Global Opportunities: Hong Kong

HSBC shifts derivatives trades to HK as HQ decision looms

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HSBC has begun shifting billions of dollars worth of derivatives trades from London to Hong Kong to take advantage of the city's favorable funding and regulatory environment, and to help position itself for a potential relocation of its headquarters, sources with direct knowledge of the bank's trading arrangements told Reuters.

The development comes as a slew of regulatory changes brought in after the 2008 financial crisis make it increasingly expensive for banks to trade derivatives in the United States and Europe. Booking trades outside Britain would potentially help reduce HSBC's exposure to the country's bank levy, one of the sources said.

The British lender, which is exploring whether to relocate its headquarters out of London, has begun moving interest rate swaps booked in Britain over to its Hong Kong subsidiary, three people with direct knowledge of HSBC's trading books said.

Interest rate swaps, which allow investors and companies to hedge their exposure to interest rate changes, comprise the bulk of the global over-the-counter derivatives market, with a notional value of around $500 trillion, according to the Bank for International Settlements.

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Large swap dealers like HSBC typically hold hundreds of billions of dollars worth of such trades on their balance sheet.

"Our approach to booking derivatives transactions is driven by a number of factors, including client needs and the type of contract," a Hong Kong-based spokesman for HSBC said in response to questions on the matter.

Global banks have typically held the majority of Asia-related derivatives trades on their European balance sheets, with London being a major booking center for such deals.

This model has historically been more efficient than having multiple booking centers, allowing banks to gain economies of scale by aggregating their capital and infrastructure in one or two locations, while London also has a deep talent pool of middle and back-office staff.

After the financial crisis, many U.S. banks increased the volume of trades they booked in London as its regulatory regime was less onerous than the one they faced on Wall Street.

During the past 18 months, many banks have begun to review their Asia trade booking arrangements amid tough new rules that have made Britain less attractive as a global trade booking center. These include ring-fencing retail customers' deposits, new European Union rules governing the processing of derivatives, and the bank levy.

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The levy is currently a tax on British banks' global balance sheets but the government has announced plans to change it so that by 2021 it will apply only to assets held in Britain.

HSBC began reviewing its trading arrangements more than 18 months ago, but started moving interest rate swaps in recent months, two of the sources said.

Hong Kong's top financial policy advisory body, the Financial Services Development Council, said in a September 2015 paper that Hong Kong should "seize the opportunity" to position itself as a global booking center to rival London and New York.

For HSBC, moving such trades to Hong Kong is easier than for many other global lenders as it has a big standalone Hong Kong-incorporated bank subsidiary which has low funding costs due to the bank's large deposit base, two sources said.

Booking more trades in Asia also helps lay the groundwork for a potential relocation of the bank's headquarters, both politically and operationally, the sources said. HSBC CEO Stuart Gulliver has said the lender will 'pivot' its strategy towards China and its Pearl River Delta.

"They [HSBC] also want to inflate the Hong Kong balance sheet so that if they decide to move their headquarters to Hong Kong they can say to the regulators 'well, look, we do as much business in Hong Kong as we do in London'," one of these people said.

Moving trades to Hong Kong involves changing a trading contract so that the bank's client, which could be a fund manager, company or another bank, has the HSBC Hong Kong entity as its counterparty.

For some clients, however, this may not be possible for legal reasons, in which case the HSBC London entity transacts a so-called 'back-to-back' trade with the Hong Kong entity. This transaction effectively transfers the trade to the Hong Kong balance sheet but the client keeps the British entity as its legal counterparty.

The bank is currently focusing on moving interest rate swaps, which comprise the largest part of the London swaps portfolio, one person said.

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A third source with direct knowledge of the bank's trading book said HSBC had also been booking a greater proportion of new Asia trades in its Hong Kong subsidiary over the past 18 months.

HSBC announced in April that it was reviewing whether it should move its headquarters out of Britain amid shareholder pressure to boost returns.

Hong Kong, the bank's former home, is considered a natural alternative by market-watchers, while the Hong Kong Monetary Authority, the city's de facto central bank, has said it would welcome such a move.