HSBC 2008 Annual Report Download - page 176

HSBC HOLDINGS PLC
Report of the Directors: Impact of Market Turmoil (continued)
SPEs > SIVs and conduits
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arrangements or capital structure of the SPE change.
The most significant categories of SPEs are
discussed in more detail below.
Structured investment vehicles and conduits
Structured investment vehicles
Structured investment vehicles (‘SIV’s) are SPEs
which invest in diversified portfolios of interest-
earning assets, generally funded through issues of
commercial paper (‘CP’), medium-term notes
(‘MTN’s) and other senior debt to take advantage of
the spread differentials between the assets in the SIV
and the funding cost. Prior to the implementation of
Basel II, it was capital efficient to many bank
investors to invest in highly-rated investment
securities in this way. HSBC sponsored the
establishment of two SIVs, Cullinan Finance
Limited (‘Cullinan’) and Asscher Finance Limited
(‘Asscher’) in 2005 and 2007, respectively, and in
November 2007 HSBC consolidated Cullinan and
Asscher.
As market illiquidity intensified, there were two
main challenges for the SIV sector which could force
asset sales: an inability to fund in the CP markets
and the sensitivity of the continuing operation of
SIVs to changes in the market value of their
underlying assets.
In order to remove the risk of having to make
forced asset sales, HSBC established three new
securities investment conduits (defined below) to
take on the assets held in Cullinan and Asscher.
Mazarin Funding Limited (‘Mazarin’), an asset
backed CP conduit, and Barion Funding Limited
(‘Barion’), a term-funding vehicle, were set up in
respect of Cullinan; and Malachite Funding Limited
(‘Malachite’), a term-funding vehicle, was set up in
respect of Asscher. During 2008, the investors in the
capital notes issued by Cullinan and Asscher had the
option of exchanging their existing capital notes for
the capital notes of the respective new conduits. In
addition, the new conduits agreed to purchase the
assets in Cullinan and Asscher. As a result of this
agreement the legal title of all Cullinan and
Asscher’s assets were transferred to the new
conduits. By 31 December 2008, all the original
assets in Cullinan and Asscher were transferred to
the new conduits.
During 2008, 91.3 per cent of the remaining
capital note holders in Asscher and all of the capital
note holders in Cullinan elected to exchange their
existing holdings for capital notes in the new
conduits. In January 2009, the remaining 8.7 per cent
of Asscher’s capital notes were redeemed. At
31 December 2007, the holders of the capital notes
bore the risk of any actual losses arising in the new
conduits up to US$2.3 billion, being the par value of
their respective holdings. Prior to the exchanges of
assets against capital note extinguishments, the par
value of the capital notes was US$2.6 billion.
At 31 December 2008, the economic first loss
protection from capital note holders amounted
to US$2.2 billion (2007: US$2.3 billion). The
reduction in economic first loss protection is
attributable to the recognition of a US$92 million
realised loss at 31 December 2008 (2007: n/a). On an
IFRS accounting basis, the capital notes were
initially recognised at fair value on consolidation,
which amounted to US$1.3 billion at 31 December
2007. At 31 December 2008, on an IFRS accounting
basis, an impairment charge of US$293 million
(2007: n/a) was recognised in addition to the realised
loss of US$92 million, therefore reducing the
carrying amount of these capital notes to
US$0.9 billion.
Conduits
HSBC sponsors and manages two types of conduits
which issue CP; multi-seller securities and
securities investment conduits (‘SIC’s). HSBC has
consolidated these conduits from inception because
it is exposed to the majority of risks and rewards of
ownership.
Securities investment conduits
Solitaire, HSBC’s principal securities investment
conduit, purchases highly rated ABSs to facilitate
tailored investment opportunities. HSBC’s other
SICs, Mazarin, Barion and Malachite, evolved from
the restructuring of HSBC’s sponsored SIVs as
discussed above.
Multi-seller conduits
These vehicles were established for the purpose of
providing access to flexible market-based sources of
finance for HSBC’s clients, for example, to finance
discrete pools of third-party originated trade and
vehicle finance loan receivables. HSBC’s principal
multi-seller conduits are Regency Assets Limited
(‘Regency’), Bryant Park Funding Limited LLC
(‘Bryant Park’), Abington Square Funding LLC
(‘Abington Square’) and Performance Trust.
The multi-seller conduits purchase or fund
interests in diversified pools of third-party assets
financed by issuing CP or drawing advances from
HSBC. The cash flows received by the conduits
from the third-party assets are used to service the
funding and provide a commercial rate of return for
HSBC for structuring, for various other