Redington13-15 Mallow StreetLondon EC1Y 8RD

T. 020 7250 3331www.redington.co.uk

Non-cash funding solutions

Jeremy Lee – RedingtonNobby Clark – HSBC Pensions Solutions Group

25 November 2010

Agenda

1. What’s the alternative?

2. A brief history

3. Recent transactions

4. Issues to consider

5. HSBC case study

6. Looking ahead

7. Questions

3

What’s the alternative?

Contingent assets

• Guarantees

• Security

• Escrow

• Letters of Credit

Business assets

• Direct transfer

Asset-backed

• Priority of cashflows

• Security over assets

Cash

Common features of recent asset-backed structures

Corporate

Pension scheme

SPV

• Income generating• Unencumbered• Tax deduction – via

pension scheme?

1. Corporate places asset in SPV

• Typically “rent”• Market rates

2. Income from asset received by SPV

• Share of profits and interest in SPV

• Fixed period• Multiple coverage by “rent”• Not direct pass through

3. Scheme’s interest pays income

• Valuation -ongoing/distress

• Covenant assessment• Shortfall at end

4. Scheme also has security over [some] assets in the SPV

Note: This is intended as an overview only. Individual objectives and circumstances will alter the structuring.

4

Non-cash funding – a brief history

20102008200620042002

Sponsors fear trapped surplus

Smarter use of balance sheet

TPR/PPF brings focus on contingent assets

Letters of credit(National Grid)

Corporate guarantee

Sponsor affordability tested

Escrow (Marconi)

Banks develop products

LP/trust structures (M&S, Sainsbury’s,

Diageo)

Super-security(KKR/Boots)

Leveraged transactions

Accelerated cash(Somerfield) Business assets

(John Lewis, Uniq?)

Insurance vehicles

Mar

ket

dri

vers

Po

pu

lar

solu

tio

ns

5

0

200

400

600

800

1000

12002

00

7

20

08

Jun

09

Jul 0

9

Au

g 0

9

Sep

09

Oct

09

No

v 0

9

Dec

09

Jan

10

Feb

10

Mar

10

Ap

r 1

0

May

10

Jun

10

Jul 1

0

Au

g 1

0

Sep

10

Oct

10

No

v 1

0

Val

ue

of

tran

sact

ion

(£

in m

illio

ns)

Asset backed Business asset

Un

iq?

Recent activity using asset-backed structures and business assets

6

Source: Annual Reports, press releasesNote: Tesco has raised funds via sale and leaseback of properties through a 50:50 JV with the pension schemeUniq is subject to review by The Pensions Regulator

£1,760m

M&

S 1

M&

S 2

GK

N

Llo

yds

Joh

n L

ewis IT

V

M&

S 3

J Sa

insb

ury

Dia

geo

Wh

itb

read

HSB

C

Ph

ilip

s

Un

iq?

Co

stai

n

Inte

rser

ve

Joh

n L

ewis

Tesc

o 1

Tesc

o 2

Tesc

o 3

Travis Perkins

7

Issues to consider

Key issues to consider

Funding deficit reduction

Impact on recovery plan

Greater security

Corporate accounting treatment

Managing future surplus

Asset concentration / Employer-related investments

Support investment strategy

Unrecognised value?

Asset valuation – ongoing/distress

Tax treatment

Trustee education / Complexity

Legal advice

M&S: Because there is no Plan B

Date Market value of property

Annual cash How long for? Final lump sum? NPV of cash

2007 £1.1bn £50m 15 years No £500m

2008 £400m £22m 14 years No £200m

2010 - £36m 15 years(from 2017)

Up to £350m in 2031

£300m

0

20

40

60

80

100

120

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

20

22

20

23

20

24

20

25

20

26

20

27

20

28

20

29

20

30

20

31

£m

Up to £350m

Source: Annual Reports, press releases8

Date Market value of property

Annual cash How long for? Final lump sum? NPV of cash

2007 £1.1bn £50m 15 years No £500m

2008 £400m £22m 14 years No £200m

Date Market value of property

Annual cash How long for? Final lump sum? NPV of cash

2007 £1.1bn £50m 15 years No £500m

Date Market value of property

Annual cash How long for? Final lump sum? NPV of cash

9

Impact on recovery plans

0 5 10 15 20 25

Average Recovery Plan

Lloyds

ITV

Whitbread

Diageo

GKN

J Sainsbury

Travis Perkins

John Lewis

M&S

Years

Comparing the length of the payment schedules

Source: Annual Reports, press releases, TPR Recovery Plan analysisNote: Payment schedules are for the asset-backed payments only

10

Greater security

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Lloyds Whitbread GKN John Lewis M&S J Sainsbury Diageo

Value of pension scheme interest as proportion of total assets in structure

Source: Annual Reports, press releasesNote: Asset-backed structures only and where sufficient information is available

11

Reducing the IAS 19 deficit

Company IAS 19 Plan Asset?

M&S Y

Lloyds Y

John Lewis N

GKN Y

Whitbread N

ITV N

J Sainsbury Y

Diageo N/K

Travis Perkins Y

Source: Annual Reports, press releasesNotes: Asset-backed structures only

12

Managing future surpluses

Company Ability to manage surplus

M&S Final payment up to £350m

Lloyds No

John Lewis Final payment between £0.5m and £99.5m

GKN Future surplus can be used to offset service cost

Whitbread Final payment up to £110m

ITV Final payment up to £150m

J Sainsbury Final payment up to £600m

Diageo Final payment up to £430m

Travis Perkins No

Source: Annual Reports, press releasesNotes: Asset-backed structures only

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

Uniq?

Tesco

Philips

Interserve

HSBC

John Lewis

Costain

M&S

GKN

J Sainsbury

Whitbread

Diageo

Travis Perkins

ITV

John Lewis

Lloyds

Value of structure as proportion of total scheme assets

13

Asset concentration

Asset-backed structures

Business assets

Source: Annual Reports, press releasesNotes: For Tesco, we have assumed 50% of the MV of properties placed into the JV, although it is not clear what the value isUniq is subject to review by The Pensions Regulator

14

Issues to consider

Key issues to consider

Funding deficit reduction

Impact on recovery plan

Greater security

Corporate accounting treatment

Managing future surplus

Asset concentration / Employer-related investments

Support investment strategy

Unrecognised value?

Asset valuation – ongoing/distress

Tax treatment

Trustee education / Complexity

Legal advice

Key issues to consider

Funding deficit reduction

Impact on recovery plan

Greater security

Corporate accounting treatment

Managing future surplus

Asset concentration / Employer-related investments

Support investment strategy

Unrecognised value?

Asset valuation – ongoing/distress

Tax treatment

Trustee education / Complexity

Legal advice

15

Global Banking and Markets

Alternatives to Cash Funding HSBC Case Study

Nobby Clark – November 2010

16

HSBC Bank (UK) Pension SchemeHSBC’s track record in managing risk

HSBC has been actively engaged with its defined benefit pension schemes on risk management since 2004

As a regulated financial, we were able to make a direct comparison between the risks being run within the HSBC Bank

(UK) Pension Scheme and within HSBC Global Markets

– Pension Scheme was running approx 3 times as much risk as the Trading Books

– Trading books had 400 traders with position limits / stop loss limits and management oversight and intervention

– Historically, Pension Scheme Trustees met quarterly and the interface with the Sponsor was primarily handled by HR

Senior management decided that, although capital treatment and disclosure may vary between Pension Scheme and

Bank it did not want to take risk in the Pension Scheme that it wouldn’t take directly on balance sheet

A strategy was developed and approved by HSBC senior management and the Trustee

The strategy was based on Group ALM Policy and involved interest rate and inflation swaps and reducing the

Schemes exposure to equities

Although exposures were thought of as direct exposures the strategy recognised the role of Trustees and their

advisers (see HSBC Annual Report)

HSBC recognised and accepted that increased contributions would be required if the strategy was implemented

HSBC risk management actions pre-dated the Basel 2 capital framework which required increased capital to be held

against pension risk

Whilst the key driver was managing economic risk the changing capital framework was expected to reward sound risk

management

17

Financial Sector Considerations - Capital

Current FSA Requirements

Pillar 1 - Funding

– A firm must deduct and IAS19 surplus from Pillar 1 capital resources, as the surplus is not available to absorb losses

– A firm must deduct either the IAS19 deficit or the Deficit Reduction Amount (DRA)

– The DRA equals the next 5 years of contributions. HSBC has generally elected the DRA for stability reasons

Pillar 2 – Risk of Increased funding

– The FSA provides Banks with guidance that it will review Bank internal calculations vs the potential increased funding requirement

at a 99.5% 1 year VaR level

Possible changes to FSA regulations

– The DRA “filter” is expected to be removed. This will increase the volatility of the capital required to support a DB Pension

Scheme. For some schemes the quantum may increase too

Observations

The pension capital regime differs from banking and trading book capital regimes

It is quite reasonable that it should differ – we have yet to see a pension scheme that manages its balance sheet

exactly like a bank does

Other supervisors differ in the filters that they allow for Pillar 1 capital, and in whether they require risk capital to be

held

Basel 3 does not require pension risk capital to be held

18

Financial Sector Considerations - Liquidity

The importance of liquidity to financial institutions – particularly banks / near banks / shadow banks – was

highlighted early on in the financial crisis

Characteristics that expose them to liquidity risks include:

– Their central role in the economy, particularly if deposit-taking

– Their high levels of leverage

– Their role in providing maturity transformation

“Liquidity regulation and supervision should be recognised as of equal importance to capital regulation”*

Global regulation is now falling into place for internationally active banks, driven by the Basel Committee:

Liquidity Coverage Ratio

– 2011 Observation, 2015 Implementation

– LCR = Value of unencumbered high quality liquid assets / cumulative cash outflow over 30 day stress period

Net Stable Funding Ratio

– 2012 Observation, 2018 Implementation

– NSFR = Available stable funding (liabilities >1Y or stable deposits) / Required stable funding

– Requires stable funding for all but the most liquid assets

– Proposals for the precise mechanism and initial calibration expected by end 2010

Pension assets do not count towards liquidity ratios

* The Turner Review, March 2009

19

HSBC Bank (UK) Pension SchemeThe 2008 funding agreement

20

HSBC Bank (UK) Pension SchemeAsset transfer summary

Process

Sponsor and Trustee agreed a conventional cash recovery plan in February 2010

The long track record of productive engagement on risk management created an environment where both parties were

prepared to commit resource to a difficult transaction that could improve both of their positions

The Bank identified assets from around the Group balance sheet that it wished to be part of the transfer

The Bank and Trustee analysed the portfolio carefully to establish suitability, market and intrinsic value

The transfer was agreed and closed in June 2010

Trustee benefits

The Trustee gained immediate increased security for members

The assets are plan assets which cannot be construed as employer-related

The Trustee benefits from the illiquidity premium that is priced into the assets, and from the Sponsor covenant

Sponsor / Bank benefits

Retained beneficial interest in illiquid assets that the Bank did not want to sell to the market

Expected asset performance should reduce the deficit faster

Pillar 1 capital improvement – offset by increase in Pillar 2 Pension Risk Capital requirement

21

Disclaimer

This document is issued by HSBC Bank plc (“HSBC”). HSBC is authorised and regulated by the Financial Services Authority (“FSA”) and is a member of the HSBC Group of companies (“HSBC Group”).

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Member HSBC Group

DISCPRES011107

Looking ahead

22

Property Machinery Inventory

Debtor books Brands Intra-group loans

PFI contracts Intellectual PropertyOther intangible

assets

Disclaimer For professional investors only. Not suitable for private customers.

The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety ofmarket factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can beduplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or otherreference rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf.Unless otherwise stated, any pricing information in this message is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs.Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence .

Redington Ltd are investment consultants regulated by the Financial Services Authority. We do not advise on all implications of the transactions described herein. This information is for discussion purposesand prior to undertaking any trade, you should also discuss with your professional tax, accounting and / or other relevant advisers how such particular trade(s) affect you. All analysis (whether in respect oftax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon as accurate.

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