Operating and Financial Review
Principal activities			11
Strategic direction			11
Challenges and uncertainties			11
Reconciliation of reported and underlying profit			11
Financial summary			14
Income statement			14

Group performance by income and expense item			15
Economic profit/(loss)			25
Balance sheet			26
Other information			28
Customer groups and global businesses			30
Geographical regions			46

Impact of Market Turmoil
Background and disclosure policy			97
Overview of exposure			98
Business model			102
Risk management			103
Accounting policies			103

Nature and extent of HSBC’s exposures			103
Fair values of financial instruments			114
Special purpose entities			125
Other off-balance sheet arrangements and commitments			136

Risk
Current challenges in regulation and supervision			138
Risk management			140
Credit risk			141
Liquidity and funding			172

Market risk			175
Operational risk			183
Reputational risk			184
Risk management of insurance operations			185
Capital management and allocation			189

Directors’ interests			235
Employee share option plans			238
Notifiable interests in share capital			243
Dealings in HSBC Holdings shares			243
First interim dividend for 2010			244
Second interim dividend for 2010			244
Proposed interim dividends for 2010			245

Interim Management Statement			245
Final results			245
Corporate governance			245
Telephone and online share dealing service			245
Stock codes			246
Copies of the Interim Report 2010 and shareholder enquiries and communications			246

 

 

Cautionary statement regarding forward-looking statements

This Interim Report 2010 contains certain forward-looking statements with respect to the financial condition, results of operations and business of HSBC. These forward-looking statements represent HSBC’s expectations or beliefs concerning future events and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ, in some instances materially, from those expressed or implied in such statements. For example, certain of the market risk disclosures, some of which are only estimates and, therefore, could be materially different from actual results, are dependent on key model characteristics and assumptions and are subject to various limitations. Certain statements that are not historical facts, such as those that include the words ‘potential’, ‘value at risk’, ‘expects’, ‘anticipates’, ‘objective’, ‘intends’, ‘seeks’, ‘plans’, ‘believes’, ‘estimates’, and similar expressions or variations on such expressions may be considered ‘forward-looking statements’.

     Written and/or oral forward-looking statements may also be made in the periodic reports to the US Securities and Exchange Commission (‘SEC’), summary financial statements to shareholders, proxy statements, offering circulars and prospectuses, press releases and other written materials and in oral statements made by HSBC’s Directors, officers or employees to third parties, including financial analysts.

     Forward-looking statements involve inherent risks and uncertainties. Readers are cautioned that a number of factors could cause actual results to differ, in some instances materially, from those anticipated or implied in any forward-looking statement. Forward-looking statements speak only as of the date they are made, and it should not be assumed that they have been revised or updated in the light of new information or future events. Past performance cannot be relied on as a guide to future performance. Trends and factors that are expected to affect HSBC’s results of operations are described in the ‘Operating and Financial Review’, ‘Market Turmoil’ and ‘Risk’. A more detailed cautionary statement is given on pages 6 and 7 of the Annual Report and Accounts 2009.

Group financial performance strongly ahead

At HSBC, we have a clear and distinctive strategy. It is to rebalance the Group towards the needs of a fast-changing global economy, while keeping our strong capital and liquidity position. Our focus is therefore to build upon our unrivalled franchise in emerging markets, while delivering connectivity for our customers everywhere in an increasingly connected world. That HSBC delivered a strongly improved performance in the first half of 2010 is in large part thanks to this strategy and our success in repositioning and transforming the business to deliver on it.

     Our Personal Financial Services and Commercial Banking businesses delivered significantly improved results, adding to another very strong performance in Global Banking and Markets. On a reported basis, pre-tax profits more than doubled to US$11.1 billion compared with the first half of 2009, including the impact of movements on the fair value on our own debt relating to credit spreads. Underlying pre-tax profits¹ increased by 30 per cent to US$9.6 billion year-on-year, driven by significantly reduced loan impairment charges.

     With regulatory change ahead, capital and funding strength will become even more important in deciding which banks can grow and which are left behind. Maintaining our strong balance sheet therefore remains core to our banking philosophy. We further strengthened our tier 1 capital through underlying profit generation and capital issuance.

We increased our tier 1 capital ratio to 11.5 per cent, we grew our core tier 1 ratio to 9.9 per cent and the outcome of the EU-wide stress test exercise by the Committee of European Banking Supervisors in July² confirmed the robustness of our capital position. Our ratio of customer advances to deposits remained steady at under 80 per cent, providing a broad indication of our funding strength and keeping our distinctive liquidity position.

     As one of the industry’s leading dividend payers, HSBC recognises the importance of dividend income to all our shareholders, not least our many retail investors. We declared dividends on ordinary shares of US$2.8 billion in respect of the first half of the year including a second interim dividend of eight US cents per ordinary share, payable on 6 October 2010. Return on average total shareholders’ equity improved to 10.4 per cent on a reported basis and was 9.3 per cent excluding the impact of movements on the fair value of our own debt related to credit spreads. As we reduce our run-off portfolios, we believe shareholders’ continuing support of HSBC will be rewarded with improving returns — albeit towards the lower end of the target range — in the medium term.

     Once again, emerging economies led the global recovery in the first half. Government infrastructure investment continued apace, while flows of cross-border trade and investment sustained their rapid recovery. We continued to rebalance our assets steadily towards the world’s emerging markets and to build new revenue streams across the Group, positioning the business for sustainable growth.

     Despite increasing economic uncertainty towards the end of the period, we saw appetite for credit grow steadily, especially among our business customers. This is now feeding through into lending growth, a trend we expect to continue. In the first half of the year, we added assets in targeted segments to the balance sheet, more than offsetting the effect of the run-off in our exit portfolios. We grew loans and advances to customers in all regions and by four per cent overall, compared with the end of 2009. Geographically, the strongest growth was in Asia, where we grew lending by 15 per cent. In Commercial Banking we grew lending by nine per cent globally.

     We gained share of international trade volumes, made progress in building our Insurance and Wealth Management businesses, and expanded our advisory services in Global Banking and Markets. As a result, fee income rose overall outside the US. Overall,

revenues were broadly in line with the second half of 2009. However, as we expected, they were lower than in the first half, given the exceptional market conditions in that period, especially in Global Banking and Markets. This also reflected our success in reducing and repositioning Personal Financial Services portfolios away from Consumer Finance and other unsecured lending products.

     As we focus on building a high quality asset base for the future, it is encouraging that loan impairment charges now stand at their lowest levels since the start of the financial crisis. They almost halved overall, reducing by US$6.8 billion to US$7.5 billion year-on-year. This reflects the benefit of more stable economic conditions for many of our customers and follows our actions, begun before the crisis, to reduce exposure to unsecured lending outside our key relationships, to exit unprofitable business lines and to tighten underwriting standards for new business.

     We continued to invest in expanding the business and transforming our operations. However, we did so with a focus on cost control. As a result, our cost efficiency ratio was only slightly above our target range at 53.1 per cent. Costs were broadly unchanged, excluding the impact of the one-off pension gain in the first half of 2009, and the UK and French payroll taxes on 2009 bonuses and pension curtailment accounting gain in the US which were accounted for in the current period. Overall, operating expenses were five per cent higher.

Profitable in every region outside North America

In Asia, performance was comfortably ahead, with pre-tax profits increasing by 20 per cent to US$5.6 billion. As levels of trade activity improved from the lows of a year ago and demand for credit, investment and insurance products increased, we continued to meet our customers’ growing financial needs. The contribution of Asian profits generated outside Hong Kong grew to 50 per cent, underlining our growing presence across the region.

     Pre-tax profits in Latin America increased by 36 per cent to US$0.9 billion, largely driven by improved credit experience in our retail businesses as we ran off higher risk consumer portfolios.

     In the Middle East, pre-tax profits were down by 39 per cent at US$393 million but were well ahead of the second half of 2009. Loan impairment charges were modestly higher year-on-year but more than halved in comparison with the second half of 2009 as credit delinquency trends improved. We have seen customer activity beginning to pick up and

believe the region has a sustainable and strong future.

     In Europe, pre-tax profits were strongly ahead in Personal Financial Services and were also higher in Commercial Banking. Overall, they were 19 per cent lower at US$2.8 billion, as Global Banking and Markets revenues reduced from the exceptional first half performance of 2009.

     Profits in the UK accounted for 52 per cent of the European total. In the UK, we grew international trade volumes and increased mortgage lending. The quality of the new mortgage book is illustrated by a low average loan to value ratio of 53 per cent.

     Continental Europe represented 48 per cent of total European pre-tax profits. We strengthened our management team to focus more closely on opportunities for growth across the region and began to centralise our processing operations to deliver greater economies of scale. Despite weak and volatile market conditions, HSBC successfully managed its sovereign risk exposures in respect of Greece, Portugal, Spain and Ireland which were US$4 billion and the overall quality of our sovereign debt portfolio remains strong.

     It is an encouraging sign of progress in the US that performance in North America was ahead by some US$2 billion, resulting in a significantly reduced pre-tax loss of US$80 million. Loan impairment charges fell markedly and we made good progress in developing our continuing businesses generally — including Premier, international trade finance, and our Global Banking and Markets business where we continued to support the needs of our Latin American corporate clients.

     Our US Consumer Finance run-off portfolios continued to decrease in line with our expectations. We reduced total balances across these portfolios by a further US$10 billion to US$69 billion since the end of 2009. In July, we also agreed in principle to sell the remainder of the vehicle finance loan portfolio and other related assets to an unaffiliated third party. The sale is expected to close in the third quarter of 2010.

Profitable in every customer group

Led by these improvements in the US, Personal Financial Services returned to profit for the first time in two years. Pre-tax profits were US$1.2 billion, following an improvement of US$2.5 billion year-on-year. We benefited from a stronger credit experience, in part driven by improved collections processes. We also saw stronger sales of wealth management, insurance and mortgage products and higher customer deposits.

     In Commercial Banking, pre-tax profits were also well ahead, rising by 40 per cent to US$3.1 billion, reflecting an improvement in the economic environment, supported by active portfolio management during the crisis, robust revenues and progress in rebuilding the balance sheet through selective lending growth.

     Although pre-tax profits were down 13 per cent at US$5.6 billion, Global Banking and Markets reported its second best performance of any half-year period, reinforcing the success of our emerging markets-led, financing-focused strategy. The business remained highly diversified with the largest revenue stream contributing some 20 per cent of the total. Balance Sheet Management revenues were lower, but they were robust and opportunities remained to redeploy our liquidity efficiently.

     Private Banking pre-tax profits were 13 per cent lower at US$0.6 billion, largely due to the impact of low interest rates. However, net new money inflows totalled US$7.3 billion, the majority of which were from emerging markets.

Building on our distinctive strengths

At HSBC, we are very clear about what makes us a different kind of bank and we are building on those strengths that enable us to serve our customers best.

Connecting customers across regions

As we see other companies in all industries working to build global scale, we are thankful for the global reach that comes from 145 years of doing business as an international bank. We are constantly working to harness the connectivity this provides so we can better meet the needs of our international customers.

     Global Banking and Markets provides an excellent example of this in action. Our global network allows us to service customers with cross-border trading or financing needs anywhere in the world, by accessing the expertise in our major dealing rooms in centres like London, Paris, New York and Hong Kong. This has helped us to increase the revenue contribution from emerging markets, which grew from 35 per cent to 37 per cent year-on-year.

Reinforcing our position as the world’s leading emerging markets bank

In July, Euromoney recognised the breadth and depth of HSBC’s presence across the world’s faster-growing regions by naming us ‘Best Global Emerging Markets Bank’. Throughout the first half, we continued to rebalance our footprint towards

these regions and we expect them to account for the majority of global growth for the foreseeable future.

     There is no market of greater strategic importance to HSBC than Greater China. We continue to protect and build on our position as the leading international bank in mainland China, where we opened our 100^th HSBC-branded outlet and opened a flagship new China Head Office in Shanghai. We are building on our strategic partnerships and subscribed for our full entitlement of H-shares in the Bank of Communications rights issue. We also incorporated locally in Taiwan which will complement our platforms in Hong Kong and mainland China and improve our access to the region.

     We are committed to building our presence in India too and so, in July, we announced our third investment in two years through the acquisition of the Indian retail and commercial operations of the Royal Bank of Scotland. This will significantly increase our scale in Asia’s third largest economy and give us access to 1.1 million customer relationships. Subject to regulatory approvals, we expect to complete the deal in the first half of 2011.

     In June, we also announced an acquisition to increase our presence in Kazakhstan, a fast-growing economy with important trade links to mainland China.

Maintaining our funding strength

One of the key lessons to emerge from the financial crisis was the critical importance of stable liquidity. At HSBC, deposits have always been fundamental to everything we do and they remain the fuel for our future growth.

     It is proof of our brand strength that — at a time of low interest rates and intense competition for savings — we increased customer deposit balances by three per cent to US$1,147 billion during the period. The effect on our profits of low deposit spreads remains significant, but I believe HSBC is a bank well positioned to benefit from a progressive rise in interest rates. Just as important as the financial returns, our liquidity position means we can respond to new growth opportunities as soon as they emerge — not least in Asia, where our funding base is particularly strong.

Building a customer base for tomorrow

There is no greater opportunity for HSBC in Personal Financial Services than serving the needs of the world’s 180 million mass affluent individuals. These customers are typically highly mobile, with

significant cross-border requirements that play to our strengths as a global bank.

     Premier is our flagship product for this sector and we are on track to build our customer base to six million by the end of 2011. In June, the monthly increase in Premier customer numbers reached 100,000 and, at the end of the period, total numbers reached 3.9 million. Revenues from Premier customers can be over four times that generated by a standard account in the current interest rate environment. Furthermore, wealth management products account for an increasing proportion of Premier revenues, highlighting our ability to manufacture and deliver a full suite of products of real value to affluent customers over their lifetimes. Looking to the longer term, we have now also launched Advance in 22 countries, an international proposition for the next generation of potential Premier customers.

     As trade volumes recover and the direction of global investment shifts, international business customers have continued to turn to HSBC and to benefit from our global scale and connectivity across the world’s emerging and developed markets. In Commercial Banking, international customers typically generate more than double the revenues of domestically focused companies and we grew this customer base by 16 per cent. Building relationships with small and medium-size companies is also core to our future growth strategy, and we increased these customer numbers by three per cent to 3.3 million, with 84 per cent of new customers in emerging markets.

     Within Global Banking and Markets, we are focusing on building broad-based relationships with those international customers where we are best equipped to meet their full range of financial needs and we have the greatest opportunity to grow revenues. Working together, Private Banking and Global Banking and Markets launched a family office partnership to provide better, more holistic relationship management, for our wealthiest clients. Private Banking also continued to focus on developing business in emerging markets and was recognised as ‘Best Global Wealth Manager’ by Euromoney in July.

Building sustainable revenue streams for the future

With a very clear understanding of our customers and their future needs, we are carefully developing our range of products and services in response. We are targeting those areas where we know HSBC has distinctive strengths, where the revenue opportunity

is big enough to make a difference and where the risk-adjusted returns are most attractive.

Expanding our wealth management offering

People in most of our key markets are living longer and demanding longer-term financial products, presenting great opportunities to grow our wealth management business. We are increasing share in key markets including Hong Kong, the UK and Canada and developing new products to meet the needs of our Premier customers. In 2009, we launched World Selection, a dynamically managed multi-manager fund product, bringing a diverse range of international assets to our local retail customers. In the first half of 2010, we extended the product to 21 countries and increased funds under management by 59 per cent to US$4.1 billion. We also launched five new Exchange Traded Funds (‘ETF’s) and, in July, announced the launch of our first emerging market ETF for Brazil as we continue to make low-cost access to global markets available for our retail customers.

Building our emerging market insurance platforms

As growth in demand for insurance in emerging markets accelerates, we are investing for the future with encouraging success, particularly in Asia and Latin America. Our ambition is to be the leading international bancassurer in Asia within the next decade.

     We have already built a leading life insurance business in Hong Kong through our integrated bancassurance strategy. In mainland China, HSBC Life has grown rapidly within its first year of operation. In India, our joint venture with Canara Bank and Oriental Bank of Commerce is a top 12 international insurer in the country after two years of operation. Our commitment to Asia was further underlined in January when we increased our investment in Vietnam — one of the fastest-growing ASEAN economies — by increasing our stake in Bao Viet Holdings from ten to 18 per cent.

     In Latin America, sales of insurance products increased and we continued to tailor our proposition to different customer segments and successfully launched new products in Mexico and Brazil.

Extending our leadership in international trade

International trade is set to grow faster than GDP for the foreseeable future and our own research shows that the trade finance needs of most mid-sized companies are growing quickly. Thanks to our global connectivity and local knowledge, we are meeting these needs. HSBC’s export-related trade

volume continued to grow steadily and we progressively gained market share during the period.

     To support the growing flows between emerging and developed economies, we are moving the right people and skills to the right places and, as the leading international emerging markets bank, we are particularly well placed to support the growing flows of ‘South-South’ trade. In Commercial Banking, we are seeing a rapid increase in trade flows between Latin America and mainland China and we are transferring bankers from Europe, the US and Latin America to mainland China and Hong Kong. In Global Banking, we transferred bankers from our Latin American operations into HSBC offices in mainland China, and set up a reciprocal China desk in Brazil.

Capturing the outflows from mainland China

I believe that the re-emergence of China’s economy will drive the biggest change to global trade patterns in the generation ahead. We expect mainland China’s total trade flows with the rest of the world to grow by some 13 per cent a year over the next five years to US$5 trillion.

     Mainland Chinese companies expanding overseas accounted for about half of new customer growth in Commercial Banking in Hong Kong over the past twelve months. We also aim to be the pre-eminent international bank in renminbi trade, settlement and bond issuance, as regulations change and the offshore renminbi market gradually develops. In Hong Kong, HSBC had a significant share of the cross-border clearance market and we expect to grow this further in the second half of the year. In June, we executed the first cross-border renminbi transaction in the UK and we aspire to be the first international bank to execute transactions across six continents. In July, we also acted as sole bookrunner and lead manager for the first ever offshore renminbi certificate of deposit issue, which provides a new investment vehicle for market participants to manage portfolio risk.

Building out our equity platform

Over the past 15 years, HSBC has built a world-class debt capital market platform in the world’s faster-growing markets, something Euromoney recognised when they named us ‘Best Global Emerging Markets Debt House’ in July. We are now leveraging these customer relationships and building out our equities platform in a co-ordinated and selective way across Advisory, Equity Capital Markets, Research and Distribution. We are expanding in Hong Kong, mainland China, India, the Middle East, Brazil and Mexico and developing our European business in the

UK, France and Germany. This will enable us to deliver a comprehensive range of Equities products to key institutional clients and personal, commercial and private banking customers alike. During the period, we made key hires, continued to invest in our trading and infrastructure platform, and gained market share in Asia and Europe.

Growing our leadership in Islamic finance

Islamic finance is a fast-developing industry, currently growing at over 20 per cent a year. HSBC Amanah represents the largest and most comprehensive Islamic proposition of any international bank, with successful operations in the UK, the Middle East and Asia-Pacific. We continued to expand our product range across our customer groups and we were delighted to be recognised as Euromoney’s ‘Best International Islamic Bank’ and ‘Best Sukuk House’ in 2010. In the first half of the year, we were the global lead underwriter for sukuk and we launched an Amanah Premier proposition in four markets in the Middle East and two markets in Asia-Pacific. In July, we opened our first Amanah-only branch in Qatar, the fourth country in which we have established dedicated branches to serve the full range of Islamic banking needs.

Transforming our business infrastructure

Of course, investment in building relationships and expanding our products and services will not be successful unless we continuously invest to improve customer service and deliver greater efficiency.

     Above all, we are delivering a better and more consistent experience for our customers. This year, we will refresh, refurbish or expand over 1,000 branches including more than 200 in the UK, and we have begun a three-year programme to invest over US$500 million in our Latin American branch network. We have taken the first steps towards improving the account opening experience across our retail businesses which will, over time, free our staff to focus directly on customer needs.

     We are also investing in adding front-line staff, to improve relationship management and drive future sales growth. In Personal Financial Services, we aim to recruit 1,000 additional relationship managers and other customer-facing staff this year to support the development of Premier. In Private Banking, we have begun a three-year programme to add up to 500 customer-facing staff covering key markets in Asia, Latin America and the Middle East. In Commercial Banking, we are recruiting up to 500 relationship

managers and business specialists to drive business expansion in Brazil and Mexico.

     At the same time, we are transforming our operations to create a more efficient, better connected bank. In Latin America, we are joining up our sites across the region so we can better compete with bigger local competitors. One example is the centralisation of our trade operations in Panama, which has allowed us to deliver a better, more consistent customer experience across a number of countries. We have adopted a new collections call model, allowing us to export our best practice in the US across the Group and, in the Middle East, this has led to a 40 per cent reduction in the number of outbound calls.

     We also continued to improve our direct channels. As a result, one million small and medium-size business customers used our Business Internet Banking platform and we grew the number of users of our online platform for larger commercial customers, HSBCnet, by 17 per cent to 55,000.

     Thanks to these important initiatives and the dedication and focus of all of our staff, we are making measurable progress in improving customer satisfaction. Among Business Banking customers, we have exceeded our brand health scores in a number of key markets. Meanwhile, among our Personal Financial Services customers, our ambition is to achieve a top three ranking for customer recommendation in all 15 markets that we track. We are already in the top three for nine of these markets. All of this is helping to reinforce the strength of our brand and we were delighted to be named the top banking brand by Brand Finance for the third year running in 2010.

Well positioned for the shifting economy and for regulatory change

Global demand will remain constrained as long as we face the likelihood of anaemic growth in various Western nations. But while these economies come to terms with austerity, we remain bullish on the outlook for emerging markets — both short and long-term. Some cooling off is possible, however I am confident that the authorities in leading economies like China can and will continue to deliver sustainable growth and support domestic demand.

     Regulatory change is now beginning to move up a gear, and HSBC’s capital strength positions us strongly for change. HSBC is preparing for a period which will be characterised by further intense public and political scrutiny of banks in the West and a complex compliance environment with a higher level of intervention by regulators. Meanwhile, finalising

the shape of the global regulatory framework remains the most urgent challenge for the industry and its supervisors. Greater clarity is required, however reform is clearly moving in the right overall direction. Our collective responsibility now is to get the details and the timetable right so trade and capital can flow freely and banks are able to play their full part in financing these flows and supporting economic growth.

     The West is realising that it does not have all the answers and the commitment of the G20 in driving forward the reform agenda is promising, with policymakers in emerging markets playing an increasing part. We believe it is essential that all G20 members participate according to the same rules, otherwise we will end up with an uneven playing field that looks very different depending on where a company is headquartered. In a global marketplace where businesses and people are mobile, one country cannot afford to pursue its own particular policy agenda without considering the possible unintended consequences for the wider economy.

     Finally, we believe that HSBC’s results over the past decade — and throughout the latest crisis — prove that a well-balanced, universal banking model of scale really works. We have weathered the storms in different regions and in different sectors precisely because our business is large, broad and diverse. As we continue to debate the shape of the regulatory framework, it remains our view that the financial system needs banks which are ‘big enough to cope.’ Soundly-managed universal banks not only contribute to financial stability — but are also best placed to support economic growth by meeting the full range of customer needs in our globalised, connected world.

Michael Geoghegan, Group Chief Executive
2 August 2010

Principal activities

HSBC is one of the largest banking and financial services organisations in the world, with a market capitalisation of US$161 billion at 30 June 2010.

     Through its subsidiaries and associates, HSBC provides a comprehensive range of banking and related financial services. Headquartered in London, HSBC operates through long-established businesses and has an international network of some 8,000 offices in 87 countries and territories in six geographical regions: Europe; Hong Kong; Rest of Asia-Pacific; the Middle East; North America and Latin America. Within these regions, a comprehensive range of financial services is offered to personal, commercial, corporate, institutional, investment and private banking clients. Services are delivered primarily by domestic banks, typically with large retail deposit bases, and by consumer finance operations.

Strategic direction

HSBC’s strategic direction reflects its position as ‘The world’s local bank’, combining the largest global developing markets banking business and a uniquely cosmopolitan customer base with an extensive international network and substantial financial strength.

     The Group’s strategy is aligned with the key trends which are shaping the global economy. In particular, HSBC recognises that, over the long term, developing markets are growing faster than the mature economies, world trade is expanding at a greater rate than gross domestic product and life expectancy is lengthening virtually everywhere. HSBC’s strategy is focused on delivering superior growth and earnings over time by building on the Group’s heritage and skills. Its origins in trade in Asia have had a considerable influence over the development of the Group and, as a consequence, HSBC has an established and longstanding presence in many countries. The combination of local knowledge and international breadth is supported by a substantial financial capability founded on balance sheet strength, largely attributable to the scale of the Group’s retail deposit bases.

     HSBC is, therefore, continuing to direct incremental investment primarily to the faster growing markets and, in the more developed markets, is focusing on businesses and customer segments which have international connectivity. A policy of maintaining HSBC’s capital strength and strong liquidity position remains complementary to these activities and is the foundation of decisions about the pace and direction of investment.

     The Group has identified three main business models for its customer groups and global businesses that embody HSBC’s areas of natural advantage:

•		businesses with international customers for whom connections with developing markets are crucial — Global Banking and Markets, Private Banking, the large business segment of Commercial Banking and the mass affluent segment of Personal Financial Services;
•		businesses with local customers where service efficiencies can be enhanced through global scale — the small business segment of Commercial Banking and the mass market segment of Personal Financial Services; and
•		products where global scale is possible by applying the Group’s efficiency, expertise and brand — product platforms such as global transaction banking.

     The means of executing the strategy and making greater use of the linkages within the Group are clear:

•		the HSBC brand and global networks will be leveraged to reach new customers and offer further services to existing clients;
•		efficiency will be enhanced by taking full advantage of local, regional and global economies of scale, in particular by adopting a common systems architecture wherever possible; and
•		objectives and incentives will be aligned to motivate and reward staff for being fully engaged in delivering the strategy.

Challenges and uncertainties

A detailed account of HSBC’s challenges and uncertainties is provided on pages 12 to 18 of the Annual Report and Accounts 2009. Further comments on expected risks and uncertainties are made throughout this Interim Management Report, particularly in the sections on Market Turmoil and Risk.

Reconciliation of reported and underlying profit before tax

HSBC measures its performance internally on a like-for-like basis by eliminating the effects of foreign currency translation differences; acquisitions and disposals of subsidiaries and businesses; fair value movements on own debt designated at fair value attributable to changes in HSBC’s own credit spread as the net result of such movements will be zero upon maturity of the debt; and gains from the

dilution of the Group’s interests in associates, all of which distort period-on-period comparisons. HSBC refers to this as its ‘underlying performance’.

     This approach is used to monitor progress against operating plans and previous period results because management believes that the underlying basis more accurately reflects operating performance. Reported results include the effect of the above items.

Constant currency

Constant currency comparatives for the half-years to 30 June 2009 and 31 December 2009, used in the 2010 commentaries, are computed by retranslating into US dollars for non-US dollar branches, subsidiaries, joint ventures and associates:

•		the income statements for the half-years to 30 June 2009 and 31 December 2009 at the average rates of exchange for the half-year to 30 June 2010; and
•		the balance sheets at 30 June 2009 and 31 December 2009 at the rates of exchange ruling at 30 June 2010.

     No adjustment has been made to the exchange rates used to translate foreign currency-denominated assets and liabilities into the functional currencies of any HSBC branches, subsidiaries, joint ventures or associates.

     When reference is made to ‘constant currency’ in tables or commentaries, comparative data reported in the functional currencies of HSBC’s operations have been translated at the appropriate exchange rates applied in the current period on the basis described above.

Underlying performance

The tables below compare HSBC’s underlying performance for the half-year to 30 June 2010 with the half-years to 30 June 2009 and 31 December

2009. Equivalent tables are provided for each of HSBC’s customer groups and geographical segments in their respective sections below.

     The foreign currency translation differences reflect the relative strengthening of the US dollar across Asia, as well as in Brazil, Mexico and the UK during the first half of 2010.

     The following acquisitions and disposals were adjusted for in arriving at the underlying comparison:

•		the acquisition of Bank Ekonomi in May 2009;
•		the gain on sale of HSBC’s 49 per cent interest in a joint venture for a UK merchant acquiring business in June 2009 of US$280 million;
•		the gain on reclassification of Bao Viet Holdings (‘Bao Viet’) from an available-for-sale asset to an associate in January 2010 of US$62 million;
•		the gain on the sale of HSBC’s stake in Wells Fargo HSBC Trade Bank in March 2010 of US$66 million;
•		the gain on disposal of HSBC Insurance Brokers Limited in April 2010 of US$107 million;
•		the dilution gain which arose on HSBC’s holding in Ping An Insurance (Group) Company of China, Limited (‘Ping An Insurance’) following the issue of shares by Ping An Insurance in May 2010, of US$188 million; and
•		the loss of US$47 million on reclassification of British Arab Commercial Bank plc from an associate to a held-for-sale asset in June 2010.

     The timing of the Bank Ekonomi acquisition creates an underlying adjustment between the first half of 2009 and the first half of 2010 but not between the second half of 2009 and the first half of 2010.

Reported profit before tax of US$11.1 billion in the first half of 2010 was 121 per cent higher than in the first half of 2009, 30 per cent on an underlying basis, with significantly lower loan impairment charges more than offsetting lower revenues. The difference between reported and underlying results is explained on page 11. Except where otherwise stated, the commentaries in the Financial Summary are on an underlying basis.

     The 11 per cent reduction in net operating income before loan impairment charges and other credit risk provisions (‘revenue’) was primarily attributable to three factors: (i) lower revenues in Balance Sheet Management as higher yielding positions matured, interest rates remained low and major yield curves flattened; (ii) lower revenues in HSBC Finance Corporation (‘HSBC Finance’) as the run-off portfolios continued to fall; and (iii) lower net trading income. Although deposit spread compression continued to constrain net interest income in a number of key markets, notably Hong Kong, there was strong growth in insurance and investment businesses in Asia along with higher fee income due to an increase in trade activity. In the UK, higher revenues were primarily driven by mortgage lending growth and stronger lending spreads.

     Loan impairment charges were significantly lower than in both the first and second halves of 2009 (US$6.8 billion or 47 per cent and US$4.9 billion or 39 per cent, respectively), reflecting initiatives taken to exit higher risk portfolios, enhanced underwriting and collection activities and a general improvement in the economic environment which helped stabilise credit quality. This substantial decline was driven by a significant reduction in the HSBC Finance run-off portfolio, largely due to lower customer loan balances and an easing in delinquency rates. The non-recurrence of a small number of specific charges related to Global Banking and Markets’ clients in the first half of 2009 and the run-off of certain consumer portfolios in Latin America also contributed to the improvement.

     Reported profit after tax was US$3.5 billion or 94 per cent higher than in the first half of 2009. The tax charge included US$1.6 billion attributable to the taxable gain arising from an internal reorganisation designed to strengthen the US operations, capital position and support the recoverability of US deferred tax assets. No gain appears in the consolidated financial statements from this reorganisation, but the transaction generated a tax charge in the US that is expected to be covered by operating tax losses and foreign tax credits. The gain on the transaction was eliminated on consolidation but the tax charge remained, resulting in an increase in the Group’s effective tax rate.

Reported net interest income fell by 4 per cent to US$19.8 billion; the decline was 7 per cent on an underlying basis.

     The decrease in net interest income was driven by the effects of the continuing low interest rate environment on all parts of the balance sheet together with a repositioning of customer assets towards secured lending, which has a lower incidence of loss and a lower yield.

     As expected, revenues in Balance Sheet Management slowed significantly as interest rates remained low and major yield curves flattened. In Balance Sheet Management, average interest-earning assets increased, reflecting a rise in the Group’s commercial deposit surplus, particularly in Hong Kong, and driving an increase in overall interest-earning assets.

     Average loans and advances to customers were broadly unchanged. However, yields were noticeably reduced as a result of a series of decisions to reposition lending in line with the Group’s revised risk appetite. Higher yielding balances declined in North America as the run-off portfolios continued to repay and charge-off. Unsecured portfolios in Mexico, India and Europe decreased as a result of tighter underwriting criteria and the cessation of some business lines. In the US, credit card balances

declined as customers repaid more and the number of active credit card accounts fell. This reduction in balances was mitigated by growth in lending in Asia and the UK in residential mortgages, which command a lower yield.

     The low interest rate environment had a favourable effect on the cost of funding the Group’s trading assets. Despite a lower cost of funds and asset repricing, the net interest spread contracted for the reasons described above. The net interest margin declined by a smaller amount as net free funds increased, in part due to the low interest rates which led customers to hold more funds in liquid non-interest bearing current accounts.

Net fee income remained broadly in line with the first half of 2009 on both a reported and underlying basis.

     Net fee income related to credit cards fell significantly, primarily in the US, due to a decline in late fees driven by lower volumes and delinquency levels, higher repayment levels, and reduced overlimit fees due to changes to charging practices following implementation of the CARD Act.

     Underwriting fees decreased due to reduced activity in debt and equity capital markets, particularly in the US and the UK.

     Insurance fee income in the US declined due to lower sales of credit protection products as a result

of the run-off of the Consumer Lending portfolio and the reduced volume within the card business.

     Offsetting the above, there were substantial increases in funds under management and unit trust income compared with the first half of 2009, particularly in Hong Kong and Rest of Asia-Pacific. Strong gains in most major markets during the latter part of 2009 led to an increase in the market value of assets, which resulted in higher management fees and an increase in customer transaction volumes as investor sentiment improved.

     Credit facilities fees also increased, primarily as a result of an increase in the arrangement of loans and loan syndication in Hong Kong and the Rest of Asia-Pacific region.

Reported net trading income at US$3.6 billion was 43 per cent lower than in the first half of 2009. On an underlying basis, it fell by 45 per cent compared with the first half of 2009 but was in line with the second half of the year.

     The decline in net trading income was driven by a US$2.1 billion adverse effect from non-qualifying hedges, which are derivatives entered into as part of a documented interest rate management strategy for which hedge accounting has not or cannot be applied. These are principally cross-currency and interest rate swaps used to economically hedge fixed rate debt issued by HSBC Holdings, floating rate debt issued by HSBC Finance and certain operating leased assets. The loss recognised in respect of non-qualifying hedges was a result of fair value losses on these instruments, primarily driven by the decrease in long-term US interest rates relative to sterling and euro interest rates. In HSBC Finance, the volume of non-qualifying hedge positions also increased as the duration of the mortgage book lengthened and swaps were used to more closely align the duration of the funding liabilities. This compared with fair value gains recognised in respect of these instruments in the same period in 2009. The size and direction of the changes in the fair value of non-qualifying hedges which are recognised in the income statement can be volatile from period to period, but do not alter the cash flows expected as part of the documented interest rate management strategy for both the instruments and the underlying economically hedged assets and liabilities.

     Net interest income earned on trading activities decreased due to a fall in interest rates. The cost of internally funding these assets also declined as a result of the reduction in interest rates. However, reported net trading income excludes this interest expense.

     Net income from trading activities declined compared with the unusually high levels reported

in the first half of 2009, which benefited from exceptional volumes and margins and favourable market conditions. Revenues slowed in the second quarter of 2010 as European sovereign debt concerns and widening credit spreads suppressed client activity and reduced demand for foreign exchange, Credit and Rates products.

     Rates income fell with the slowdown in client activity in Europe, while increased competition in the US adversely affected volumes and margins. The decrease was partly offset by fair value gains on structured liabilities as credit spreads widened, compared with losses in the same period in 2009.

     Credit trading recorded a net release of previous write-downs on legacy positions and monoline exposures of US$362 million, reflecting an improvement in asset prices; the first half of 2009 included a reported net charge of US$602 million. This benefit however, was more than offset by the non-recurrence of gains in other parts of the business that arose in the first half of 2009.

     Performance in the foreign exchange business remained strong but suffered from a reduction in market volatility and customer-driven volumes compared with the unprecedented levels experienced in late 2008 and early 2009. Additionally, as a number of competitors sought to rebuild their businesses, the trading environment became more competitive, reducing spreads and adversely affecting revenues.

     Trading income benefited from foreign exchange gains on trading assets held as economic hedges of foreign currency debt designated at fair value, with the offset reported in ‘Net income from financial instruments designated at fair value’. Foreign exchange losses were reported on these instruments in the first half of 2009.

HSBC designates certain financial instruments at fair value to remove or reduce accounting mismatches in measurement or recognition, or where financial instruments are managed and their performance is evaluated together on a fair value basis. All income and expense from financial instruments designated at fair value are included in this line except for interest arising from HSBC’s issued debt securities and related derivatives managed in conjunction with those debt securities, which is recognised in ‘Interest expense’.

     HSBC principally uses the fair value designation in the following instances (for which all numbers are ‘reported’):

•		for certain fixed-rate long-term debt issues whose rate profile has been changed to floating through interest rate swaps as part of a documented interest rate management strategy. Approximately US$64 billion (31 December 2009: US$63 billion) of the Group’s debt issues have been accounted for using the fair value option.
		The movement in fair value of these debt issues includes the effect of own credit spread changes and any ineffectiveness in the economic relationship between the related swaps and own debt. As credit spreads widen or narrow, accounting profits or losses, respectively, are booked. The size and direction of the changes in own credit spread and ineffectiveness, which will be recognised in the income statement, can be volatile from period to period, but do not alter the cash flows envisaged as part of the documented interest rate management strategy. As a consequence, gains and losses arising from changes in own credit spread on long-term debt, and other fair value movements on the long-

		term debt and related derivatives, are not regarded internally as part of managed performance and are therefore not allocated to customer groups, but are reported in the ‘Other’ group. Own credit spread movements are excluded from underlying results. Similarly, such gains and losses are ignored in the calculation of regulatory capital;
•		for US$15 billion (31 December 2009: US$15 billion) of financial assets held to meet liabilities under insurance contracts, and certain liabilities under investment contracts with discretionary participation features (‘DPF’); and
•		for US$7 billion (31 December 2009: US$8 billion) of financial assets held to meet liabilities under unit-linked and other investment contracts, as well as the associated liabilities.

     On an underlying basis, HSBC reported income of US$11 million in the first half of 2010 compared with income of US$917 million in the first half of 2009. The large difference between the reported and underlying results is due to the exclusion from the latter of the credit spread-related movements in the fair value of HSBC’s own long-term debt. A gain of US$1.1 billion was reported in the first half of 2010, which resulted from a widening of credit spreads, compared with a loss of US$2.5 billion reported in the first half of 2009.

     An expense of US$229 million was recorded due to a fair value movement on assets held to back insurance and investment contracts, compared with

income of US$892 million in 2009. This reflected investment losses in the current period which were driven by weaker markets, and predominantly affected the value of assets held in unit-linked and participating funds in Hong Kong, the UK and France. Investment gains were also lower in Brazil than in the first half of 2009.

•

To the extent that the investment gains or losses related to assets held to back investment contracts, the income or expense associated with the corresponding movement in liabilities to customers was also recorded under ‘Net income from financial instruments designated at fair

		value’. This amounted to income of US$198 million in the first half of 2010 compared with an expense of US$158 million in the same period in 2009.
•		To the extent that the investment gains or losses related to assets held to back insurance contracts or investment contracts with DPF, they were offset by a corresponding change in ‘Net insurance claims incurred and movement in liabilities to policyholders’ to reflect the extent to which unit-linked policyholders, in particular, participate in the investment performance experienced in the associated asset portfolios.

Reported net gains from financial investments of US$557 million were US$234 million higher than in the first half of 2009. On an underlying basis, excluding a US$62 million accounting gain arising from the reclassification of Bao Viet as an associate following the purchase of additional shares, they increased by US$147 million. This was primarily from a reduction in the level of impairments on available-for-sale equity securities.

     Net gains on the disposal of debt securities increased. These gains were primarily attributable to

the sale of assets by Balance Sheet Management and by Global Markets, including available-for-sale government debt securities and mortgage-backed securities.

     Net gains on the disposal of equity securities were lower than in the first half of 2009. Disposal gains in the private equity portfolios increased. However, this was more than offset by the non-recurrence of the gain on disposal of holdings of Visa Inc. shares in 2009.

Reported net earned insurance premiums amounted to US$5.7 billion, 13 per cent higher than in the first half of 2009. On an underlying basis, they increased by 11 per cent.

     Growth in net earned insurance premiums was driven by continuing strong performance in the Hong Kong life insurance business, with higher sales

of unit-linked, whole life and deferred annuity products reflecting successful sales campaigns and additional sales staff. The life insurance product designed for high net worth individuals introduced in Hong Kong in 2009 performed well.

     Net earned insurance premiums also grew strongly in Latin America, driven by improved

economic conditions and stronger sales, mainly in unit-linked pension products. Within other regions, successful marketing campaigns in France, Malaysia and Taiwan, and new product launches in the latter, resulted in higher sales.

     Partly offsetting this growth was the effect of closing the loss-making motor underwriting business in the UK during the second half of 2009. In the US, the run-off of payment protection insurance following the decision to cease new real estate lending in HSBC Finance, led to a decrease in net earned premiums.

     As a consequence of the increase in premiums from new business noted above, there was an

increase in liabilities to policyholders reported in ‘Net insurance claims incurred and movement in liabilities to policyholders’ which reflected new liabilities established on the inception of policies. The relationship between insurance premiums and movement in liabilities to policyholders becomes more direct as the level of policyholder participation in asset performance increases; this is particularly the case for unit-linked contracts and, to a lesser extent, those with DPF.

Reported other operating income of US$1.5 billion was 28 per cent higher than in the first half of 2009. Income in the first half of 2010 included a gain of US$188 million following the dilution of HSBC’s holding in Ping An Insurance, gains of US$107 million from the sale of HSBC Insurance Brokers and US$66 million from the disposal of the Group’s interest in the Wells Fargo HSBC Trade Bank, and a write-down of US$47 million resulting from an agreement to sell HSBC’s shareholding in British Arab Commercial Bank plc.

     Reported results in the first half of 2009 included gains of US$280 million from the sale of the card merchant-acquiring business. On an underlying basis, excluding the items referred to above, other operating income increased by 34 per cent, mainly from gains on the disposal of property in France and the US.

     Net losses recognised on assets held for sale declined, reflecting lower losses on foreclosed properties held for sale in HSBC Finance due to the stabilisation in property prices. In addition, a US$77 million loss was recognised on the sale of

the US vehicle finance servicing operations and an associated US$1.0 billion loan portfolio to Santander Consumer USA Inc.

     The improvement in the property markets in Hong Kong and the UK led to gains and lower valuation losses, respectively, on investment properties, resulting in reduced net investment valuation losses for HSBC. In addition, property gains of US$194 million and US$56 million, respectively, were recognised on the sale and leaseback of HSBC’s Paris and New York headquarters.

     Favourable movements in the present value of in-force (‘PVIF’) long-term insurance business were mainly due to an increase in sales of life insurance products in Hong Kong. These were partly offset by the non-recurrence of gains recognised in the first half of 2009 following the refinement of the income recognition methodology in HSBC Finance.

     Gains recognised in the first half of 2009 on the sale of US prime residential mortgage portfolios did not recur.