Interim Report - 23 of 26

RNS Number : 1391M

HSBC Holdings PLC

12 August 2011

 



19   Notes on the statement of cash flows

	Half-year to
	30 June                2011		30 June                2010		31 December                2010
	US$m		US$m		US$m
Other non-cash items included in profit before tax
Depreciation, amortisation and impairment .................................................	1,631		1,442		1,359
Gains arising from dilution of interests in associates .....................................	(181)		(188)		-
Revaluations on investment property ...........................................................	(38)		8		(101)
Share-based payment expense .......................................................................	588		371		441
Loan impairment losses gross of recoveries and other credit risk provisions .	6,011		7,976		7,083
Provisions ....................................................................................................	937		158		522
Impairment of financial investments ............................................................	339		40		65
Charge/(credit) for defined benefit plans .......................................................	(321)		246		280
Accretion of discounts and amortisation of premiums ..................................	(141)		(500)		(315)
	8,825		9,553		9,334
Change in operating assets
Change in prepayments and accrued income .................................................	(590)		839		(382)
Change in net trading securities and net derivatives ......................................	7,079		20,176		40,161
Change in loans and advances to banks .........................................................	(6,738)		(8,515)		13,728
Change in loans and advances to customers ..................................................	(85,132)		(3,812)		(75,471)
Change in financial assets designated at fair value .........................................	(2,480)		5,460		(5,306)
Change in other assets ..................................................................................	(4,699)		(18)		(127)
	(92,560)		14,130		(27,397)
Change in operating liabilities
Change in accruals and deferred income ........................................................	(474)		(1,016)		1,732
Change in deposits by banks .........................................................................	14,895		2,444		(16,732)
Change in customer accounts ........................................................................	91,262		(11,714)		80,405
Change in debt securities in issue ...................................................................	4,402		6,583		(8,078)
Change in financial liabilities designated at fair value ....................................	11,285		342		5,317
Change in other liabilities .............................................................................	8,931		1,972		(18,983)
	130,301		(1,389)		43,661
Interest and dividends
Interest paid .................................................................................................	(12,644)		(9,932)		(11,473)
Interest received ...........................................................................................	33,578		31,397		32,299
Dividends received ........................................................................................	376		380		183
	At           30 June                2011		At             30 June                2010		At    31 December                2010
	US$m		US$m		US$m
Cash and cash equivalents
Cash and balances at central banks ................................................................	68,218		71,576		57,383
Items in the course of collection from other banks........................................	15,058		11,195		6,072
Loans and advances to banks of one month or less .......................................	215,381		171,022		189,197
Treasury bills, other bills and certificates of deposit less than three months ..	30,011		24,093		28,087
Less: items in the course of transmission to other banks ...............................	(16,317)		(11,976)		(6,663)
	312,351		265,910		274,076

20   Contingent liabilities, contractual commitments and guarantees

	At           30 June                2011		At             30 June                2010		At    31 December                2010
	US$m		US$m		US$m
Contingent liabilities and guarantees
Guarantees and irrevocable letters of credit pledged as collateral security ..	75,281		66,140		71,157
Other contingent liabilities .......................................................................	356		173		166
	75,637		66,313		71,323
Commitments
Documentary credits and short-term trade-related transactions .................	13,616		10,618		12,051
Forward asset purchases and forward forward deposits placed .....................	66		29		30
Undrawn formal standby facilities, credit lines and other commitments to lend ......................................................................................................	646,493		538,063		590,432
	660,175		548,710		602,513

The above table discloses the nominal principal amounts of contingent liabilities, commitments and guarantees; mainly credit-related instruments including both financial and non-financial guarantees and commitments to extend credit. Contingent liabilities arising from legal proceedings, investigations and regulatory matters against the Group are disclosed in Note 24. Nominal principal amounts represent the amounts at risk should contracts be fully drawn upon and clients default. The amount of the loan commitments shown above reflects, where relevant, the expected level of take-up of pre-approved loan offers made by mailshots to personal customers. As a significant proportion of guarantees and commitments is expected to expire without being drawn upon, the total of the nominal principal amounts is not representative of future liquidity requirements.

Financial Services Compensation Scheme

The Financial Services Compensation Scheme ('FSCS') has provided compensation to consumers following the collapse of a number of deposit takers. The compensation paid out to consumers is currently funded through loans from the Bank of England and HM Treasury. HSBC Bank could be liable to pay a proportion of the outstanding borrowings that the FSCS has borrowed from HM Treasury which at 1 March 2011 stood at approximately £20bn (US$30bn). Currently, the levy paid by the bank represents its share of the interest on these borrowings. The accrual at 30 June 2011 was US$157m in respect of the 2010/11 and 2011/12 levy years (30 June 2010: US$207m in respect of the 2009/10 and 2010/11 levy years; 31 December 2010: US$144m in respect of the 2010/11 and 2011/12 levy years).

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

21   Special purpose entities

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

SPEs are assessed for consolidation in accordance with the accounting policy set out on page 251 of the Annual Report and Accounts 2010.

Total consolidated assets held by SPEs by balance sheet classification

	Conduits		Securit-       isations		Money        market           funds		Non-money        market investment           funds		Total
	US$bn		US$bn		US$bn		US$bn		US$bn
At 30 June 2011
Cash ............................................................................	0.7		0.5		-		0.3		1.5
Trading assets .............................................................	0.1		0.6		0.3		0.5		1.5
Financial assets designated at fair value........................	0.1		-		-		7.9		8.0
Derivatives .................................................................	-		0.3		-		-		0.3
Loans and advances to banks .......................................	-		0.9		-		-		0.9
Loans and advances to customers ................................	9.7		20.2		-		-		29.9
Financial investments .................................................	29.6		-		-		-		29.6
Other assets ................................................................	1.9		0.2		-		-		2.1
	42.1		22.7		0.3		8.7		73.8
At 30 June 2010
Cash ............................................................................	-		-		-		0.4		0.4
Trading assets .............................................................	-		0.9		44.4		0.7		46.0
Financial assets designated at fair value........................	0.1		-		-		5.3		5.4
Derivatives .................................................................	-		0.9		-		-		0.9
Loans and advances to banks .......................................	0.2		-		-		-		0.2
Loans and advances to customers ................................	9.6		29.7		-		-		39.3
Financial investments .................................................	30.9		-		-		-		30.9
Other assets ................................................................	2.1		-		-		-		2.1
	42.9		31.5		44.4		6.4		125.2
At 31 December 2010
Cash ............................................................................	1.0		0.7		-		0.3		2.0
Trading assets .............................................................	0.1		0.6		0.4		0.5		1.6
Financial assets designated at fair value .......................	0.1		-		-		6.4		6.5
Derivatives .................................................................	-		0.3		-		-		0.3
Loans and advances to banks .......................................	-		1.4		-		-		1.4
Loans and advances to customers ................................	8.4		22.2		-		-		30.6
Financial investments .................................................	30.5		0.1		-		-		30.6
Other assets ................................................................	1.6		0.4		-		0.4		2.4
	41.7		25.7		0.4		7.6		75.4

HSBC's maximum exposure to SPEs

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

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

	Consolidated SPEs								Unconsolidated SPEs
	Total assets		Funding provided by HSBC		Liquidity and credit enchance- ments		HSBC's maximum exposure		Total assets		Funding provided by HSBC		HSBC's maximum exposure
	US$bn		US$bn		US$bn		US$bn		US$bn		US$bn		US$bn
At 30 June 2011
Conduits .................................	42.1		28.4		38.1		49.9		-		-		-
Securities investment conduits .......................................	31.6		28.0		23.2		35.0		-		-		-
Multi-seller conduits ...........	10.5		0.4		14.9		14.9		-		-		-
Securitisations.........................	22.7		1.9		0.1		4.3		9.0		-		0.4
Money market funds ..............	0.3		0.3		-		0.3		93.7		0.9		0.9
Constant net asset value funds .......................................	-		-		-		-		69.2		0.7		0.7
Other .................................	0.3		0.3		-		0.3		24.5		0.2		0.2
Non-money market investment funds ..................................	8.7		8.4		-		8.4		288.7		1.6		1.6
Other .....................................	-		-		-		-		19.2		9.4		4.3
	73.8		39.0		38.2		62.9		410.6		11.9		7.2
At 30 June 2010
Conduits .................................	42.9		31.1		39.6		52.4		-		-		-
Securities investment conduits .......................................	32.9		30.5		26.9		39.7		-		-		-
Multi-seller conduits ...........	10.0		0.6		12.7		12.7		-		-		-
Securitisations ........................	31.5		2.5		0.1		5.9		10.0		-		-
Money market funds ..............	44.4		1.2		-		1.2		55.2		0.3		0.3
Constant net asset value funds .......................................	43.9		0.7		-		0.7		30.3		0.1		0.1
Other .................................	0.5		0.5		-		0.5		24.9		0.2		0.2
Non-money market investment funds ..................................	6.4		6.1		-		6.1		237.4		1.4		1.4
Other .....................................	-		-		-		-		19.3		8.8		3.4
	125.2		40.9		39.7		65.6		321.9		10.5		5.1
At 31 December 2010
Conduits .................................	41.7		28.6		38.3		50.5		-		-		-
Securities investment conduits .......................................	32.2		28.6		25.6		37.8		-		-		-
Multi-seller conduits ...........	9.5		-		12.7		12.7		-		-		-
Securitisations ........................	25.7		1.9		0.1		4.7		9.9		-		-
Money market funds ..............	0.4		0.4		-		0.4		95.8		0.7		0.7
Constant net asset value funds .......................................	-		-		-		-		74.9		0.5		0.5
Other .................................	0.4		0.4		-		0.4		20.9		0.2		0.2
Non-money market investment funds ..................................	7.6		6.9		-		6.9		274.7		1.7		1.7
Other .....................................	-		-		-		-		19.0		9.4		3.7
	75.4		37.8		38.4		62.5		399.4		11.8		6.1

Conduits

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

Securities investment conduits

Solitaire, HSBC's principal SIC, purchases highly rated ABSs to facilitate tailored investment opportunities. At 30 June 2011, Solitaire held US$11.8bn of ABSs (30 June 2010: US$12.0bn; 31 December 2010: US$11.7bn). These are included within the disclosures of ABS 'held through consolidated SPEs' on page 124. HSBC's other SICs, Mazarin Funding Limited ('Mazarin'), Barion Funding Limited ('Barion') and Malachite Funding Limited ('Malachite'), evolved from the restructuring of HSBC's sponsored structured investment vehicles ('SIV's) in 2008.

Solitaire

Commercial Paper ('CP') issued by Solitaire benefits from a 100% liquidity facility provided by HSBC. At 30 June 2011, US$8.9bn of Solitaire's assets were funded by the draw-down of the liquidity facility (30 June 2010: US$8.5bn; 31 December 2010: US$7.6bn). HSBC is exposed to credit losses on the drawn amounts.

HSBC's maximum exposure represents the risk that HSBC may be required to fund the vehicle in the event the CP is redeemed without reinvestment from third parties. At 30 June 2011 this amounted to US$15.9bn (30 June 2010: US$18.0bn; 31 December 2010: US$16.8bn).

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 2011, this amounted to US$10.2bn (30 June 2010: US$12.1bn; 31 December 2010: US$11.6bn). First loss protection is provided through the capital notes issued by Mazarin, which are substantially all held by third parties.

At 30 June 2011, HSBC held 1.3% of Mazarin's capital notes (30 June 2010: 1.3%; 31 December 2010: 1.3%) which have a par value of US$17m (30 June 2010: US$17m; 31 December 2010: US$17m) and a carrying amount of US$0.6m (30 June 2010: US$0.6m; 31 December 2010: US$0.6m).

Barion and Malachite

HSBC's primary exposure to these SICs is represented by the amortised cost of the debt required to support the non-cash assets of the vehicles. At 30 June 2011, this amounted to US$8.9bn (30 June 2010: US$9.6bn; 31 December 2010: US$9.4bn). First loss protection is provided through the capital notes issued by these vehicles, which are substantially all held by third parties.

At 30 June 2011, HSBC held 3.8% of the capital notes issued by these vehicles (30 June 2010: 3.8%; 31 December 2010: 3.7%) which have a par value of US$36.3m (30 June 2010: US$34m; 31 December 2010: US$35m) and a carrying amount of US$2m (30 June 2010: US$1.9m; 31 December 2010: US$2m).

Multi-seller conduits

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

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

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

Weighted average life of portfolios

Weighted average life (years)	Solitaire		Other SICs		Total SICs		Total multi-     seller conduits
At 30 June 2011 ....................................................	5.9		4.2		4.9		2.1
At 30 June 2010 ......................................................	5.8		3.9		4.6		2.1
At 31 December 2010 ..............................................	5.1		4.0		4.4		1.8

Securitisations

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

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

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

Money market funds

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

The majority of these money market funds are Constant Net Asset Value funds ('CNAV'), which invest in shorter-dated and highly-rated money market securities with the objective of providing investors with a highly liquid and secure investment.

In December 2010, management determined that it was no longer appropriate to consolidate certain CNAV funds which HSBC had previously consolidated in September 2008. Further details are included on pages 363 and 364 of the Annual Report and Accounts 2010.

HSBC's maximum exposure to money market funds is represented by HSBC's investment in the units of each fund, which at 30 June 2011 amounted to US$1.2bn (30 June 2010: US$1.5bn; 31 December 2010: US$1.1bn).

Non-money market investment funds

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

HSBC's maximum exposure to non-money market investment funds is represented by its investment in the units of each fund which at 30 June 2011 amounted to US$10.0bn (30 June 2010: US$7.5bn; 31 December 2010: US$8.6bn).

Other

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

In certain transactions, HSBC is exposed to risk often referred to as gap risk. Gap risk typically arises in transactions where the aggregate potential claims against the SPE by HSBC pursuant to one or more derivatives could be greater than the value of the collateral held by the SPE and securing such derivatives. HSBC often mitigates such gap risk by incorporating in the SPE transaction features which allow for deleveraging, a managed liquidation of the portfolio, or other mechanisms including trade restructuring or unwinding the trade. Following the inclusion of such risk reduction mechanisms, HSBC has, in certain circumstances, retained all or a portion of the underlying exposure in the transaction. In these circumstances, HSBC assesses whether the exposure retained causes a requirement under IFRSs to consolidate the SPE. When this retained exposure represents ABSs, it has been included in 'Securitisation exposures and other structured products' on page 121.

Third-party sponsored SPEs

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

Additional off-balance sheet arrangements and commitments

Additional off-balance sheet commitments such as financial guarantees, letters of credit and commitments to lend are disclosed in Note 20.

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 132.

22   Segmental analysis

The basis of identifying segments and measuring segmental results is set out on page 296 of the Annual Report and Accounts 2010. There have been no material changes to the segments identified since 31 December 2010.

	Europe		Hong         Kong		Rest of         Asia-      Pacific		MENA		North   America		Latin   America		Intra-      HSBC        items		Total
	US$m		US$m		US$m		US$m		US$m		US$m		US$m		US$m
Net operating income
Half-year to:
30 June 2011 ........	10,167		5,389		5,248		1,137		5,191		4,863		(1,567)		30,428
30 June 2010 ..........	11,220		4,833		4,351		750		4,446		3,895		(1,467)		28,028
31 December 2010 ..	8,510		5,255		4,442		1,033		4,306		4,292		(1,658)		26,180

Profit/(loss) before tax

Half-year to:
30 June 2011 ........	2,147		3,081		3,742		747		606		1,151		-		11,474
30 June 2010 ..........	3,521		2,877		2,985		346		492		883		-		11,104
31 December 2010 ..	781		2,815		2,917		546		(38)		912		-		7,933

Total assets

At 30 June 2011 .......	1,379,308		474,044		298,590		58,038		529,386		163,611		(211,990)		2,690,987
At 30 June 2010 .........	1,280,698		410,991		244,624		49,637		495,408		121,885		(184,789)		2,418,454
At 31 December 2010	1,249,527		429,565		278,062		52,757		492,487		139,938		(187,647)		2,454,689

23   Goodwill impairment

It is HSBC's policy to test goodwill allocated to each cash-generating unit ('CGU') for impairment as at 1 July each year. Goodwill is also tested for impairment whenever there is an indication that goodwill may be impaired.

The allocation of goodwill to CGUs is described on page 333 of the Annual Report and Accounts 2010.

There was no indication of impairment in the period to 30 June 2011 and therefore goodwill has not been retested.

24   Legal proceedings, investigations and regulatory matters

HSBC is party to legal proceedings, investigations and regulatory matters in a number of jurisdictions including the UK, EU and the US arising out of its normal business operations. Apart from the matters described below, HSBC considers that none of these matters is material, either individually or in the aggregate. HSBC recognises a provision for a liability in relation to these matters when it is probable that an outflow of economic benefits will be required to settle an obligation which has arisen as a result of past events, and for which a reliable estimate can be made of the amount of the obligation. While the outcome of these matters is inherently uncertain, management believes that, based on the information available to it, appropriate provisions have been made in respect of legal proceedings, investigations and regulatory matters as at 30 June 2011 (see Note 17, Provisions).

Securities litigation

As a result of an August 2002 restatement of previously reported consolidated financial statements and other corporate events, including the 2002 settlement with 46 State Attorneys General relating to real estate lending practices, Household International (now HSBC Finance) and certain former officers were named as defendants in a class action law suit, Jaffe v Household International Inc, et al No 2. C 5893 (N.D.Ill, filed 19 August 2002). The complaint asserted claims under the US Securities Exchange Act of 1934, on behalf of all persons who acquired and disposed of Household International common stock between 30 July 1999 and 11 October 2002. The claims alleged that the defendants knowingly or recklessly made false and misleading statements of material fact relating to Household's Consumer Lending operations, including collections, sales and lending practices, some of which ultimately led to the 2002 State settlement agreement, and facts relating to accounting practices evidenced by the restatement. Following a jury trial concluded in April 2009, which was decided partly in favour of the plaintiffs, the Court issued a ruling on 22 November 2010 within the second phase of the case to determine actual damages, that claim forms should be mailed to class members, and also set out a method for calculating damages for class members who filed claims. As previously reported, lead plaintiffs, in court filings in March 2010, estimated that damages could range 'somewhere between US$2.4bn to US$3.2bn to class members', before pre-judgement interest.

Class members had until 24 May 2011 to file claims. In filings with the Court, plaintiffs indicated that the Court‑appointed claims administrator has made a preliminary determination that 45,332 of the claimants have an allowed loss, and that the 'preliminary, estimated damages for these potential class members, subject to revision as duplicate claims are identified and supplemental information is received, exceeds US$2bn'. All submitted claims are subject to a validation process that, as indicated in the plaintiffs' filings, will not be completed until December 2011. Once the claims administration process is complete, plaintiffs are expected to ask the Court to assess pre-judgement interest to be included as part of the Court's final judgement.

Despite the jury verdict and the 22 November 2010 ruling, HSBC continues to believe that it has meritorious grounds for appeal of one or more of the rulings in the case, and intends to seek an appeal of the Court's final judgement, which could involve a substantial amount. Upon appeal, HSBC Finance will be required to provide security for the judgement in order to suspend its execution while the appeal is ongoing by depositing cash in an interest-bearing escrow account or posting an appeal bond in the amount of the judgement (including any pre-judgement interest awarded).

Given the complexity and uncertainties associated with the actual determination of damages, including the outcome of any appeals, there is a wide range of possible damages. HSBC believes it has meritorious grounds for appeal on matters of both liability and damages and will argue on appeal that damages should be nil or a relatively insignificant amount. If the Appeals Court partially accepts or rejects HSBC's arguments, the cost of damages, including pre‑judgement interest, could be higher, and may lie in a range from a relatively insignificant amount to somewhere in the region of US$3bn.

Bernard L. Madoff Investment Securities LLC

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

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

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

Plaintiffs (including funds, fund investors, and the Madoff Securities trustee) have commenced Madoff-related proceedings against numerous defendants in a multitude of jurisdictions. Various HSBC companies have been named as defendants in suits in the US, Ireland, Luxembourg, and other jurisdictions. The suits (which include US class actions) allege that the HSBC defendants knew or should have known of Madoff's fraud and breached various duties to the funds and fund investors.

One of the funds HSBC companies provided custodial and administration services for was Thema International Fund plc, a limited liability company incorporated and authorised in Ireland as a UCITS fund under the European Communities (Undertaking for Collective Investments in Transferable Securities) Regulations 1985. HSBC estimates that the purported net asset value of Thema International Fund plc as at 30 November 2008 was US$1.1bn and that Thema International Fund plc's actual transfers to Madoff Securities minus its actual withdrawals were approximately US$312m. On 7 June 2011, HSBC Securities Services (Ireland) Limited, HSBC Institutional Trust Services (Ireland) Limited, HSBC Holdings plc and, subject to the granting of leave to effect a proposed pleading amendment, HSBC Bank USA, N.A. entered into an agreement, without any admission of wrongdoing or liability, to settle the action pending in the US District Court for the Southern District of New York, relating to Thema International Fund plc. The settlement is subject to various conditions to its effectiveness and the HSBC defendants may terminate the settlement in certain circumstances. The payment to be made by the HSBC defendants is US$62.5m.

In December 2010, the Madoff Securities trustee commenced suits against various HSBC companies in the US bankruptcy court and in the English High Court. The US action (which also names certain funds, investment managers, and other entities and individuals) seeks US$9bn in damages and additional recoveries from HSBC and the various co-defendants. It seeks damages against HSBC for allegedly aiding and abetting Madoff's fraud and breach of fiduciary duty. In July 2011, after withdrawing the case from the Bankruptcy Court in order to decide certain threshold issues, the US District Court Judge dismissed the trustee's various common law claims on the grounds that the trustee lacks standing to assert them. The trustee may appeal this ruling. The District Court returned the case to the US Bankruptcy Court for further proceedings on the remaining claims. Those claims seek, pursuant to US bankruptcy law, recovery of unspecified amounts received by HSBC from funds invested with Madoff, including amounts that HSBC received when it redeemed units HSBC held in the various funds. HSBC acquired those fund units in connection with financing transactions HSBC had entered into with various clients. The trustee's US bankruptcy law claims also seek recovery of fees earned by HSBC for providing custodial, administration and similar services to the funds. The trustee's English action seeks recovery of unspecified transfers of money from Madoff Securities to or through HSBC, on the ground that the HSBC defendants actually or constructively knew of Madoff's fraud.

In July 2011, one of the clients with whom HSBC entered into a Madoff-related financing transaction commenced suit in the US seeking to rescind the transaction and recover approximately US$16m it paid to HSBC in connection with the transaction.

Between October 2009 and March 2011, Fairfield Sentry Limited and Fairfield Sigma Limited ('Fairfield'), funds whose assets were directly or indirectly invested with Madoff Securities, commenced multiple suits in the British Virgin Islands ('BVI') and the US against numerous fund shareholders, including various HSBC companies that acted as nominees for clients of HSBC's private banking business and other clients who invested in the Fairfield funds. The Fairfield actions seek restitution of amounts paid to the defendants in connection with share redemptions, on the ground that such payments were made by mistake, based on inflated values resulting from Madoff's fraud, and some actions also seek recovery of the share redemptions under BVI insolvency law.

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

Payment Protection Insurance

On 10 August 2010 the FSA published Policy Statement 10/12 ('PS 10/12') on the assessment and redress of Payment Protection Insurance ('PPI') complaints. On 8 October 2010, an application for Judicial Review was issued by the British Bankers' Association ('BBA') acting on behalf of a group of UK banks, which included HSBC Bank, seeking an order to quash PS 10/12 and also Guidance issued by the Financial Ombudsman Service ('FOS') on handling PPI complaints. The Judicial Review application was heard by the Court in January 2011.

On 20 April 2011, the High Court issued an adverse judgement on the Judicial Review application. Subsequently the BBA, acting on behalf of its members, confirmed that it would not appeal the judgement. HSBC Bank accepts the High Court's decision and is working with the FSA and the FOS in order to ensure all PPI complaints are handled and, where appropriate, redressed in accordance with PS 10/12.

There are many factors affecting the resulting financial impact of the judgement, including the effect of the decision on the nature and volume of customer complaints; and the extent to which HSBC Bank might be required to take action, and the nature of any such action, in relation to non-complainants. The extent of any redress that may be required as a result of the decision to uphold PS 10/12 and the FOS Guidance will also depend on the facts and circumstances of each individual customer's case. For these reasons, there is currently a high degree of uncertainty as to the eventual costs of redress for this matter. There is a provision of US$509m as at 30 June 2011 in respect of the estimated liability for redress in respect of the possible mis-selling of PPI policies in previous years.

US mortgage-related investigations

In April 2011, HSBC Bank USA entered into a consent cease and desist order with the Office of the Comptroller of the Currency and HSBC Finance and HSBC North America entered into a similar consent order with the Federal Reserve Board following completion of a broad horizontal review of industry residential mortgage foreclosure practices. These consent orders require prescribed actions to address the deficiencies noted in the joint examination and described in the consent orders. These consent orders require a review of foreclosures from January 2009 to December 2010 to determine if any customer was financially injured as a result of an error in the foreclosure process. An independent consultant has been retained to conduct that review, and remediation, including restitution, may be required if a customer is found to have been financially injured. HSBC Bank USA, HSBC Finance and HSBC North America continue to work with the Office of the Comptroller of the Currency and the Federal Reserve Board to define and address the requirements of the consent orders.

These consent orders do not preclude additional enforcement actions against HSBC Bank USA, HSBC Finance or HSBC North America by bank regulatory, governmental or law enforcement agencies, such as the US Department of Justice ('DoJ') or State Attorneys General, which could include the imposition of fines and actions to recover civil money penalties and other financial penalties relating to the activities that were the subject of the consent orders. The Federal Reserve Board has indicated in a press release relating to the financial services industry in general that it believes monetary sanctions are appropriate for the enforcement actions and that it plans to announce monetary penalties. An increase in private litigation concerning these practices is also possible. While it is possible that civil money penalties will be imposed on HSBC Bank USA, HSBC Finance or HSBC North America, HSBC is unable at this time to estimate reliably the amounts, or range of possible amounts, of any such penalties, or claims arising from any private litigation.

Media reports suggest that the five largest US mortgage servicers are engaged in discussions with bank regulators, the DoJ and State Attorneys General regarding a broader settlement with respect to foreclosure and other mortgage servicing practices, and that the settlement will involve a substantial payment. Following the conclusion of these discussions and the announcement of any such settlement with the five largest servicers, it is expected that the next nine largest mortgage servicers, including HSBC Bank USA and HSBC Finance, will be approached regarding a settlement although the timing and proposed terms of such settlement discussions are not presently known.

Participants in the US mortgage securitisation market that purchased and repackaged whole loans have been the subject of lawsuits and governmental and regulatory investigations and inquiries, which have been directed at groups within the US mortgage market, such as servicers, originators, underwriters, trustees or sponsors of securitisations, and at particular participants within these groups. HSBC Bank USA has received subpoenas from the Securities and Exchange Commission ('SEC') and DoJ seeking production of documents and confirmation relating to its involvement and the involvement of its affiliates in specified private-label residential mortgage-backed securities ('MBS') transactions as an issuer, sponsor, underwriter, depositor, trustee, custodian or servicer. As the industry's residential mortgage foreclosure issues continue, HSBC Bank USA has taken title to an increasing number of foreclosed homes as trustee on behalf of various securitisation trusts. As record owner of these properties, HSBC Bank USA has been sued by municipalities and tenants alleging various violations of law, including laws regarding property upkeep and tenants rights. While HSBC believes and continues to maintain that the obligations at issue and the related liability are properly those of the servicer of each trust, HSBC continues to receive significant and adverse publicity in connection with these and similar matters. In addition, HSBC Securities Inc. has been named as defendant in a small number of actions in its role as underwriter in specified private-label residential MBS offerings, which generally allege that the offering documents for securities issued by securitisation trusts contained material misstatements and omissions, including statements regarding the underwriting standards governing the underlying mortgage loans. HSBC expects this level of focus will continue and, potentially, intensify, so long as the US real estate markets continue to be distressed. As a result, HSBC Group companies may be subject to additional litigation and governmental and regulatory scrutiny related to its participation in the US mortgage securitisation market, either individually or as a member of a group. HSBC is unable to estimate reliably the financial effect of any action or litigation relating to these matters. As situations develop it is possible that any related claims could be significant.

Other US regulatory and law enforcement investigations

In October 2010, HSBC Bank USA entered into a consent cease and desist order with the Office of the Comptroller of the Currency and the indirect parent of that company, HSBC North America, entered into a consent cease and desist order with the Federal Reserve Board. These actions require improvements for an effective compliance risk management programme across the Group's US businesses, including US Bank Secrecy Act ('BSA') and Anti

Money Laundering ('AML') compliance. Steps continue to be taken to address the requirements of these Orders and to ensure that compliance and effective policies and procedures are maintained. Various HSBC Group companies are the subject of ongoing investigations, including Grand Jury subpoenas and other requests for information, by US Government agencies, including the US Attorney's Office, the DoJ and the New York County District Attorney's Office. These investigations pertain to, among other matters, HSBC Bank USA's bank note and dollar clearing services and their compliance with BSA and AML controls, as well as various HSBC Group companies' compliance with Office of Foreign Asset Control ('OFAC') requirements, and whether various HSBC Group companies acted appropriately in relation to certain customers who had US tax reporting requirements and various HSBC Group companies' adherence to the US broker dealer rules when dealing with US securities. In April 2011, HSBC Bank USA received a summons from the US Internal Revenue Service directing HSBC Bank USA to produce records identifying US taxpayers with bank accounts at the offices of an HSBC Group company and continues to work with the US Internal Revenue Service to meet their requirements.

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

Investigations into the setting of London interbank offered rates

Various regulators and enforcement authorities around the world including in the UK, the US and the EU, are conducting investigations related to certain past submissions made by panel banks to the BBA in connection with the setting of London interbank offered rates ('LIBOR'). As HSBC Bank is a panel bank, HSBC and/or its subsidiaries have received requests from these various regulators for information and are cooperating with their enquiries. In addition, HSBC and other panel banks have been named recently in several putative class action lawsuits filed by private parties in the US with respect to the setting of LIBOR. These ongoing matters are at an early stage. Based on the facts currently known, it is not practicable at this time for HSBC to predict the resolution of these regulatory investigations or putative class action lawsuits, including the timing and potential impact, if any, on HSBC.

25   Events after the balance sheet date

On 31 July 2011, we announced that we had reached an agreement with First Niagara Bank, N.A. to sell 195 retail branches, including certain loans, deposits and related branch premises, primarily located in upstate New York, for consideration of a premium equal to 6.67% of the deposits to be transferred at closing. Based on 31 May 2011 balances, the consideration would represent approximately US$1.0bn. This will result in a gain upon closing of the transaction. Branch premises will be sold for fair value and loans and other transferred assets will be sold at their book values. The all-cash transaction is expected to close in early 2012, subject to regulatory approvals, including approval by the acquirer's regulator. The branches held approximately US$15.0bn in deposits and US$2.8bn in loans as of 31 May 2011.

A second interim dividend for the financial year ending 31 December 2011 was declared by the Directors after 30 June 2011, as described in Note 3.

26   Interim Report 2011 and statutory accounts

The information in this Interim Report 2011 is unaudited and does not constitute statutory accounts within the meaning of section 434 of the Companies Act 2006. The Interim Report 2011 was approved by the Board of Directors on 1 August 2011. The statutory accounts for the year ended 31 December 2010 have been delivered to the Registrar of Companies in England and Wales in accordance with section 447 of the Companies Act 2006. The auditor has reported on those accounts. Its report was unqualified; did not include a reference to any matters to which the auditors drew attention by way of emphasis without qualifying their report; and did not contain a statement under section 498(2) or (3) of the Companies Act 2006.

The Directors are required to prepare the financial statements on the going concern basis unless it is not appropriate. Since the Directors are satisfied that the Group and parent company have the resources to continue in business for the foreseeable future, the financial statements continue to be prepared on the going concern basis.

The Directors, the names of whom are set out on pages 165 to 170 of this Interim Report, confirm that to the best of their knowledge:

·     the condensed set of financial statements has been prepared in accordance with IAS 34 'Interim Financial Reporting' as adopted by the EU;

·     the Interim Management Report includes a fair review of the information required by:

(a)   DTR 4.2.7R of the Disclosure Rules and Transparency Rules, being an indication of important events that have occurred during the first six months of the financial year ending 31 December 2011 and their impact on the condensed set of financial statements; and a description of the principal risks and uncertainties for the remaining six months of the financial year; and

(b)   DTR 4.2.8R of the Disclosure Rules and Transparency Rules, being related party transactions that have taken place in the first six months of the financial year ending 31 December 2011 and that have materially affected the financial position or performance of HSBC during that period; and any changes in the related parties transactions described in the Annual Report and Accounts 2010 that could do so.

On behalf of the Board

D J Flint

Group Chairman

1 August 2011

Introduction

We have been engaged by HSBC Holdings plc ('the Company') to review the financial information for the six months ended 30 June 2011 set out on pages 171 to 218 which comprise the consolidated income statement, consolidated statement of comprehensive income, consolidated balance sheet, consolidated statement of cash flows, consolidated statement of changes in equity and related notes. We have read the other information contained in the Interim Report 2011 and considered whether it contains any apparent misstatements or material inconsistencies with the information in the financial information.

This report is made solely to the Company in accordance with the terms of our engagement to assist the Company in meeting the requirements of the Disclosure Rules and Transparency Rules ('DTR') of the UK's Financial Services Authority ('the UK FSA'). Our review has been undertaken so that we might state to the Company those matters we are required to state to it in this report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company for our review work, for this report, or for the conclusions we have reached.

Directors' responsibilities

The Interim Report 2011 is the responsibility of, and has been approved by, the Directors. The Directors are responsible for preparing the Interim Report 2011 in accordance with the DTR of the UK FSA. As disclosed in Note 1, the annual financial statements of the Company are prepared in accordance with IFRSs as adopted by the EU. The financial information included in the Interim Report 2011 has been prepared in accordance with IAS 34 Interim Financial Reporting as adopted by the EU.

Our responsibility

Our responsibility is to express to the Company a conclusion on the financial information in the Interim Report 2011 based on our review.

Scope of review

We conducted our review in accordance with International Standard on Review Engagements (UK and Ireland) 2410 Review of Interim Financial Information Performed by the Independent Auditor of the Entity issued by the Auditing Practices Board for use in the UK. A review of interim financial information consists of making enquiries, primarily of persons responsible for financial and accounting matters, and applying analytical and other review procedures. A review is substantially less in scope than an audit conducted in accordance with International Standards on Auditing (UK and Ireland) and consequently does not enable us to obtain assurance that we would become aware of all significant matters that might be identified in an audit. Accordingly, we do not express an audit opinion.

Conclusion

Based on our review, nothing has come to our attention that causes us to believe that the financial information in the Interim Report 2011 for the six months ended 30 June 2011 is not prepared, in all material respects, in accordance with IAS 34 as adopted by the EU and the DTR of the UK FSA.

G Bainbridge

For and on behalf of KPMG Audit Plc

Chartered Accountants

London, England

1 August 2011

 

END

 

 

IR DKKDPQBKDOFD