Interim Report - 14 of 21

RNS Number : 9202Q

HSBC Holdings PLC

13 August 2010

 



result of a referral following the sale of a loan or similar credit product. HSBC has undertaken an analysis of the required changes to the STIP product and its sales processes resulting from the CC's remedies. Following an appeal to the Competition Appeal Tribunal, the CC has reconsidered whether a ban on firms selling PPI at the point of sale of the credit product is an appropriate and justified remedy for the deficiencies it identified in the PPI market. It published its provisional decision in May 2010, indicating that it remains of the opinion that it is, but its final decision will not be published until the second half of 2010, following consideration of further submissions by the firms.

The principal insurance risk faced by HSBC is that, over time, the combined cost of acquiring, administering and paying claims on contracts may exceed the aggregate amount of premiums received and investment income.

In respect of financial risks, subsidiaries manufacturing products with guarantees are usually exposed to falls in market interest rates and equity prices to the extent that the market exposure cannot be managed by utilising a discretionary bonus feature within the policy.

The Group manages its exposure to insurance risk by applying formal underwriting, reinsurance and claims-handling procedures designed to ensure compliance with regulations and insurance risk appetite, the latter proposed by local businesses and authorised centrally. This is supplemented by undertaking stress testing. The following tables provide an analysis of the insurance risk exposures by geographical region and by type of business. Life business tends to be longer-term in nature than non-life business and frequently involves an element of savings and investment in the contract. Accordingly, separate tables are provided for life and non-life businesses, reflecting their distinctive risk characteristics. The life insurance risk table provides an analysis of insurance liabilities as the best available overall measure of insurance exposure, because provisions for life contracts are typically set by reference to expected future cash outflows relating to the underlying policies. The table for non‑life business uses written premiums as the best available measure of risk exposure, because policies are typically priced by reference to the risk being underwritten.

HSBC's management of insurance risk, including the risks relating to different life and non-life products, is described on pages 266 to 269 in the Annual Report and Accounts 2009.

Analysis of life insurance risk - liabilities to policyholders⁴⁴

	Europe		Hong         Kong		Rest of         Asia-      Pacific		North   America		Latin   America		Total
	US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2010
Life (non-linked) ...............................................	1,789		16,261		617		1,017		2,002		21,686
Insurance contracts with DPF45 ......................	286		15,663		240		-		-		16,189
Credit life .......................................................	664		-		41		40		1		746
Annuities .......................................................	409		-		27		771		1,559		2,766
Term assurance and other long-term contracts ...................................................................	430		598		309		206		442		1,985
Life (linked) ......................................................	1,785		2,875		422		-		3,702		8,784
Investment contracts with DPF45,46 ...................	19,636		-		35		-		-		19,671
Insurance liabilities to policyholders ..................	23,210		19,136		1,074		1,017		5,704		50,141
At 30 June 2009
Life (non-linked)	3,377		12,864		404		1,035		1,772		19,452
Insurance contracts with DPF45 ......................	1,054		12,687		208		-		-		13,949
Credit life .......................................................	649		-		12		57		-		718
Annuities .......................................................	430		-		28		788		1,349		2,595
Term assurance and other long-term contracts ...................................................................	1,244		177		156		190		423		2,190
Life (linked) ......................................................	1,817		2,542		348		-		2,624		7,331
Investment contracts with DPF45,46 ...................	18,834		-		33		-		-		18,867
Insurance liabilities to policyholders ..................	24,028		15,406		785		1,035		4,396		45,650

	Europe		Hong          Kong		Rest of          Asia-       Pacific		North     America		Latin     America		Total
	US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2009
Life (non-linked) ...............................................	2,998		14,456		526		1,026		1,973		20,979
Insurance contracts with DPF45 ......................	1,128		14,095		227		-		-		15,450
Credit life .......................................................	953		-		20		50		-		1,023
Annuities .......................................................	452		-		28		777		1,554		2,811
Term assurance and other long-term contracts ...................................................................	465		361		251		199		419		1,695
Life (linked) ......................................................	2,125		2,896		437		-		3,528		8,986
Investment contracts with DPF45,46 ...................	20,979		-		35		-		-		21,014
Insurance liabilities to policyholders ..................	26,102		17,352		998		1,026		5,501		50,979

For footnotes, see page 196.

Analysis of non-life insurance risk - net written insurance premiums^44,47

	Europe		Hong         Kong		Rest of         Asia-     Pacific		North   America		Latin   America		Total
	US$m		US$m		US$m		US$m		US$m		US$m
Half-year to 30 June 2010
Accident and health ...........................................	45		85		4		1		19		154
Motor ................................................................	-		7		15		-		130		152
Fire and other damage ........................................	22		17		4		8		10		61
Liability .............................................................	-		12		2		-		-		14
Credit (non-life) ................................................	11		-		-		28		1		40
Marine, aviation and transport ..........................	1		5		3		-		8		17
Other non-life insurance contracts .....................	13		18		-		5		40		76
Total net written insurance premiums ................	92		144		28		42		208		514
Net insurance claims incurred and movement in liabilities to policyholders ..............................	(85)		(61)		(13)		(3)		(85)		(247)
Half-year to 30 June 2009
Accident and health ...........................................	44		85		2		1		9		141
Motor ................................................................	112		6		9		-		120		247
Fire and other damage ........................................	41		19		2		7		14		83
Liability .............................................................	-		9		2		-		11		22
Credit (non-life) ................................................	-		-		-		54		-		54
Marine, aviation and transport ..........................	1		5		2		-		9		17
Other non-life insurance contracts .....................	19		16		-		7		14		56
Total net written insurance premiums ................	217		140		17		69		177		620
Net insurance claims incurred and movement in liabilities to policyholders ..............................	(315)		(56)		(7)		(70)		(75)		(523)
Half-year to 31 December 2009
Accident and health ...........................................	50		75		5		2		14		146
Motor ................................................................	11		8		11		-		114		144
Fire and other damage ........................................	31		3		6		9		8		57
Liability .............................................................	-		6		2		-		(9)		(1)
Credit (non-life) ................................................	35		-		-		32		-		67
Marine, aviation and transport ..........................	6		4		2		-		8		20
Other non-life insurance contracts .....................	5		16		1		5		44		71
Total net written insurance premiums ................	138		112		27		48		179		504
Net insurance claims incurred and movement in liabilities to policyholders ..............................	(433)		(51)		(10)		(26)		(80)		(600)

For footnotes, see page 196.

Balance sheet of insurance manufacturing subsidiaries by type of contract

A principal tool used by HSBC to manage its exposure to insurance risk, in particular for life insurance contracts, is asset and liability matching. Models are used to assess the effect of a range of possible scenarios on the future values of financial assets and associated liabilities, and ALCOs employ the outcomes in determining how the assets and liabilities should be matched. The scenarios include stresses applied to factors which affect insurance risk such as mortality and lapse rates. In addition to assessing the actual cash inflow required to meet cash outflows, of particular importance is the need to match the expected pattern of cash inflows with the benefits payable on the underlying contracts, which can extend for many years.

The table below shows the composition of assets and liabilities and demonstrates that there were sufficient assets to cover the liabilities to policyholders at 30 June 2010.

Balance sheet of insurance manufacturing subsidiaries by type of contract

	Insurance contracts											Investment contracts
With                                                 DPF				Unit- linked		Annu-     ities		Term assur- ance48						Unit- linked		Other		Other assets49		Total
										Non-life	With       DPF46
		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 30 June 2010
Financial assets ...............		16,070		7,947		2,686		2,379		2,025		19,273		6,944		3,988		6,825		68,137
- trading assets ............		-		-		-		-		10		-		-		-		-		10
- financial assets designated at fair value.................................		876		7,643		549		609		56		5,018		5,838		1,450		1,207		23,246
- derivatives ...............		25		-		-		1		-		131		362		1		9		529
- financial investments .................................		13,371		-		1,743		1,196		645		13,478		-		1,757		4,293		36,483
- other financial assets		1,798		304		394		573		1,314		646		744		780		1,316		7,869
Reinsurance assets ..........		7		872		343		273		422		-		-		-		65		1,982
PVIF50 ............................		-		-		-		-		-		-		-		-		2,966		2,966
Other assets and investment properties ..		192		6		18		436		215		398		17		45		648		1,975
Total assets ....................		16,269		8,825		3,047		3,088		2,662		19,671		6,961		4,033		10,504		75,060
Liabilities under investment contracts:
- designated at fair value		-		-		-		-		-		-		6,934		3,450		-		10,384
- carried at amortised cost		-		-		-		-		-		-		-		413		-		413
Liabilities under insurance contracts ......		16,189		8,784		2,766		2,731		2,375		19,671		-		-		-		52,516
Deferred tax ...................		7		-		19		3		5		1		-		2		626		663
Other liabilities ...............		-		-		-		-		-		-		-		-		1,974		1,974
Total liabilities ...............		16,196		8,784		2,785		2,734		2,380		19,672		6,934		3,865		2,600		65,950
Total equity ...................		-		-		-		-		-		-		-		-		9,110		9,110
Total equity and liabilities51 ...................		16,196		8,784		2,785		2,734		2,380		19,672		6,934		3,865		11,710		75,060
At 30 June 2009
Financial assets ...............		13,796		6,501		2,388		2,481		2,394		18,416		6,233		3,816		6,886		62,911
- trading assets ............		-		-		-		-		34		-		-		-		-		34
- financial assets designated at fair value.................................		562		6,096		467		512		59		4,571		5,709		1,690		1,875		21,541
- derivatives ...............		11		-		-		11		-		4		179		76		95		376
- financial investments .................................		11,568		-		1,309		606		933		13,665		-		1,494		3,108		32,683
- other financial assets		1,655		405		612		1,352		1,368		176		345		556		1,808		8,277
Reinsurance assets ..........		6		887		357		418		428		-		-		-		61		2,157
PVIF50 ............................		-		-		-		-		-		-		-		-		2,449		2,449
Other assets and investment properties ..		175		6		31		550		232		456		22		49		530		2,051
Total assets ....................		13,977		7,394		2,776		3,449		3,054		18,872		6,255		3,865		9,926		69,568
Liabilities under investment contracts:
- designated at fair value		-		-		-		-		-		-		6,077		3,408		-		9,485
- carried at amortised cost		-		-		-		-		-		-		-		355		-		355
Liabilities under insurance contracts ......		13,949		7,331		2,595		2,908		2,534		18,867		-		-		-		48,184
Deferred tax ...................		7		7		25		34		7		1		-		3		567		651
Other liabilities ...............		-		-		-		-		-		-		-		-		2,749		2,749
Total liabilities ...............		13,956		7,338		2,620		2,942		2,541		18,868		6,077		3,766		3,316		61,424
Total equity ...................		-		-		-		-		-		-		-		-		8,144		8,144
Total equity and liabilities52 ...................		13,956		7,338		2,620		2,942		2,541		18,868		6,077		3,766		11,460		69,568

	Insurance contracts											Investment contracts
With                                                 DPF				Unit-    linked		Annu-      ities		Term assur- ance48						Unit-    linked		Other		Other assets49		Total
										Non-life	With       DPF46
		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
At 31 December 2009
Financial assets ...............		15,322		8,204		2,567		2,053		2,290		20,501		7,366		4,008		7,252		69,563
- trading assets ............		-		-		-		-		10		-		-		-		-		10
- financial assets designated at fair value		599		7,837		446		482		63		5,498		6,572		1,582		2,085		25,164
- derivatives ...............		16		1		-		3		-		144		299		2		3		468
- financial investments .................................		13,013		-		1,511		1,033		742		13,948		-		1,701		3,901		35,849
- other financial assets		1,694		366		610		535		1,475		911		495		723		1,263		8,072
Reinsurance assets ..........		6		831		376		389		467		-		-		-		60		2,129
PVIF50 ............................		-		-		-		-		-		-		-		-		2,780		2,780
Other assets and investment properties ..		165		5		25		634		242		516		13		56		601		2,257
Total assets ....................		15,493		9,040		2,968		3,076		2,999		21,017		7,379		4,064		10,693		76,729
Liabilities under investment contracts:
- designated at fair value .................................		-		-		-		-		-		-		7,347		3,518		-		10,865
- carried at amortised cost...........................		-		-		-		-		-		-		-		417		-		417
Liabilities under insurance contracts ......		15,450		8,986		2,811		2,718		2,728		21,014		-		-		-		53,707
Deferred tax ...................		6		-		22		1		7		1		-		2		750		789
Other liabilities ...............		-		-		-		-		-		-		-		-		2,371		2,371
Total liabilities ...............		15,456		8,986		2,833		2,719		2,735		21,015		7,347		3,937		3,121		68,149
Total equity ...................		-		-		-		-		-		-		-		-		8,580		8,580
Total equity and liabilities52 ...................		15,456		8,986		2,833		2,719		2,735		21,015		7,347		3,937		11,701		76,729

For footnotes, see page 196.

Capital management and allocation

Capital management

HSBC's capital management approach is driven by its strategic and organisational requirements, taking into account the regulatory, economic and commercial environment in which it operates.

It is HSBC's objective to maintain a strong capital base to support the development of its business and to meet regulatory capital requirements at all times. To achieve this, the Group's policy is to hold capital in a range of different forms and from diverse sources and all capital raising is agreed with major subsidiaries as part of their individual and the Group's overall capital management processes.

The Group's policy is underpinned by the Capital Management Framework, which enables HSBC to manage its capital in a consistent and aligned manner. The framework, which is approved by the Group Management Board, incorporates a number of different capital measures including market capitalisation, invested capital, economic capital and regulatory capital, defined by HSBC as follows:

·     market capitalisation is the stock market value of the company;

·     invested capital is the equity capital invested in HSBC by its shareholders;

·     economic capital is the internally calculated capital requirement which is deemed necessary by HSBC to support the risks to which it is exposed at a confidence level consistent with a target credit rating of AA; and

·     regulatory capital is the capital which HSBC is required to hold in accordance with the rules established by the FSA for the consolidated Group and by HSBC's local regulators for individual Group companies.

The Group has identified the following as being the material risks faced and managed through the Capital Management Framework: credit, market, operational, pension fund, residual and insurance risks and interest rate risk in the banking book. All these risks pose a significantly greater challenge in a severe economic downturn and management's response to these risks has, correspondingly, intensified in the current conditions.

Stress testing is incorporated into the Capital Management Framework and is used as an important mechanism in understanding the sensitivities of the core assumptions in the Group's capital plans to the adverse effect of extreme, but plausible, events. Stress testing allows senior management to formulate its response in advance of conditions starting to exhibit the stress scenarios identified. The actual market stresses which occurred throughout the financial system during the past two years have been used to inform the capital planning process and further develop the stress scenarios employed by the Group. In addition to HSBC's internal stress tests, other stress tests are carried out, both at the request of regulators and by the regulators themselves using assumptions prescribed by the regulators. HSBC takes into account the results of all such regulatory stress testing when undertaking its internal capital management assessment.

The responsibility for global capital allocation principles and decisions rests with the Group Management Board. Through its structured internal governance processes, HSBC maintains discipline over its investment and capital allocation decisions, seeking to ensure that returns on investment are adequate after taking account of capital costs. HSBC's strategy is to allocate capital to businesses on the basis of their economic profit generation, regulatory and economic capital requirements and cost of capital.

HSBC's capital management process is articulated in an annual Group capital plan which is approved by the Board. The plan is drawn up with the objective of maintaining both the appropriate amount of capital and the optimal mix between the different components of capital. When HSBC Holdings and its major subsidiaries raise non-equity tier 1 capital and subordinated debt, this is done in accordance with the Group's guidelines on market and investor concentration, cost, market conditions, timing, effect on composition and maturity profile. Each subsidiary manages its own capital to support its planned business growth and meet its local regulatory requirements within the context of the approved annual Group capital plan. In accordance with HSBC's Capital Management Framework, capital generated by subsidiaries in excess of planned requirements is returned to HSBC Holdings, normally by way of dividends.

HSBC Holdings is the primary provider of equity capital to its subsidiaries and these investments are substantially funded by HSBC Holdings' own capital issuance and profit retention. As part of its capital management process, HSBC Holdings seeks to maintain a prudent balance between the composition of its capital and that of its investment in subsidiaries.

During the first half of 2010, the Group continued to target a tier 1 ratio within the range 7.5 to 10.0 per cent for the purposes of its long-term capital planning. This is consistent with 2009, which reflected revised market expectations on capital strength and the higher volatility of capital requirements resulting from pro-cyclicality embedded within the Basel II rules. The tier 1 ratio increased to 11.5 per cent at 30 June 2010 (30 June 2009: 10.1 per cent, 31 December 2009: 10.8 per cent). Although this ratio lies beyond the upper end of the target range noted above, HSBC is satisfied that this is appropriate in light of the current evolution of the regulatory framework. HSBC will continue to review the level of the target range as regulatory requirements evolve.

Capital measurement and allocation

The FSA supervises HSBC on a consolidated basis and therefore receives information on the capital adequacy of, and sets capital requirements for, the Group as a whole. Individual banking subsidiaries are directly regulated by their local banking supervisors, who set and monitor their capital adequacy requirements.

HSBC calculates capital at a Group level using the Basel II framework of the Basel Committee on Banking Supervision; local regulators are at different stages of implementation and local rules may still be on a Basel I basis, notably in the US. In most jurisdictions, non-banking financial subsidiaries are also subject to the supervision and capital requirements of local regulatory authorities.

Basel II is structured around three 'pillars': minimum capital requirements, supervisory review process and market discipline. The Capital Requirements Directive ('CRD') implemented Basel II in the EU and the FSA then gave effect to the CRD by including the requirements of the CRD in its own rulebooks.

Capital

HSBC's capital is divided into two tiers:

·     tier 1 capital is divided into core tier 1 and other tier 1 capital. Core tier 1 capital comprises shareholders' equity and related equity in a subsidiary not attributable directly or indirectly to HSBC (non-controlling interest previously termed minority interest). The book values of goodwill and intangible assets are deducted from core tier 1 capital and other regulatory adjustments are made for items reflected in shareholders' equity which are treated differently for the purposes of capital adequacy. Qualifying hybrid capital instruments such as non-cumulative perpetual preference shares and innovative tier 1 securities are included in other tier 1 capital; and

·     tier 2 capital comprises qualifying subordinated loan capital, non-controlling interests classified as tier 2 capital, allowable collective impairment allowances and unrealised gains arising on the fair valuation of equity instruments held as available for sale. Tier 2 capital also includes reserves arising from the revaluation of properties.

To ensure the overall quality of the capital base, the FSA's rules set limits on the amount of hybrid capital instruments that can be included in tier 1 capital relative to core tier 1 capital, and also limits overall tier 2 capital to no more than tier 1 capital.

The basis of consolidation for financial accounting purposes is described on page 367 of the Annual Report and Accounts 2009 and differs from that used for regulatory purposes. Investments in banking associates, which are equity accounted in the financial accounting consolidation, are proportionally consolidated for regulatory purposes. Subsidiaries and associates engaged in insurance and non-financial activities are excluded from the regulatory consolidation and are deducted from regulatory capital. The regulatory consolidation does not include SPEs where significant credit risk has been transferred to third parties. Exposures to these SPEs are treated as securitisation positions for regulatory purposes and are either risk-weighted or deducted from capital.

Pillar 1

Pillar 1 covers the capital resources requirements for credit risk, market risk and operational risk. Credit risk also covers both counterparty credit risk and securitisation requirements. All these requirements are expressed in terms of risk-weighted assets ('RWA's).

Credit risk

Basel II provides three approaches of increasing sophistication to the calculation of pillar 1 credit risk capital requirements. The most basic, the standardised approach, requires banks to use external credit ratings to determine the risk weightings applied to rated counterparties and group other counterparties into broad categories and apply standardised risk weightings to these categories. The next level, the internal ratings-based ('IRB') foundation approach, allows banks to calculate their credit risk capital requirements on the basis of their internal assessment of the probability that a counterparty will default ('PD'), but subjects their quantified estimates of exposure at default ('EAD') and loss given default ('LGD') to standard supervisory parameters. Finally, the IRB advanced approach allows banks to use their own internal assessment in both determining PD and quantifying EAD and LGD.

The capital resources requirement, which is intended to cover unexpected losses, is derived from a formula specified in the regulatory rules, which incorporates these factors and other variables such as maturity and correlation. Expected losses under the IRB approaches are calculated by multiplying PD by EAD and LGD. Expected losses are deducted from capital to the extent that they exceed accounting impairment allowances.

For credit risk, with the FSA's approval, HSBC has adopted the IRB advanced approach for the majority of its business, with the remainder on either IRB foundation or standardised approaches.

For consolidated group reporting, the FSA's rules permit the use of other regulators' standardised approaches where they are considered equivalent. The use of other regulators' IRB approaches is subject to the agreement of the FSA. Under the Group's Basel II rollout plans, a number of Group companies are in transition to advanced IRB approaches. At December 2009, corporate portfolios in France, Hong Kong and Rest of Asia-Pacific completed the transition from foundation to advanced IRB approaches. Other Group companies and portfolios remain on the standardised or foundation approaches under Basel II, pending definition of local regulations or model approval, or under exemptions from IRB treatment.

Counterparty credit risk

Counterparty credit risk arises for OTC derivatives and securities financing transactions. It is calculated in both the trading and non-trading books, and is the risk that the counterparty to a transaction may default before completing the satisfactory settlement of the transaction. Three approaches to calculating counterparty credit risk and determining exposure values are defined by Basel II: standardised, mark-to-market and internal model method. These exposure values are used to determine capital requirements under one of the credit risk approaches; standardised, IRB foundation and IRB advanced.

HSBC uses the mark-to-market and internal model method approaches for counterparty credit risk. Its longer-term aim is to migrate more positions from the mark-to-market to the internal model method approach.

Securitisation

Basel II specifies two methods for calculating credit risk requirements for securitisation positions in the non-trading book, being the standardised and IRB approaches. Both approaches rely on the mapping of rating agency credit ratings to risk weights, which range between 7 per cent and 1,250 per cent. Positions that would otherwise be weighted at 1,250 per cent are deducted from capital.

Within the IRB approach, HSBC uses the Ratings Based Method for the majority of its non-trading book securitisation positions, and the Internal Assessment Approach for unrated liquidity facilities and programme wide enhancements for asset-backed securitisations.

HSBC uses the IRB approach for the majority of its non-trading book securitisation positions, while those in the trading book are treated like other market risk positions.

Market risk

Market risk is the risk that movements in market risk factors, including foreign exchange, commodity prices, interest rates, credit spread and equity prices will reduce HSBC's income or the value of its portfolios. Market risk is measured, with FSA permission, using VAR models, or the standard rules prescribed by the FSA.

HSBC uses both VAR and standard rules approaches for market risk. Its longer-term aim is to migrate more positions from standard rules to VAR.

Operational risk

Basel II includes capital requirements for operational risk, again utilising three levels of sophistication. The capital required under the basic indicator approach is a simple percentage of gross revenues, whereas under the standardised approach it is one of three different percentages of gross revenues allocated to each of eight defined business lines. Both these approaches use an average of the last three financial years' revenues. Finally, the advanced measurement approach uses banks' own statistical analysis and modelling of operational risk data to determine capital requirements.

HSBC has adopted the standardised approach in determining its Group operational risk capital requirements.

Pillar 2

The second pillar of Basel II (Supervisory Review and Evaluation Process) involves both firms and regulators taking a view on whether a firm should hold additional capital against risks not covered in pillar 1. Part of the pillar 2 process is the Internal Capital Adequacy Assessment Process which is the firm's self assessment of the levels of capital that it needs to hold. The pillar 2 process culminates in the FSA providing firms with Individual Capital Guidance ('ICG'). The ICG is set as a capital resources requirement higher than that required under pillar 1.

Pillar 3

Pillar 3 of Basel II is related to market discipline and aims to make firms more transparent by requiring them to publish specific, prescribed details of their risks, capital and risk management under the Basel II framework. HSBC's Pillar 3 Disclosures 2009 is published as a separate document on the Group Investor Relations website.

Future developments

The regulation and supervision of financial institutions is currently undergoing a period of significant change in response to the global financial crisis. Increased capital requirements for market risk and securitisations have already been announced by the Basel Committee and are due for implementation in the EU in 2011. The Basel Committee's proposals on 'Strengthening the resilience of the banking sector' were issued on 17 December 2009, and subjected to a Quantitative Impact Study ('QIS') during the first half of 2010. The results will be used to inform the Basel Committee in producing a fully calibrated set of requirements which are expected to be published by the end of 2010. The proposals will be phased in as financial conditions improve and the economic recovery is assured, with the aim of implementation by the end of 2012. On 26 July 2010, the Basel Committee announced that it had reached broad agreement on the overall design of the capital and liquidity reform package, having considered the comments received during the public consultation and the results of the QIS. An outline of the agreement was provided, together with an extended implementation timetable for the liquidity and leverage proposals. The full details of all the proposals are expected to be issued towards the end of 2010, together with a summary of the results of the QIS.

The Basel Committee issued a further proposal in a consultative document 'Countercyclical capital buffer proposal' on 16 July 2010, which complements the December 2009 proposals. The consultation period closes on 10 September 2010.

Capital structure

	At 30 June		At 30 June		At 31 December
	2010		2009		2009
	US$m		US$m		US$m
Composition of regulatory capital
Tier 1 capital
Shareholders' equity ...................................................................................	136,719		131,024		135,252
Shareholders' equity per balance sheet53 .................................................	135,943		118,355		128,299
Preference share premium ......................................................................	(1,405)		(1,405)		(1,405)
Other equity instruments ........................................................................	(5,851)		(2,133)		(2,133)
Deconsolidation of special purpose entities54 ..........................................	8,032		16,207		10,491
Non-controlling interests ...........................................................................	3,949		3,634		3,932
Non-controlling interests per balance sheet ............................................	7,380		6,943		7,362
Preference share non-controlling interests .............................................	(2,391)		(2,342)		(2,395)
Non-controlling interest transferred to tier 2 capital ..............................	(676)		(644)		(678)
Non-controlling interest in deconsolidated subsidiaries ............................	(364)		(323)		(357)
Regulatory adjustments to the accounting basis ..........................................	(3,079)		(147)		164
Unrealised (gains)/losses on available-for-sale debt securities55 ................	(797)		2,020		906
Own credit spread ...................................................................................	(1,779)		(4,360)		(1,050)
Defined benefit pension fund adjustment56 ..............................................	1,940		4,103		2,508
Reserves arising from revaluation of property and unrealised gains on available-for-sale equities ....................................................................	(2,500)		(2,250)		(2,226)
Cash flow hedging reserve .......................................................................	57		340		26
Deductions .................................................................................................	(30,753)		(32,806)		(33,088)
Goodwill capitalised and intangible assets ................................................	(26,398)		(28,130)		(28,680)
50% of securitisation positions................................................................	(1,754)		(1,690)		(1,579)
50% of tax credit adjustment for expected losses.....................................	269		389		546
50% of excess of expected losses over impairment allowances ...............	(2,870)		(3,375)		(3,375)
Core tier 1 capital ..................................................................................	106,836		101,705		106,260
Other tier 1 capital before deductions .........................................................	17,577		15,691		15,798
Preference share premium ......................................................................	1,405		1,405		1,405
Preference share non-controlling interests .............................................	2,391		2,342		2,395
Innovative tier 1 securities .....................................................................	13,781		11,944		11,998
Deductions .................................................................................................	(345)		(43)		99
Unconsolidated investments57 ................................................................	(614)		(432)		(447)
50% of tax credit adjustment for expected losses ....................................	269		389		546
Tier 1 capital ...........................................................................................	124,068		117,353		122,157
Tier 2 capital
Total qualifying tier 2 capital before deductions .........................................	48,170		53,466		50,075
Reserves arising from revaluation of property and unrealised gains on available-for-sale equities ....................................................................	2,500		2,250		2,226
Collective impairment allowances58 ........................................................	3,526		3,917		4,120
Perpetual subordinated debt ....................................................................	2,982		2,972		2,987
Term subordinated debt ..........................................................................	38,862		44,027		40,442
Non-controlling interest in tier 2 capital ................................................	300		300		300
Total deductions other than from tier 1 capital ..........................................	(17,352)		(15,633)		(16,503)
Unconsolidated investments57 ................................................................	(12,727)		(10,568)		(11,547)
50% of securitisation positions ...............................................................	(1,754)		(1,690)		(1,579)
50% of excess of expected losses over impairment allowances ...............	(2,870)		(3,375)		(3,375)
Other deductions ....................................................................................	(1)		-		(2)
Total regulatory capital .........................................................................	154,886		155,186		155,729
Risk-weighted assets
Credit risk ..................................................................................................	839,079		908,231		903,518
Counterparty credit risk .............................................................................	57,323		53,824		51,892
Market risk ................................................................................................	52,964		76,105		51,860
Operational risk .........................................................................................	125,898		121,114		125,898
Total .........................................................................................................	1,075,264		1,159,274		1,133,168

For footnotes, see page 196.

Capital structure (continued)

	At 30 June		At 30 June		At 31 December
	2010		2009		2009
	%		%		%
Capital ratios
Core tier 1 ratio .........................................................................................	9.9		8.8		9.4
Tier 1 ratio ................................................................................................	11.5		10.1		10.8
Total capital ratio ......................................................................................	14.4		13.4		13.7

Source and application of tier 1 capital

	Half-year to
	30 June		30 June		31 December
	2010		2009		2009
	US$m		US$m		US$m
Movement in tier 1 capital
Opening tier 1 capital ................................................................................	122,157		95,336		117,353
Contribution to tier 1 capital from profit for the period .........................	6,030		5,374		4,873
Consolidated profits attributable to shareholders of the parent company	6,763		3,347		2,487
Removal of own credit spread net of tax ................................................	(733)		2,027		2,386
Net dividends .............................................................................................	(1,678)		(1,914)		(2,055)
Dividends ...............................................................................................	(3,261)		(2,728)		(2,911)
Add back: shares issued in lieu of dividends ..............................................	1,583		814		856
Decrease/(increase) in goodwill and intangible assets deducted .....................	2,282		(1,269)		(550)
Ordinary shares issued ................................................................................	61		18,182		217
Rights issue (net of expenses)59 ..............................................................	-		18,179		147
Other .....................................................................................................	61		3		70
Innovative tier 1 securities issued net of redemptions .................................	2,368		-		-
Foreign currency translation differences .....................................................	(6,002)		3,396		1,441
Other .........................................................................................................	(1,150)		(1,752)		878
Closing tier 1 capital ..................................................................................	124,068		117,353		122,157
Movement in risk-weighted assets
At beginning of period ...............................................................................	1,133,168		1,147,974		1,159,274
Movements ................................................................................................	(57,904)		11,300		(26,106)
At end of period .........................................................................................	1,075,264		1,159,274		1,133,168

For footnote, see page 196.

Movement in tier 1 capital

HSBC complied with the FSA's capital adequacy requirements throughout 2009 and the first half of 2010. Internal capital generation contributed US$4.4 billion to tier 1 capital, being profits attributable to shareholders of the parent company, after taking account of own credit spread and net dividends. Tier 1 capital was further strengthened by an issue of US$3.7 billion of innovative tier 1 securities, net of issuance costs, partly offset by a redemption of US$1.3 billion of similar securities. Foreign currency translation differences decreased tier 1 capital by US$6.0 billion. However, the impact was partly offset by the decrease in goodwill which was mainly due to the strengthening of the US dollar against the euro.

Movement in risk-weighted assets

Total RWAs decreased by US$58 billion, or 5.1 per cent, in the first half of 2010. Foreign currency translation effects are estimated to have decreased RWAs by US$21 billion, mainly as a result of the strengthening of the US dollar, particularly against sterling and the euro. This resulted in an estimated underlying decrease of US$37 billion, comprising a decrease of US$43 billion in credit risk, partly offset by an increase of US$6 billion in counterparty credit risk and market risk. The decrease in credit risk was predominantly in North America, in part due to the run-off of the non-core retail portfolios.

Risk-weighted assets by principal subsidiary

In order to give an indication of how HSBC's capital is deployed, the table below analyses the disposition of RWAs by principal subsidiary. The RWAs are calculated using FSA rules and exclude intra-HSBC items. 

Risk-weighted assets by principal subsidiary

	At           30 June                2010		At             30 June                2009		At    31 December                2009
	US$m		US$m		US$m
Risk-weighted assets
The Hongkong and Shanghai Banking Corporation ...................................	294,129		264,546		288,225
Hang Seng Bank .....................................................................................	61,987		49,640		60,991
HSBC Bank Malaysia .............................................................................	10,157		8,810		8,606
The Hongkong and Shanghai Banking Corporation and other subsidiaries ...............................................................................................................	221,985		206,096		218,628
HSBC Bank ...............................................................................................	298,408		347,629		318,570
HSBC Private Banking Holdings (Suisse) ................................................	18,725		19,854		20,200
HSBC France .........................................................................................	44,280		61,200		50,462
HSBC Bank and other subsidiaries ..........................................................	235,403		266,575		247,908
HSBC North America ................................................................................	285,001		392,043		363,622
HSBC Finance ........................................................................................	148,528		190,483		174,595
HSBC Bank Canada60 .............................................................................	-		33,532		34,831
HSBC Bank USA and other subsidiaries ..................................................	136,473		168,028		154,196
HSBC Mexico ............................................................................................	23,035		21,209		22,624
HSBC Bank Middle East ............................................................................	33,281		33,414		33,773
HSBC Bank Canada60 .................................................................................	32,909		-		-
HSBC Brazil ..............................................................................................	45,726		32,655		41,782
HSBC Bank Panama ..................................................................................	9,498		8,265		9,142
HSBC Bank Bermuda .................................................................................	5,292		4,735		4,663
Other ........................................................................................................	47,985		54,778		50,767
	1,075,264		1,159,274		1,133,168

For footnote, see page 196.

Footnotes to Risk

Credit risk

  1 The amount of the loan commitments reflects, where relevant, the expected level of take-up of pre-approved loan offers made by mailshots to personal customers. In addition to those amounts, there is a further maximum possible exposure to credit risk of US$158,587 million (30 June 2009: US$36,199 million; 31 December 2009: US$62,286 million), reflecting the full take-up of such irrevocable loan commitments. The take-up of such offers is generally at modest levels.

  2 As discussed  under 'Write-off of loans and advances' on page 205 of the Annual Report and Accounts 2009, there was a change in the write-off period in North America during 2009 and the figures reported as at 31 March 2010 (where applicable), 30 June 2010 and 31 December 2009 are on the basis of this new period. The effect of this change at 31 December 2009 was an acceleration of write-offs which reduced gross residential mortgages by US$1,924 million, other personal loans by US$1,340 million, total personal lending by US$3,264 million, second lien mortgages by US$425 million and total mortgage lending by US$2,349 million, with a corresponding reduction in impairment allowances. There was no significant effect on net loans and advances or loan impairment charges.

  3 Residential mortgages include Hong Kong Government Home Ownership Scheme loans of US$3,362 million at 30 June 2010 (30 June 2009: US$3,686 million; 31 December 2009: US$3,456 million).

  4 Other personal loans and advances include second lien mortgages and other personal property-related lending.

  5 Other commercial loans and advances include advances in respect of agriculture, transport, energy and utilities.

  6 Included within 'Total gross loans and advances to customers' is credit card lending of US$61,022 million (30 June 2009: US$70,044 million; 31 December 2009: US$68,289 million).

  7 Includes residential mortgages of HSBC Bank USA and HSBC Finance.

  8 Comprising Hong Kong, Rest of Asia-Pacific, Middle East and Latin America.

  9 Negative equity arises when the value of the loan exceeds the value of available equity, generally based on values at balance sheet date. The comparative data for 30 June 2009 for the UK and the US are restated accordingly (previously these values were based on the origination date).

10 Loan to value ratios are generally based on values at the balance sheet date. The comparative data for 30 June 2009 for the UK and the US are restated accordingly (previously these ratios were based on the origination date).

11 HSBC Finance mortgage lending is shown on a management basis and includes loans transferred to HSBC USA Inc. which are managed by HSBC Finance.

12 Excluding the change in write-off period discussed in footnote 2, HSBC Finance mortgage lending at 31 December 2009 totalled US$63,724 million, of which US$52,914 million was fixed rate, US$9,537 million was adjustable rate and US$1,274 million was interest only. Of the total, US$55,625 million was first lien and US$8,098 million was second lien.

13 Stated income lending forms a subset of total Mortgage Services lending across all categories.

14 By states which individually account for 5 per cent or more of HSBC Finance's US customer loan portfolio.

15 Percentages are expressed as a function of the relevant gross loans and receivables balance.

16 The average loss on sale of foreclosed properties is calculated as cash proceeds after deducting selling costs and commissions, minus the book value of the property when it was moved to 'Real estate owned' divided by the book value of the property when it was moved to 'Real estate owned'.

17 The average total loss on foreclosed properties sold during each quarter includes both the loss on sale and the cumulative write-downs recognised on the loans up to and upon classification as 'Real estate owned'. This average total loss on foreclosed properties is expressed as a percentage of the book value of the property prior to its transfer to 'Real estate owned'.

18 HSBC observes the disclosure convention that, in addition to those classified as EL9 to EL10, retail accounts classified EL1 to EL8 that are delinquent by 90 days or more are considered impaired, unless individually they have been assessed as not impaired (see page 162, 'Past due but not impaired gross financial instruments').

19 The EL percentage is derived through a combination of PD and LGD, and may exceed 100 per cent in circumstances where the LGD is above 100 per cent reflecting the cost of recoveries.

20 Impairment allowances are not reported for financial instruments whereby the carrying amount is reduced directly for impairment and not through the use of an allowance account.

21 Impairment is not measured for assets held in trading portfolios, designated at fair value or derivatives as assets in such portfolios are managed according to movements in fair value, and the fair value movement is taken directly to the income statement. Consequently, all such balances are reported under 'Neither past due nor impaired'.

22 Includes asset-backed securities that have been externally rated as strong (30 June 2010: US$4,156 million; 30 June 2009: US$7,827 million; 31 December 2009: US$5,707 million), good (30 June 2010: US$1,039 million; 30 June 2009: nil; 31 December 2009: US$881 million), satisfactory (30 June 2010: US$223 million; 30 June 2009: nil; 31 December 2009: US$311 million), sub-standard (30 June 2010: US$511 million; 30 June 2009: nil; 31 December 2009: US$468 million) and impaired (30 June 2010: US$243 million; 30 June 2009: nil; 31 December 2009: US$460 million).

23 Impaired loans and advances are those classified as CRR 9, CRR 10, EL 9 or EL 10 and all retail loans 90 days or more past due, unless individually they have been assessed as not impaired.

24 Collectively assessed loans and advances comprise homogeneous groups of loans that are not considered individually significant, and loans subject to individual assessment where no impairment has been identified on an individual basis, but on which a collective impairment allowance has been calculated to reflect losses which have been incurred but not yet identified.

25 Collectively assessed loans and advances not impaired are those classified as CRR1 to CRR8 and EL1 to EL8 but excluding retail loans 90 days past due.

26 The impairment allowances on loans and advances to banks relate to the geographical regions, Europe, Middle East and North America.

27 Net of repo transactions, settlement accounts and stock borrowings.

28 As a percentage of loans and advances to banks and loans and advances to customers, as applicable.

29 Excludes trading loans classified as in default.

Liquidity and funding

30 Figures provided for HSBC Bank plc and The Hongkong and Shanghai Banking Corporation incorporate the major overseas branches of these entities. Subsidiaries of these entities are not included unless there is unrestricted transferability of liquidity between the subsidiaries and the parent.

31 This comprises the Group's other main banking subsidiaries and, as such, includes businesses spread across a range of locations, in many of which HSBC may require a higher ratio of net liquid assets to customer liabilities to reflect local market conditions.

32 Unused committed sources of secured funding for which eligible assets were held.

33 Client-originated asset exposures relate to consolidated multi-seller conduits (see page 126). These vehicles provide funding to Group customers by issuing debt secured by a diversified pool of customer-originated assets.

34 HSBC-managed asset exposures relate to consolidated securities investment conduits, primarily Solitaire and Mazarin (see page 126). These vehicles issue debt secured by ABSs which are managed by HSBC. Of the total contingent liquidity risk under this category, US$8.5 billion was already funded on-balance sheet at 30 June 2010 (30 June 2009: US$21.9 billion; 31 December 2009: US$18.7 billion) leaving a net contingent exposure of US$18.4 billion (30 June 2009: US$9.0 billion; 31 December 2009: US$10.4 billion).

35 Other conduit exposures relate to third-party sponsored conduits (see page 136).

36 The five largest committed liquidity facilities provided to customers other than those facilities to conduits.

37 The total of all committed liquidity facilities provided to the largest market sector, other than those facilities to conduits.

Market risk

38 The structural foreign exchange risk is monitored using sensitivity analysis (see page 182). The reporting of commodity risk is consolidated with foreign exchange risk and is not applicable to non-trading portfolios.

39 The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included in the Group VAR. The management of this risk is described on page 182.

40 Credit spread sensitivity is reported separately for insurance operations (see page 186).

41 The standard deviation measures the variation of daily revenues about the mean value of those revenues.

42 The effect of any month-end adjustments not attributable to a specific daily market move is spread evenly over the days in the month in question.

43 The total VAR is non-additive across risk types due to diversification effects.

Risk management of insurance operations

44 HSBC has no insurance manufacturing subsidiaries in the Middle East.

45 Insurance contracts and investment contracts with discretionary participation features ('DPF') can give policyholders the contractual right to receive, as a supplement to their guaranteed benefits, additional benefits that may be a significant portion of the total contractual benefits, but whose amount and timing are determined by HSBC. These additional benefits are contractually based on the performance of a specified pool of contracts or assets, or the profit of the company issuing the contracts. In the first half of 2010, policyholder liabilities in relation to certain hybrid contracts were reclassified from 'Insurance contracts with DPF' and 'Life (linked) contracts' to 'Investment contracts with DPF' to reflect policyholder behaviour which supports the contracts being presented as a single contract in accordance with its dominant contractual feature, rather than being separately analysed into its component parts.

46 Although investment contracts with DPF are financial instruments, HSBC continues to account for them as insurance contracts as permitted by IFRS 4.

47 Net written insurance premiums represent gross written premiums less gross written premiums ceded to reinsurers.

48 Term assurance includes credit life insurance.

49 Other assets comprise shareholder assets.

50 Present value of in-force long-term insurance contracts and investment contracts with DPF.

51 Does not include associated insurance companies, Ping An Insurance, SABB Takaful Company or Bao Viet, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

52 Does not include associated insurance companies, Ping An Insurance and SABB Takaful Company or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

Capital management and allocation

53 Includes externally verified profits for the half-year to 30 June 2010.

54 Mainly comprises unrealised losses on available-for-sale debt securities within SPEs which are excluded from the regulatory consolidation.

55 Under FSA rules, unrealised gains/losses on debt securities net of tax must be excluded from capital resources.

56 Under FSA rules, the defined benefit liability may be substituted with the additional funding that will be paid into the relevant schemes over the following five year period.

57 Mainly comprise investments in insurance entities.

58 Under FSA rules, collective impairment allowances on loan portfolios on the standardised approach are included in tier 2 capital.

59 The rights issue excludes losses arising on derivative contracts and certain fees that were recognised in the income statement. These amounted to US$147 million in the half-year to 31 December 2009 and US$344 million in the half-year to 30 June 2009.

60 HSBC Bank Canada was transferred from HSBC North America to the ownership of HSBC Overseas Holdings (UK) Limited with effect from 31 January 2010.

 

END

 

 

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