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OPINION

HSBC needs reform

HSBC needs reform
April 29, 2015
HSBC needs reform

The bank was so large and geographically diverse, we reasoned, that it was unlikely to be knocked over by local upsets. The most recent financial crisis seemed an excellent illustration. Thanks to its hugely profitable franchise in Hong Kong, even the gargantuan problems in the US banking system that surfaced in 2008 did not push HSBC's balance sheet or income statement into the red.

As it happens, the group's shares have risen slightly since we published that feature. But our reasoning, which was somewhat contrarian at the time of writing, sounds even less fashionable today.

HSBC has been hit by scandal after scandal. The most recent of these centres on the group's Swiss private bank, which helped its clients dodge tax. Before that there were big fines for - among other things - financing drug cartels in Mexico and rigging currency markets and the interest rate benchmark Libor. In response, management has argued it had no idea what was going on. Rather than large and well diversified, HSBC has therefore come to be seen as large and unmanageable.

Chief executive Stuart Gulliver ditched the 'world's local bank' tagline when he took over in 2011, and has since attempted to rationalise the group's global footprint. Yet there was little evidence in the 2014 annual results that the strategy was working. Even stripping out provisions for misconduct, operating expenses rose 6 per cent, which management blamed in part on "increased regulatory and compliance costs". The cost-to-income ratio - a key measure of efficiency for banks - rose to 67 per cent, the highest in five years and higher than the industry average, according to the Banker magazine. The company consequently missed consensus profit forecasts by more than 10 per cent.

This brings us to the reason HSBC made headlines again last weekend. At the company's annual meeting on 24 April, chairman Douglas Flint said the board had asked management to "look at where the best place is for HSBC to be headquartered". That revived speculation of a move back to Hong Kong.

The group was based in the Asian city state from its foundation in 1865 until it took over Britain's Midland Bank in 1992. Hong Kong is still its biggest single profit contributor, accounting for 36 per cent of earnings in 2013 (last year the bank collapsed Asia and Hong Kong into one segment, which made nearly four-fifths of profits). HSBC conducted regular reviews into where it should be headquartered until two years ago, when it suspended the practice in the face of rapid regulatory change. But Mr Flint said the industry was starting to see the "final shape of regulation and of structural reform, including the requirement to ring-fence [retail banking] in the UK", making the question again relevant.

Relocating to Hong Kong could cut costs - not least in tax. Because the UK bank levy is based on the value of global liabilities for UK-based lenders, but only local liabilities for other banks, moving abroad would cut HSBC's exposure - expected to be $1.8bn this year if the current regime remains in place, and higher under Labour - by more than half. One stockbroker put the potential savings at $1.4bn a year. The shares jumped about 3 per cent on the announcement.

There are other considerations, of course. The Hong Kong Monetary Authority issued a statement welcoming HSBC's review. But the bank would have to gauge the value of the Chinese city's support in a crisis. Given Britain's recent history of bailing out troubled banks, any perception that Hong Kong would or could not do the same would push up HSBC's funding costs. To put it another way, HSBC currently benefits from an implicit UK government guarantee. A Hong Kong government guarantee might not be worth as much.

Calling HSBC the best company in the world is hyperbole, but the reasons why we like it - effectively the old argument for business conglomerates - remain valid, however unfashionable. At the same time, the group clearly needs to get a better grip on its cost base. Moving the headquarters to Hong Kong may be one answer, but cannot be the only one. Mr Gulliver is due to unveil a "strategic update" on 9 June. It needs to be meaty.