HSBC 2007 Annual Report Download - page 189

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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’.
HSBC’s CNAV funds hold senior notes issued
by a number of SIVs and, due to current market
liquidity conditions and consequential actions of the
rating agencies, the market value of this SIV paper
has deteriorated. This has caused the CNAV funds to
record unrealised losses on their SIV investments.
While the majority of these SIVs are bank-
sponsored, and are not judged to be impaired, there
are holdings in three independent SIVs which have
experienced greater difficulties; two of these, in
which HSBC’s CNAV funds have invested
US$0.3 billion, were placed in enforcement in
early 2008; the process by which the winding down
of the independent SIVs and repaying secured
creditors begins.
The deterioration in the market value of
holdings of SIV paper raised the possibility that
certain CNAV funds would be forced to realise
liquid assets to meet potential redemptions. To help
address this potential impact, on 24 December 2007,
HSBC provided two letters of limited indemnity,
capped at US$33 million and £4 million
(US$8 million) respectively, in relation to certain
holdings of SIV assets of two of its CNAV funds
with total assets under management (‘AUM’) at
31 December 2007 of US$27.1 billion. These limited
indemnities did not result in HSBC consolidating
these funds because HSBC was not exposed to the
majority of the risks and rewards of ownership and
the investors of the funds continue to bear the first
loss. Separately, in December 2007, HSBC acquired
US$0.3 billion of SIV paper at fair value from these
CNAV funds.
Since 31 December 2007, HSBC has
provided two additional letters of limited indemnity
capped at US$33 million and £2 million
(US$4 million) respectively, in relation to certain
holdings of SIV assets of a further two CNAV funds
with AUM at 31 December 2007 of US$8.7 billion.
HSBC is not exposed to the majority of risks and
rewards of ownership of the funds.
HSBC has continued to create and liquidate
shares in all its CNAV funds at a constant price.
Enhanced VNAV funds
Enhanced VNAV funds price their assets on a fair
value basis and consequently prices may change
from one day to the next. These funds pursue an
‘enhanced’ investment strategy, as part of which
investors accept greater credit and duration risk in
the expectation of higher returns.
Money market activities are highly developed
in France due to the historical restriction on the
payment of interest on current accounts, and the
search for enhanced yields has resulted in
sophisticated money market funds which are
essentially used as an alternative to cash. However,
since July 2007, French dynamic money market
funds have experienced unprecedented redemption
requests caused by the market’s lack of confidence
in funds containing exposure primarily to US
sub-prime assets. In August 2007, the decision by
two French institutions to suspend withdrawals from
certain asset-backed securities funds caused a
general acceleration of redemption requests on
dynamic money market funds.
In the third quarter of 2007, HSBC acquired
underlying assets and shares in two of its dynamic
money market funds of €1.2 billion (US$1.8 billion)
and €0.6 billion (US$0.9 billion) respectively to fund
asset redemptions. No additional shares were
acquired in the fourth quarter. HSBC’s aggregate
holding in these funds at 31 December 2007 was
€0.9 billion (US$1.3 billion). The total AUM
of these two funds at 31 December 2007 was
€2.1 billion (US$3.1 billion). These funds were not
consolidated by HSBC at 31 December 2007
because the acquisition of additional shares in these
funds did not expose HSBC to the majority of risks
and rewards of ownership. However, post year end,
one of the funds has been consolidated by HSBC as
a result of continued redemptions by unit holders
which caused HSBC’s percentage holding in the
funds to increase to a level where HSBC would
obtain the majority of risks and rewards of
ownership.
A further Enhanced VNAV fund experienced
high shareholder redemptions in the fourth quarter
of 2007 which depleted its stock of liquid assets,
reducing its ability to meet further redemption
payments. During November 2007, HSBC made two
purchases of shares in the fund for US$0.3 billion
and US$0.1 billion, respectively, to fund asset
redemptions. This resulted in HSBC consolidating
the fund because its resultant holding of 52 per cent
represents the majority of risks and rewards
of ownership.