Residential MBSs	4.4		5.7		10.1		0.6		-
Commercial MBSs	2.1		3.1		5.2		0.2		-
Auto floor plan	-		-		-		2.2		-
Trade receivables	-		-		-		2.7		-
Student loan securities	2.2		2.0		4.2		-		-
Vehicle finance loan securities	-		0.3		0.3		-		-
Leverage loan securities	1.5		2.2		3.7		-		-
Other ABSs	0.8		1.3		2.1		1.7		-
	11.2		14.6		25.8		13.4		-
Finance
Commercial bank securities and deposits	-		4.4		4.4		0.4		-
Investment bank debt securities	-		0.5		0.5		-		-
Finance company debt securities	-		0.4		0.4		-		0.3
Other assets	0.9		0.3		1.2		0.1		0.1
	0.9		5.6		6.5		0.5		0.4
	12.1		20.2		32.3		13.9		0.4
Sub-prime mortgages	0.9		1.3		2.2		-		-
US Alt-A	2.3		2.2		4.5		-		-
	3.2		3.5		6.7		-		-

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

Asset analysis by geographical origination for multi-seller conduits1

	At      30 June      2009		At      31 December     2008
	US$bn		US$bn
Europe	5.8		7.5
Rest of Asia-Pacific	0.6		0.9
North America	5.2		5.5
	11.6		13.9

1    For details on the geographical origin of the mortgage loans held at fair value and ABSs, including those represented by MBSs and CDOs held in consolidated SIVs and securities investment conduits, see 'Nature and extent of HSBC's exposures' on page 102.

Total assets by balance sheet classification

	Solitaire		Other     SICs		Total      SICs		Total      multi-seller     conduits	Total      SICs	Total     SIVs
	US$bn		US$bn		US$bn		US$bn	US$bn	US$bn
At 30 June 2009
Financial instruments designated at  fair value	0.1		-		0.1		-		-
Loans and advances to banks	0.1		0.1		0.2		-		-
Loans and advances to customers	-		-		-		11.2		-
Financial investments	11.0		18.4		29.4		-		-
Other assets	0.4		0.1		0.5		0.4		-
	11.6		18.6		30.2		11.6		-
At 31 December 2008
Financial instruments designated at  fair value	0.1		-		0.1		-		-
Derivative assets	-		0.2		0.2		0.1		-
Loans and advances to banks	-		0.1		0.1		-		0.1
Loans and advances to customers	-		-		-		13.4		-
Financial investments	11.1		19.9		31.0		-		0.3
Other assets	0.9		-		0.9		0.4		-
	12.1		20.2		32.3		13.9		0.4

Funding structure

	Solitaire				Other SICs				Total SICs				Total multi-seller conduits				Total SIVs
	Total		Provided      by HSBC		Total		Provided      by HSBC		Total		Provided      by HSBC		Total		Provided      by HSBC		Total		Provided     by HSBC
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 30 June 2009
Capital notes	-		-		0.6		-		0.6		-		-		-		-		-
Drawn liquidity  facility	8.6		8.6		-		-		8.6		8.6		-		-		-		-
Commercial paper	10.6		2.1		10.4		10.4		21.0		12.5		10.7		0.1		-		-
Medium-term notes	-		-		3.9		3.9		3.9		3.9		-		-		-		-
Term repos executed	-		-		11.3		11.3		11.3		11.3		-		-		-		-
	19.2		10.7		26.2		25.6		45.4		36.3		10.7		0.1		-		-
At 31 December 2008
Capital notes	-		-		0.9		-		0.9		-		-		-		-		-
Drawn liquidity  facility	2.4		2.4		-		-		2.4		2.4		-		-		-		-
Commercial paper	17.2		8.3		10.5		10.4		27.7		18.7		12.9		2.1		-		-
Medium-term notes	-		-		3.4		3.4		3.4		3.4		-		-		0.1		-
Term repos executed	0.8		0.8		13.3		13.3		14.1		14.1		-		-		-		-
	20.4		11.5		28.1		27.1		48.5		38.6		12.9		2.1		0.1		-

Weighted average life of the funding liabilities

	Solitaire		Other     SICs		Total      SICs		Total      multi-seller     conduits	Total      SICs	Total     SIVs
	Years		Years		Years		Years	US$bn	Years
At 30 June 2009
CP funding	0.2		0.1		0.2		0.1		-
MTN funding	n/a		10.7		10.7		n/a		-
At 31 December 2008
CP funding	0.1		0.2		0.1		0.1		n/a
MTN funding	n/a		7.3		7.3		n/a		0.1

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

HSBC's maximum exposure 

Conduits

Mazarin

• HSBC is exposed to the par value of Mazarin's assets through the provision of a liquidity facility equal to the lesser of the amortised cost of issued senior debt and the amortised cost of non-defaulted assets. At 30 June 2009, HSBC's exposure amounted to US$14.4 billion (31 December 2008: US$15.5 billion). First loss protection is provided through the capital notes issued by Mazarin, which are substantially all held by third parties.

• In addition, at 30 June 2009, HSBC held 1.3 per cent (31 December 2008: 1.3 per cent) of Mazarin's capital notes, which had a par value of US$17 million (31 December 2008: US$17 million), and a carrying amount of US$0.4 million (31 December 2008: US$0.6 million).

Barion and Malachite

• These SICs are term funded by HSBC, consequently HSBC's primary exposure to them is represented by the amortised cost of the debt required to support the non-cash assets of the vehicles. At 30 June 2009 this amounted to US$11.1 billion (31 December 2008: US$11.7 billion).

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

•     In addition, at 30 June 2009, HSBC held 3.81 per cent (31 December 2008: 3.53 per cent) of the capital notes issued by these vehicles which have a par value of US$37 million (31 December 2008: US$35 million), and a carrying amount of US$2.0 million (31 December 2008: US$1.3 million).

Solitaire

• CP issued by Solitaire benefits from a 100 per cent liquidity facility provided by HSBC. First loss credit protection against CP-funded securities, after any transaction-specific credit enhancement (as described on page 100) and retained reserves, is provided by HSBC in the form of letters of credit with a combined notional value of US$1.2 billion at 30 June 2009 (31 December 2008: US$1.2 billion). 

• At 30 June 2009, US$8.6 billion of Solitaire's assets were funded by the draw-down of the liquidity facility (31 December 2008: US$2.4 billion). HSBC is exposed to credit losses on the drawn amounts.

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

• HSBC's maximum exposure at 30 June 2009 amounted to US$19.1 billion (31 December 2008: US$20.4 billion).

Multi-seller conduits

• HSBC provides transaction-specific liquidity facilities to each of its multi-seller conduits, designed to be drawn in order to ensure the repayment of the CP issued. At 30 June 2009, the committed liquidity facilities amounted to US$16.0 billion (31 December 2008: US$17.1 billion).

• First loss protection is provided through transaction-specific credit enhancements, for example, over-collateralisation and excess spread. These credit enhancements are provided by the originator of the assets and not by HSBC. In addition, a layer of secondary loss protection is provided by HSBC in the form of programme-wide enhancement facilities, and at 30 June 2009 this amounted to US$0.7 billion (31 December 2008: US$0.6 billion). HSBC's maximum exposure is equal to the transaction-specific liquidity facilities offered to the multi-seller conduits, as described above.

• The liquidity facilities are set to support total commitments and therefore exceed the funded assets at both 30 June 2009 and 31 December 2008.

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

Structured investment vehicles 

•     Cullinan and Asscher's only assets are cash equivalents with liabilities to the extent of the liquidation costs and cash balances due to Mazarin, Barion and Malachite. 

•     At 30 June 2009, HSBC retains no market exposure to the SIVs (31 December 2008: Cullinan held Mazarin CP amounting to US$0.3 billion. At that date, HSBC retained no marginal exposure through Cullinan to Mazarin's activities over the maximum exposure value stated for Mazarin).

Money market funds

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

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

In aggregate, HSBC has established money market funds with total assets of US$99.8 billion at 30 June 2009 (31 December 2008: US$102.7 billion).

The main sub-categories of money market funds are: 

• US$72.4 billion (31 December 2008: US$72.0 billion) in Constant Net Asset Value ('CNAV') funds, which invest in shorter-dated and highly-rated money market securities with the objective of providing investors with a highly liquid and secure investment; 

• US$1.5 billion (31 December 2008: US$2.7 billion) in French domiciled dynamique ('dynamic') funds and Irish 'enhanced' funds, together Enhanced Variable Net Asset Value ('Enhanced VNAV') funds, which invest in longer-dated money market securities to provide investors with a higher return than traditional money market funds; and

• US$25.9 billion (31 December 2008: US$28.0 billion) in various other money market Variable Net Asset Value ('VNAV') funds, including funds predominantly domiciled in Brazil, France, India and Mexico.

These money market funds invest in diverse portfolios of highly-rated debt instruments, including limited holdings in instruments issued by SIVs. At 30 June 2009, the exposure of these funds to SIVs was US$0.3 billion (31 December 2008: US$0.5 billion). 

Constant Net Asset Value funds 

CNAV funds price their assets on an amortised cost basis, subject to the amortised book value of the portfolio remaining within 50 basis points of its market value. This feature enables CNAV funds to create and liquidate shares in the funds at a constant price. If the amortised value of an asset portfolio were to vary by more than 50 basis points from its market value, the CNAV fund would be required to price its assets at market value, and consequently would no longer be able to create or liquidate shares at a constant price. This is commonly known as 'breaking the buck'.

During 2008, HSBC consolidated certain CNAV funds as a result of actions taken by HSBC to support the CNAV funds to maintain their AAA rating and mitigate the forced sale of liquid assets to meet potential redemptions. As a consequence, HSBC incurred losses totalling US$114 million at 31 December 2008. Further information is provided on pages 180 and 181 of the Annual Report and Accounts 2008.

Composition of CNAV asset portfolio

	At      30 June      2009		At      31 December     2008
	US$bn		US$bn
ABSs	0.2		0.8
Certificates of deposit	10.5		13.0
CP	17.7		18.1
Floating rate notes	1.4		5.2
Government agency bonds	8.5		1.9
Other assets	5.1		4.8
Total	43.4		43.8

The associated liabilities included on HSBC's balance sheet at 30 June 2009 amounted to US$42.7 billion (31 December 2008: US$43.1 billion).

HSBC's maximum exposure

HSBC's maximum exposure to consolidated and unconsolidated CNAV funds is represented by HSBC's investment in the units of each CNAV fund, and by the maximum limit of the letters of limited indemnity provided to the CNAV funds. HSBC's exposure at 30 June 2009 amounted to US$0.8 billion (31 December 2008: US$0.7 billion) and nil (31 December 2008: US$58 million) for investment in units within the CNAV funds and letters of limited indemnity, respectively. 

Enhanced Variable Net Asset Value funds

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

During 2008, HSBC consolidated two of its French dynamic money market funds as a result of continued redemptions by unitholders. HSBC's aggregate holdings in these funds at 30 June 2009 amounted to €0.4 billion (US$0.6 billion) (31 December 2008: €0.5 billion (US$0.6 billion)).

HSBC's maximum exposure

HSBC's maximum exposure to consolidated and unconsolidated Enhanced VNAV and consolidated and unconsolidated VNAV funds is represented by HSBC's investment in the units of each fund. HSBC's maximum exposure at 30 June 2009 amounted to US$0.6 billion (31 December 2008: US$0.6 billion) and US$0.9 billion (31 December 2008: US$1.6 billion), for Enhanced VNAV and VNAV funds, respectively.

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

	At      30 June      2009		At    31 December      2008
	US$bn		US$bn
Cash	0.1		0.3
Trading assets	44.6		43.3
Other assets	0.1		2.3
	44.8		45.9

Non-money market investment funds

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

In aggregate, HSBC has established non-money market funds with total assets of US$214.9 billion at 30 June 2009 (31 December 2008: US$200.3 billion).

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

• US$95.8 billion (31 December 2008: US$83.1 billion) in specialist funds, which comprise fundamental active specialists and active quantitative specialists;

• US$102.7 billion (31 December 2008: US$96.2 billion) in local investment management funds, which invest in domestic products, primarily for retail and private clients; and

• US$16.4 billion (31 December 2008: US$21.0 billion) in multi-manager funds, which offer fund of funds and manager of manager products across a diversified portfolio of assets.

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

	At      30 June      2009		At    31 December      2008
	US$bn		US$bn
Cash	0.4		0.4
Trading assets	0.2		0.2
Financial instruments designated at fair value	3.3		2.3
Financial investments	0.7		0.8
	4.6		3.7

HSBC's maximum exposure 

HSBC's maximum exposure to consolidated and unconsolidated non-money market funds is represented by HSBC's investment in the units of each respective fund. HSBC's exposure at 30 June 2009 amounted to US$5.4 billion (31 December 2008: US$4.4 billion).

Securitisations

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

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

	At      30 June      2009		At    31 December      2008
	US$bn		US$bn
Trading assets	0.9		1.3
Loans and advances to customers	44.0		50.8
Other assets	2.4		1.1
Derivatives	1.2		1.4
	48.5		54.6

These assets include US$0.9 billion (31 December 2008: US$1.3 billion) of exposure to US sub-prime mortgages.

Total assets of HSBC's securitisations which are offߛbalance sheet

	At      30 June      2009		At    31 December      2008
	US$bn		US$bn
HSBC originated assets	0.7		0.6
Non-HSBC originated assets - term securitisation     programmes	12.1		13.5
	12.8		14.1

HSBC's financial investments in off-balance sheet securitisations at 30 June 2009 amounted to US$0.1 billion (31 December 2008: US$0.2 billion). These assets include assets which are classified as available-for-sale securities and measured at fair value, and have been securitised by HSBC under arrangements by which HSBC retains a continuing involvement in them.

HSBC's maximum exposure

The maximum exposure is the aggregate of any holdings of notes issued by these vehicles and the reserve account positions intended to provide credit support under certain pre-defined circumstances to senior note holders. HSBC is not obligated to provide further funding. At 30 June 2009, HSBC's maximum exposure to consolidated and unconsolidated securitisations amounted to US$5.3 billion (31 December 2008: US$8.0 billion).

Other

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

Structured credit transactions

HSBC provides structured credit transactions to thirdߛparty professional and institutional investors who wish to obtain exposure, sometimes on a leveraged basis, to a reference portfolio of debt instruments. In such structures, the investor receives returns referenced to the underlying portfolio by purchasing notes issued by the SPEs. HSBC enters into contracts with the SPEs, generally in the form of derivatives, in order to pass the required risks and rewards of the reference portfolios to the SPEs. HSBC's risk in relation to the derivative contracts with the SPEs is managed within HSBC's trading market risk framework (see 'Market risk' on page 173). 

In certain transactions HSBC is exposed to risk often referred to as gap risk. Gap risk typically arises in transactions where the aggregate potential claims against the SPE by HSBC pursuant to one or more derivatives could be greater than the value of the collateral held by the SPE and securing such derivatives. HSBC often mitigates such gap risk by incorporating in the SPE transaction features which allow for deleveraging, a managed liquidation of the portfolio, or other mechanisms. Following the inclusion of such risk reduction mechanisms, HSBC has, in certain circumstances, retained all or a portion of the underlying exposure in the transaction. When this retained exposure represents ABSs, it has been included in 'Nature and extent of HSBC's exposures' on page 102.

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

The total fair value of liabilities (notes issued and derivatives) in structured credit transaction SPEs was US$21.7 billion at 30 June 2009 (31 December 2008: US$21.2 billion). These amounts included US$0.2 billion (31 December 2008: US$0.3 billion) in SPEs that were consolidated by HSBC.

Other uses of SPEs

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

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

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

HSBC's maximum exposures to SPEs

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

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

			Securities						Enhanced				Non-money market funds
	SIVs		investment      conduits1		Multi-seller     conduits		CNAV      funds		VNAV      funds		VNAV      funds		Specialist     funds		Local      funds2		Securi-     tisations3		Other		Total
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 30 June 2009
Total assets	-		30.2		11.6		43.4		0.6		0.8		0.3		4.3		48.5		0.2		139.9
Direct lending4	-		-		-		-		-		-		-		-		0.9		-		0.9
ABSs4	-		23.9		-		0.2		-		-		-		-		-		-		24.1
Other	-		6.3		11.6		43.2		0.6		0.8		0.3		4.3		47.6		0.2		114.9
	-
Funding provided by HSBC	-		36.3		0.1		0.7		0.6		0.7		0.1		4.2		1.9		-		44.6
CP	-		12.5		0.1		-		-		-		-		-		-		-		12.6
MTNs	-		3.9		-		-		-		-		-		-		1.7		-		5.6
Junior notes	-		-		-		-		-		-		-		-		0.2		-		0.2
Term repos executed	-		11.3		-		-		-		-		-		-		-		-		11.3
Investments in funds	-		-		-		0.7		0.6		0.7		0.1		4.2		-		-		6.3
Drawn liquidity facility	-		8.6		-		-		-		-		-		-		-		-		8.6
Capital notes5	-		-		-		-		-		-		-		-		-		-		-
	-
Total maximum exposure to  consolidated SPEs6	-		44.6		16.0		0.7		0.6		0.7		0.1		4.2		5.2		0.1	-	72.2
Liquidity and credit enhancements
Deal-specific liquidity facilities	-		-		16.0		-		-		-		-		-		-		-		16.0
Indemnities7	-		-		-		-		-		-		-		-		-		-		-
Programme-wide liquidity facilities	-		30.9		-		-		-		-		-		-		-		-		30.9
Programme-wide limited credit enhancements	-		1.2		0.7		-		-		-		-		-		-		-		1.9
Other liquidity and credit enhancements	-		-		-		-		-		-		-		-		0.1		-		0.1

			Securities						Enhanced				Non-money market funds
	SIVs		investment      conduits1		Multi-seller     conduits		CNAV      funds		VNAV      funds		VNAV      funds		Specialist     funds		Local       funds2		Securi-      tisations3		Other		Total
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 31 December 2008
Total assets	0.4		32.3		13.9		43.8		0.7		1.4		0.6		3.1		54.6		0.3		151.1
Direct lending4	-		-		-		-		-		-		-		-		1.3		-		1.3
ABSs4	-		25.8		-		0.8		-		-		-		-		-		-		26.6
Other	0.4		6.5		13.9		43.0		0.7		1.4		0.6		3.1		53.3		0.3		123.2
Funding provided by HSBC	-		38.6		2.1		0.7		0.6		1.3		0.2		3.2		0.7		0.2		47.6
CP	-		18.7		2.1		-		-		-		-		-		-		-		20.8
MTNs	-		3.4		-		-		-		-		-		-		0.4		0.2		4.0
Junior notes	-		-		-		-		-		-		-		-		0.3		-		0.3
Term repos executed	-		14.1		-		-		-		-		-		-		-		-		14.1
Investments in funds	-		-		-		0.7		0.6		1.3		0.2		3.2		-		-		6.0
Drawn liquidity facility	-		2.4		-		-		-		-		-		-		-		-		2.4
Capital notes5	-		-		-		-		-		-		-		-		-		-		-
Total maximum exposure to  consolidated SPEs6	-		47.6		17.1		0.8		0.    0.6		1.3		0.2		3.2		7.8		0.2		78.8
Liquidity and credit enhancements
Deal-specific liquidity facilities	-		-		17.1		-		-		-		-		-		-		-		17.1
Indemnities7	-		-		-		0.1		-		-		-		-		-		-		0.1
Programme-wide liquidity facilities	-		34.8		-		-		-		-		-		-		-		-		34.8
Programme-wide limited credit enhancements	-		1.2		0.6		-		-		-		-		-		-		-		1.8
Other liquidity and credit enhancements	-		-		-		-		-		-		-		-		0.1		-		0.1

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

2    Local investment management funds.

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

4    These assets only include those measured at fair value. For details on the geographical origin of the mortgage loans held at fair value and ABSs, including those represented by MBSs and CDOs held in consolidated SIVs and securities investment conduits, see 'Nature and extent of HSBC's exposures' on page 102. The geographical origin of the loans and receivables held by the multi-seller conduits is disclosed on page 128.

5    The carrying amount of HSBC's holding of capital notes in the securities investment conduits amounted to US$2.4 million (31 December 2008: US$1.9 million) with a par value of US$54 million (31 December 2008: US$52 million).

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

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

HSBC's maximum exposure to unconsolidated SPEs

	Securitisations1				Money market funds1						Non-money market funds1
	HSBC    originated      assets		Non-HSBC    originated      assets2		CNAV     funds		Enhanced    VNAV     funds		VNAV    funds		Specialist     funds		Local     funds3		Multi-    manager     funds		Other		Total
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 30 June 2009
Total assets	0.7		12.1		29.0		0.9		25.1		95.5		98.4		16.4		21.5		299.6
Funding provided by HSBC	-		0.1		0.1		-		0.2		-		1.0		0.1		7.9		9.4
MTNs	-		0.1		-		-		-		-		-		-		7.9		8.0
Investments in funds	-		-		0.1		-		0.2		-		1.0		0.1		-		1.4
Total maximum exposure to unconsolidated SPEs	-		0.1		0.1		-		0.2		-		1.0		0.1		2.4		3.9
At 31 December 2008
Total assets	0.6		13.5		28.2		2.0		26.6		82.5		93.1		21.0		20.9		288.4
Funding provided by HSBC	-		0.2		-		-		0.3		-		1.0		-		8.3		9.8
MTNs	-		0.2		-		-		-		-		-		-		8.3		8.5
Investments in funds	-		-		-		-		0.3		-		1.0		-		-		1.3
											-
Total maximum exposure to unconsolidated SPEs	-		0.2		-		-		0.3		-		1.0		-		4.1		5.6

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

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

3    Local investment management funds.

Third-party sponsored SPEs

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

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

	Commit-    ments		Drawn
	US$bn		US$bn
At 30 June 2009
Third-party conduits	1.2		0.3
Third-party securitisations	0.6		-
	1.8		0.3
At 31 December 2008
Third-party conduits	1.1		0.1
Third-party securitisations	0.6		0.1
	1.7		0.2

Other off-balance sheet arrangements and commitments

Financial guarantees, letters of credit and similar undertakings

Note 16 on the Financial Statements describes various types of guarantees and discloses the maximum potential future payments under such arrangements. Credit risk associated with all forms of guarantees is assessed in the same manner as for on-balance sheet credit advances and, where necessary, provisions for assessed impairment are included in 'Other provisions'. 

Commitments to lend

Undrawn credit lines are disclosed in Note 16 on the Financial Statements. The majority by value of undrawn credit lines arise from 'open to buy' lines on personal credit cards, advised overdraft limits and other pre-approved loan products, and mortgage offers awaiting customer acceptance. HSBC generally has the right to change or terminate any conditions of a personal customer's overdraft, credit card or other credit line upon notification to the customer. In respect of corporate commitments to lend, in most cases HSBC's position will be protected through restrictions on access to funding in the event of material adverse change.

Leveraged finance transactions

Loan commitments in respect of leveraged finance transactions are accounted for as derivatives where it is HSBC's intention to sell the loan after origination. Further information is provided on page 112.

 

END

 

 

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