Legal Issues Driving down Governance Rating at HSBC

By Greg Ruel, Senior Research Associate

HSBC Holdings plc (LON:HSBA), Europe’s largest lender in terms of market value, has been mired in regulatory trouble throughout the fall. Since this time last year, GMI Ratings has typically scored HSBC in the average range for long-term sustainability risk. However, the company’s rating as  measured by its global percentile rank dropped nearly 20 percent from the end of May to the close of October after a windfall of legal issues began to plague one of the world’s largest lenders over the summer.

On June 22, Moody’s downgraded HSBC and 14 additional banks to reflect the risk of losses from volatile capital market activities. A week later, the Financial Services Authority confirmed settlements by HSBC Holdings and three additional U.K. banks after it found “serious failings” in the sale of interest-rate hedging products.

In July, HSBC’s head of compliance informed a U.S. Senate committee that he would be stepping down from his role at the company during a hearing to determine whether the company has violated anti-money-laundering rules. At the hearing, The Senate’s Permanent Subcommittee on Investigations grilled HSBC execs for allegedly ignoring signs that “violent drug gangs in Mexico, suspected terrorist financiers in the Middle East, and other rogue characters and enemy states may have been moving billions of dollars into and out of their vaults.” Indeed, the Subcommittee’s report describes HSBC’s Mexican affiliate as moving $7 billion in into its U.S. operations between 2007 and 2008.

Also in July, Reuters reported that HSBC was among a group of banks under investigation in the Libor probe and in August, followed up by announcing the company was among a handful of banks subpoenaed in the joint New York-Connecticut investigation. Most recently, a series of regulatory investigations and corporate litigation in the first couple weeks of November serve to drive HSBC’s overall ESG Rating from a “C” down to a “D.”

On November 5, a Reuters report suggested that a U.S. fine for violating federal anti-money laundering laws could cost HSBC Holdings significantly more than $1.5 billion. In addition, criminal charges were expected to be filed against the company. In response, the lender made a further $800 million provision in the third quarter to add to the $700 million HSBC had already set aside in anticipation of money-laundering fines. In the filing, the company states that “The US authorities have substantial discretion in deciding exactly how to resolve this matter. Indeed, the final amount of the financial penalties could be higher, possibly significantly higher, than the amount accrued.”

The Daily Telegraph then reported on November 9 that British tax authorities were investigating alleged loss of data for HSBC Clients. HSBC stated they were investigating the report, in which a whistleblower handed authorities a list of names, addresses, and account balances for more than 4,000 UK clients of HSBC Holdings on the island of Jersey, a known tax haven. The Telegraph reported that this client list includes a drug dealer who was convicted of possessing more than 300 weapons at his home in Devon, a man once dubbed London’s “number two computer crook,” and three bankers facing significant fraud allegations.

On Monday, reports surfaced that HSBC Holdings settled its first case over losses it suffered during the collapse of Bernie Madoff’s fraudulent financial empire. The company settled a dispute with Kalix Fund for $35.6 million in what is likely just the first of claims against fund custodians to be settled.

On Tuesday, Reuters reported that Jersey’s financial watchdog was to launch a probe into anti-money laundering systems and controls at HSBC Holdings. The investigation follows a report that HSBC Holdings PLC was protecting money for convicted criminals. A report from The Daily Telegraph on November 9 stated that the paper had been handed leaked data identifying 4,388 British-based people holding 699 million pounds ($1.1 billion) in current accounts, including celebrities and bankers. On November 13, Jersey’s Financial Services Commission said it would investigate “the matters raised by the press, including how the misappropriation of data occurred.”

The GMI Litigation Risk Model, which projects the probability of shareholder class action and is updated monthly based on financial statements, has considered HSBC to be “High Risk” for the past year.

 

Indeed, HSBC currently ranks in the 8th percentile of all companies in Western Europe in terms of class action litigation probability, indicating higher shareholder class action litigation risk than 92% of all rated companies in this region. Recent events will likely increase the probability of litigation when the Litigation Model Score Trend is next updated.

While HSBC scores as average in terms of board composition and compensation globally, its social rating is a resounding “F” compared to companies in the U.K. and across the world. Recent events have caused GMI Ratings to red flag HSBC for Social Impact Investigations, including regulatory investigations, as well as additional flags for Corruption or Money Laundering Events and Anti-Competitive Behavior Events. Indeed, the bevy of regulatory investigations and corporate litigation in these first two weeks of November will undoubtedly push HSBC into a below average ESG Rating going forward. Especially since problems with the Justice Department and additional regulatory agencies may just be underway as we learn more about the company’s money laundering and additional issues yet to be resolved.

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