HSBC 2008 Annual Report Download - page 182

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
SPEs > SIVs and conduits
180
These money market funds invest in diverse
portfolios of highly-rated debt instruments, including
limited holdings in instruments issued by SIVs. At
31 December 2008, the exposure of these funds to
SIVs was US$0.5 billion (2007: US$3.9 billion).
Constant Net Asset Value funds
CNAV funds price their assets on an amortised cost
basis, subject to the amortised book value of the
portfolio remaining within 50 basis points of its
market value. This feature enables CNAV funds to
create and liquidate shares in the funds at a constant
price. If the amortised value of an asset portfolio
were to vary by more than 50 basis points from its
market value, the CNAV fund would be required to
price its assets at market value, and consequently
would no longer be able to create or liquidate shares
at a constant price. This is commonly known as
‘breaking the buck’.
Investments made by the CNAV funds in senior
notes issued by SIVs continued to deteriorate in
valuation terms during 2008. The market values of
the underlying assets of those SIVs were affected by
market nervousness over possible default levels,
exacerbated by severe illiquidity. This reduced the
ability of SIVs to sell assets in order to fund
maturing liabilities, or issue new senior notes in
order to raise cash. As a consequence, the CNAV
funds recorded unrealised losses on their SIV
holdings.
During 2008, the following actions were taken
by HSBC in respect of the CNAV funds to maintain
their AAA rating and mitigate any forced sale of
liquid assets to meet potential redemptions:
• the provision of additional letters of limited
indemnity (‘LOI’) to the directors of the CNAV
funds that held investments in SIVs, as well as
amendments to existing letters of limited
indemnity. The total assets under management
(‘AUM’) of the funds in respect of which
indemnities were provided amounted to
US$43.8 billion at 31 December 2008 (2007:
US$27.1 billion); and
• in early October 2008, HSBC:
(i) purchased all the SIV assets that were in
enforcement from the CNAV funds, which
amounted to US$687 million. Enforcement
is the process by which winding down of
independent SIVs and repaying secured
creditors begins. The purchased SIV assets
are included within HSBC’s consolidated
holdings of ABSs on page 151;
(ii) made a payment of US$43 million under
the letters of limited indemnity as a
consequence of HSBC purchasing all the
SIV assets that were in enforcement from
the CNAV funds; and
(iii) made capital contributions amounting to
US$53 million.
The following table provides a breakdown of the
losses incurred and capital contributions made as a
result of the actions taken by HSBC.
2008
US$m
Payment under LOI ..................................... 43
Capital contribution ..................................... 53
Fair value write down1 ................................. 18
Total ............................................................. 114
1 When HSBC purchased the enforced SIV assets from a fund
at their amortised cost, an immediate loss was recognised
by HSBC on initial recognition.
As stated on page 173, a reassessment of the
required consolidation accounting tests is performed
whenever there is a change in the substance of the
relationship between HSBC and an SPE. As a result
of the events described above, a reassessment of the
consolidation tests was, therefore, performed.
When considered together, the actions taken by
HSBC demonstrated the Group’s support, within
limited parameters, of the CNAV funds in the
prevailing market conditions. This support was
based on a commercial decision to support the funds
at that time, but did not constitute any commitment
to undertake further action and the future operations
of the funds in question continue to be governed by
their respective prospectuses. HSBC concluded that
this substantively changed the relationship HSBC
had with these CNAV funds, and therefore HSBC
consolidated them from 30 September 2008.
Although the actions taken by HSBC described
above occurred in early October 2008,
management’s intention had been agreed prior
to this date.
The effect of consolidating the CNAV funds
on HSBC’s balance sheet was to include
US$43.8 billion of assets and US$43.1 billion of
liabilities. HSBC’s exposure to the funds is
described below.