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Edited Transcript of HSBA.L earnings conference call or presentation 5-Aug-19 6:30am GMT

Half Year 2019 HSBC Holdings PLC Earnings Call

London Aug 8, 2019 (Thomson StreetEvents) -- Edited Transcript of HSBC Holdings PLC earnings conference call or presentation Monday, August 5, 2019 at 6:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Ewen James Stevenson

HSBC Holdings plc - Group CFO & Executive Director

* Mark Edward Tucker

HSBC Holdings plc - Non-Executive Group Chairman of the Board

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Conference Call Participants

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* Alastair William Ryan

BofA Merrill Lynch, Research Division - Co-Head of European Banks Equity Research

* Christopher Robert Manners

Barclays Bank PLC, Research Division - Co-Head of European Banks Equity Research

* Edward Hugo Anson Firth

Keefe, Bruyette & Woods Limited, Research Division - Analyst

* Fahed Irshad Kunwar

Redburn (Europe) Limited, Research Division - Research Analyst

* Guy Stebbings

Exane BNP Paribas, Research Division - Analyst of Banks

* Joseph Dickerson

Jefferies LLC, Research Division - Head of European Banks Research & Equity Analyst

* Magdalena Lucja Stoklosa

Morgan Stanley, Research Division - MD

* Manus James Macgregor Costello

Autonomous Research LLP - Founding Partner and Managing Partner

* Martin Leitgeb

Goldman Sachs Group Inc., Research Division - Analyst

* Raul Sinha

JP Morgan Chase & Co, Research Division - Analyst

* Thomas Andrew John Rayner

Numis Securities Limited, Research Division - Analyst

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Presentation

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Operator [1]

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This presentation and subsequent discussion may contain certain forward-looking statements with respect to the financial condition, results of operations, capital position and business of the group. These forward-looking statements represent the group's expectations or beliefs concerning future events and involve known and unknown risks and uncertainty that can cause actual results, performance or events to differ materially from those expressed or implied in such statements.

Additional detailed information concerning important factors that can cause actual results to differ materially is available in our interim report. Past performance cannot be relied on as a guide to future performance.

This presentation contains non-GAAP financial information. Reconciliation of non-GAAP financial measurements to the most directly comparable measures under GAAP are provided in the reconciliations of non-GAAP financial measure supplement available at www.hsbc.com. The analyst and investor conference call for HSBC Holdings plc's interim results will begin in 2 minutes. (Operator Instructions).

Good morning, ladies and gentlemen, and welcome to the Investor and Analyst Conference Call for HSBC Holdings plc's Interim Results 2019. For your information, this conference is being recorded.

At this time, I will hand the call over to your host, Mr. Mark Tucker, Group Chairman.

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [2]

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Thank you, and good morning to everyone in London, and good afternoon -- Let's start again. Good morning and -- at everybody in London, and good afternoon in Hong Kong, and welcome to the 2019 HSBC Interim Results Call. With me today is Ewen Stevenson, our Group Chief Financial Officer.

You will have all seen by now our announcement regarding John Flint, arranged by mutual agreement with the Board, stepping down as Group Chief Executive. I will share a few words about that and then hand over to Ewen. And Ewen will talk about our good interim results, which are a credit to John, the management team and the 238,000 HSBC people.

The bank is very grateful to John for his personal commitment, dedication and the significant contribution he has made over his long career at HSBC. HSBC is clearly, as you've seen by today's results, in a strong position to deliver on its strategy. However, in the increasingly complex and challenging global environment in which the bank operates, the Board believes that a change is needed to make the most of the significant opportunities ahead of us.

For this reason, we've initiated a process to find a new Group Chief Executive, and we'll be considering both internal and external candidates. Noel Quinn has agreed to serve as interim Group Chief Executive until a successor is appointed. Noel has been the Chief Executive of Global Commercial Banking since 2015. He is a proven leader with a strong track record of achieving business success, excellent client relationships and deep global experience. I'm sure we'll come back to this later and happy to answer any questions but I think, more importantly, to go to Ewen now and the interim results. Ewen?

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [3]

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Thanks, Mark. Morning or afternoon, all. I'm now going to quickly step through the slide pack, which you can find on our Investor Relations website.

Turning to Slide 1 on the key messages. We continue to make good progress in the first half. Reported profits before tax were $12.4 billion. That's up 16% on the first half of last year, and adjusted profits before tax were up 7%. We're pleased with the progress we're making on improved cost control, which has helped drive a much stronger jaws performance.

Our return on tangible equity in the first half was 11.2%. Results were flattered by $828 million dilution gain from the merger of Saudi British Bank and Alawwal Bank, but those largely offset a large nonrecurring PPI charge and some severance costs.

Our core Tier 1 ratio remained stable at the first quarter at 14.3%. We're announcing today a $1 billion buyback, and that's part of our ongoing commitment to neutralize scrip dividends over time.

On outlook, we continue to progress towards our 2020 return on equity target, but the interest rate outlook has softened relative to the first quarter, and geopolitical risks have tightened across many of our major markets. In response to this, we're actively managing costs and investment growth in order to respond to a more challenged revenue outlook.

Looking at Slide 2 and progress against our 8 strategic priorities. We're making good progress against most of these. To call out a few: Asia continues to grow well for us with revenue growth in the first half of 9%. We're continuing to build leadership and sustainable finance, an area where we see considerable growth opportunity over the coming years. And our U.K. ring-fenced bank is growing both volumes and revenues, and we continue to take market share in both mortgages and Commercial Banking.

However, one priority where we're not on track is the turnaround of our U.S. business. While good underlying progress has been made on costs and capital, costs were down 7% in the second quarter relative to the second quarter in 2018. And we got CCAR approval to dividend a further $1.8 billion of capital back to the group.

The U.S. revenue outlook has become more challenged in recent months. There's been a sizable shift in U.S. dollar interest rate expectations, so we're now not expecting to achieve a 6% return on tangible equity in 2020. But we recognize that current returns in the U.S. are not acceptable, and it remains a firm priority of ours to improve these.

Turning to outlook more generally on Slide 3. Consistent with what I've just said about our U.S. franchise, the interest rate outlook for the dollar block has shifted in recent months. In addition, geopolitical risks have risen across many of our major markets, which creates additional volatility around our central base case.

In the very near term, Brexit remains unresolved with skewed risk to the downside. And trade tensions between the U.S. and China are progressively impacting the growth outlook for both markets. We're responding to this changed revenue outlook with a tightened focus on cost. We've slowed investment growth and some of which you can see reflected in today's results.

Going into the detail now on our results on Slide 4. In the first half, we had adjusted revenue growth of 8%, and this excludes the dilution gain from the Saudi merger. Cost control has improved. First half cost growth was 3.5%. That's down from 5.6% for the full year in 2018. And returns were up in the first half, a return on tangible equity of 11.2%, driving earnings per share up $0.06 to $0.42.

On Slide 5, we continue to see robust top line growth, up 7% in the second quarter and up 8% in the first half. Looking across the 4 global businesses. In Retail Banking and Wealth Management, overall revenues were up 14% in the second quarter. In Retail Banking, revenues were up 10% driven by a good lending growth and higher deposit margins. And our insurance franchise had a strong quarter with the value of new business up 19%.

Commercial Banking continued to grow strongly in the second quarter with 8% revenue growth. But given the impact of interest rates and lower global trade flows, we do expect second half growth to moderate. In Global Banking and Markets, revenues were down 8% in the second quarter and down 3% in the first half.

Most of our transaction franchises continue to perform strongly. Securities Services, GLCM and GTRF had combined revenue growth in the second quarter of 10%, but this was offset by Global Markets down 11% and Global Banking down 8%.

Global Private Banking had another good quarter. Revenue is up 8%. Total net new money inflows in the first half were $14 billion. That's more than double the run rate we saw in the first half of 2018.

In Corporate Centre, our revenues were up $185 million on the second quarter in 2018. Favorable valuation differences on long-term debt and associated swaps together with reduced losses on legacy portfolios more than offset the expected lower revenues from Balance Sheet Management.

Turning to the next slide. Net interest margin was up 3 basis points to 162 basis points in the second quarter. Average interest-earning assets grew by 1% and net interest income by 5%. Underlying this, in Asia, net interest margin improved by 6 basis points. 1-month HIBOR in the second quarter was much more supportive, up 70 basis points to an average of 2% across the quarter. And in the U.K. ring-fenced bank, NIM declined by 8 basis points in the quarter driven by a combination of a changed asset mix towards mortgages, the continued issuance of MREL and the start of wholesale funding programs.

On Slide 7, we're now showing progress on better cost control. Cost growth in the first half was 3.5%, down from 5.6% in the full year 2018. Significant work sits behind that. We've taken the decision to materially shift the 2020 cost run rate, and so we've been working hard across the bank on various cost plans, some of which you see reflected in today's results.

Severance costs were $199 million in the second quarter and $248 million in the first half. For the full year, we expect total severance costs in the order of $650 million to $700 million. The payback on this is good with around 1-for-1 pretax annual savings, so we expect $650 million to $700 million of pretax run rate benefits in full year 2020.

Also note this quarter, in significant items, there's a $559 million PPI charge. This includes a provision for the official receiver for its bankrupt customers' claims. And for the remainder, it's a combination of modeling much higher information requests for July and August relative to the first half run rate and the required auto conversion of these requests into complaints.

Turning to Slide 8. We invested a further $1.2 billion in the second quarter, and we're on track to spend around $5 billion this year. That's up over 20% on 2018 and over 1/3 on 2017. Given the changed outlook, we're now planning to spend around $14.5 billion to $15 billion over 2018 to 2020. On a currency-adjusted basis, that's towards the bottom end of the $15 billion to $17 billion range we announced last year.

This should be put in perspective, though. We're spending around $100 million a week on investments, so we're talking about deferring less than 1/4 of investment spend across 2019 and 2020 combined. On what we're investing in, around half is focused on growth and enhancing digital capabilities, and the other half on productivity improvement and regulatory and mandatory investments.

On the next slide, on credit, ECLs continued to perform in line with expectations with credit charges of $555 million or 22 basis points in the second half quarter. With $1.1 billion of credit charges in the first half, and from what we can see at this point, we remain comfortable with full year 2019 consensus of $2.7 billion.

I would, however, continue to caution on the U.K. in particular. It remains the market we're most focused on. U.K. provisioning will remain sensitive to forward economic guidance, which given the uncertainty around Brexit, has considerable potential to diverge in the second half. Also note that we changed the probability of an adverse trade scenario, now at 10%, resulting in a modestly higher trade economic uncertainty charge.

Turning to the next slide. Our core Tier 1 ratio remained stable at 14.3% during the second quarter. RWAs were up $6.5 billion in the second quarter and up $20.7 billion in the first half. We expect full year RWAs to be broadly in line with the second quarter, resulting in overall annual growth just above our 1% to 2% guidance range. As we've previously signaled, more of our RWA mitigation actions this year will fall into the second half.

We're also announcing today a $1 billion buyback. This represents just over 10 basis points of core Tier 1 to be deducted in the third quarter. We think this creates the right capital management balance between continuing to execute against our commitment to neutralize scrip issuance over the medium term while being appropriately conservative given Brexit uncertainties.

Also note that our TNAV per share for the first half benefited by $0.10 per share. Our first quarter dividend will be accounted for when it is paid in the third quarter, so this is purely a timing difference on recognition.

To conclude, we've delivered a good set of numbers for the second quarter and the first half. We continued to show good top line volume and revenue growth. We've made real progress in moderating cost growth. Credit conditions remain below long-term trends. And both profits and returns are growing.

The $1 billion buyback announcement is a clear signal of our continued commitment to active capital management. But given the changed dollar block interest rate outlook, we're now facing a weaker revenue outlook for most of our businesses. And we're operating with higher geopolitical uncertainty across various markets. So while we're pleased with these results, we recognize the outlook has softened, and we need to and are taking action to adjust for this.

Mark and I will now take your questions. And before we do that, Michaela, if you could please explain the procedure for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question today from Martin Leitgeb of Goldman Sachs.

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Martin Leitgeb, Goldman Sachs Group Inc., Research Division - Analyst [2]

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The first question, if I may, is just trying to understand what the announcement from today might mean in terms of the broader strategy of the group, and I'm not sure whether this is the right timing or to what extent this can be answered at this stage. But just looking at the group by profitability coming from Hong Kong and U.K. retail, and obviously given the incremental disclosure on ring-fenced and non-ring-fenced, there remains to be, what we can see, a meaningful drag in terms of profitability from the non-ring-fenced bank. So I was just wondering if you could comment where this -- where we might be heading in terms of strategic direction and what measures you might undertake, in particular, in the non-ring-fenced bank in terms to improve profitability?

And the second question is more with regard to capital management. Just looking at your disclosure for the ring-fenced bank, it seems to be that there is a payout ratio of close to 100% in terms to holdings. How should we think about that capital contribution going forward? So the U.K. ring-fenced bank being profitable, upstreaming bulk of profit. Is this essentially going to be the source to help the group neutralize scrip going forward?

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [3]

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Yes. I think Mark will start on the first question, Martin, and then I'll add, and I'll carry out after that.

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [4]

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Yes. Let me fit context, and I think Ewen can give you more detail, Martin. I think the way we think about this is we've agreed that the high-level strategic priorities that shape our business, and again the -- there is total alignment between -- in the organization, agreement on the strategic direction. And these high-level strategic priorities remain very firmly in place. Having said that, I think where the -- where we're looking to do more is on realizing and how we go about realizing those priorities.

And I'll let Ewen give you a sense of how we're thinking about that.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [5]

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Yes. So Martin, in terms of the non-ring-fenced bank, I would sort of bucket it along with the U.S. as well. Yes, geographically, clearly, our most challenged return businesses, we have about 30% of our capital invested across the non-ring-fenced bank and the U.S. The 2 businesses combined are achieving, yes, extremely low returns at the moment.

In terms of commonality across the 2, we've got loss-making or breakeven retail businesses in the U.S. and France. We've got multiyear plans to turn them around, which we're continuing to invest in. Wholesale banking, obviously, faced quite challenged market conditions both in the U.S. and particularly in Europe in the first half. And I think the commercial bank across most -- both markets is actually performing okay. Both markets have a cost problem, cost/income ratios in the mid-80s, so a focus on cost is a priority.

In the U.S., we also have an issue with excess capital sitting in the U.S. business. I think the CCAR results from -- the CCAR results from about a month or so ago is another important step in that, getting about $1.8 billion out of our U.S. business in the coming months. And I would say with some of the customer selection, too, we're looking hard at that because we still got a lot of the corporate customers where we're not earning a sufficient return. And we are trying to recycle capital away from those relationships, either reprice them or recycle them into better-returning customers. But overall, I think we would ask that they will be patient. Look, these turnarounds across these 2 markets is going to take time. But we recognize that the type of returns that we're achieving at the moment are not acceptable and need to be driven higher.

On the ring-fenced bank, I wouldn't read in or try and overly be too complex about dividend flows across the group. We think we've got adequate dividend serviceability, and it would have no impact on our ability to continue to commit to neutralizing scrip dividend over time. I think the overall challenge at the group level is a more complex issue. We've committed to keeping our core Tier 1 above 14%, which we think remains appropriate. You'll see in our Pillar 3 document some additional disclosures today around MREL and where it sits across the group.

And double leverage, that's another thing that we're managing, too. And we're also cognizant of the fact that we've got some potential capital challenges on the horizon, Basel III reform being one, and the other is we're waiting to see where we end up on G-SIB buffers at the end of the year. If we were to bump up a buffer, which is not clear at the moment, that would come into effect on 1st of January 2021. But in terms of the ring-fenced bank, cash flow really no impact in terms of our dividend serviceability of the group.

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Operator [6]

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Our next question today comes from the line of Joseph Dickerson from Jefferies.

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Joseph Dickerson, Jefferies LLC, Research Division - Head of European Banks Research & Equity Analyst [7]

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I guess just a couple of quick questions. Mark, you know the region very well. And alluding to some of the outlook comments on geopolitical risk, would you consider the role of Chief Executive of HSBC because it seems like somebody with your experience in the region would be welcome at this point?

Secondly, on the U.S., just given the lack of progress on returns, I appreciate your point, Ewen, you can take out -- look to take out cost or put in further cost efficiencies. But is there a broader strategic issue with the scale of the business and the mix of business in the U.S.? And would some sort of either M&A or divestiture be more appropriate in the medium term?

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [8]

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Joseph, thanks for the question. The answer is under no circumstances. I think the -- I spent 32 years as a CEO, and that is, I think, a decent-enough innings to justify. I have made a very conscious decision to be a Nonexecutive Chairman, and that's what I intend to be. And I think we have people with much better capability and much -- and youth on their side that can do a materially better job. So I hope that's fairly clear.

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Joseph Dickerson, Jefferies LLC, Research Division - Head of European Banks Research & Equity Analyst [9]

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Very clear.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [10]

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Yes. And on the U.S., Joseph, I don't think it's a scale issue. Yes, there are plenty of businesses in the U.S. with a similar scale to us earning much better returns. It's a combination of needing to be -- needing to drive higher revenues, reduce costs and be more efficient on capital. But I don't think it's a scale issue. We don't think we need M&A to solve our returns problem in the U.S. and nor do we think the market will be particularly supportive of M&A. Equally, we think it's critical that we do have a meaningful presence in the U.S. It's critical to our global business. And therefore, I don't think you should expect us to be reducing our presence in the U.S.

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Operator [11]

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Our next question today comes from Chris Manners from Barclays.

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Christopher Robert Manners, Barclays Bank PLC, Research Division - Co-Head of European Banks Equity Research [12]

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So 2 questions, if I might. The first one was just to follow up on the G-SIB comments that you were making. I saw that Page 99 on your derivatives disclosure showed your derivative notional is up about $5 trillion half-on-half. And I guess that was one of the bits where the bucket could push your G-SIBs to north of the magic 4 30. If you do trip into the next G-SIB bucket either this time or in the future, should we be adding 50 basis points to that greater-than-14% capital target? Or should we assume that that's sort of encapsulated within that?

And then the second question was just a net interest margin question. Obviously good print in the quarter, and you're up 3 basis points, a lot of that coming from move in HIBOR and as you flagged that U.K. was a bit weaker. How should we think about that dynamic? Obviously, HIBOR has come down about 100 bps from the peak, but it's still running around the level that it was the average of Q2. Maybe if you could sort of walk us through the net interest margin drivers and whether we should be expecting slippage over the next sort of several quarters from the 1 62, and that's the revenue headwind -- one of the revenue headwinds you're talking about, or whether that we would actually be able to sort of see it stick around the same level?

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [13]

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Yes. So on G-SIB, look, we're comfortable with our 14% target for the time being. I don't think if we went up a bucket that we -- from what we can see today that that's going to change our view on what the appropriate core Tier 1 ratio is for us. Remember, it's adding 50 basis points to our regulatory number and not our target. So I think, look, for the time being, we're very comfortable that the 14% target is appropriate.

The G-SIB indicators are a bit of a blunt instrument. As you know, it's a set of basic indicators. And yes, we have much more sophisticated modeling on how we manage our capital base. There was a technical reason in relation to the increase in derivatives, but we've got some systems improvements going through, so you should expect that number to come down.

On NIM, this is my favorite debate with you all every quarter and how much I love not forecasting NIM. But given -- look, given the recent rate cut in the U.S. and given the likely direction of further, at least, another rate cut this year, I think you all should expect NIM to come down. And HIBOR for the time being, at least, has been relatively uncorrelated with U.S. dollar interest rates. But yes, at some point, if it connects, would be expected to come down as well. So overall, I think I would be unsurprised if NIM was lower at the end of the year.

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Operator [14]

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Our next question today comes from the line of Tom Rayner from Numis.

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Thomas Andrew John Rayner, Numis Securities Limited, Research Division - Analyst [15]

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Because you love it so much, Ewen, I thought I'll ask you another question on NIM, if that's okay. I see as the one of the sort of negative offsets to the positive HIBOR was deposit mix shifting towards interest bearing. I think after Q1, you said that this had largely stopped in Hong Kong. So I'm just wondering, are we now seeing deposit mix issues elsewhere such as in the U.K.?

And I have a second question, just more on strategy, which may be for Mark as well. I don't know how you want to deal with that.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [16]

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Do you want to ask that question now and...?

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Thomas Andrew John Rayner, Numis Securities Limited, Research Division - Analyst [17]

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Yes. It's just when I look at what sort of changed today, it doesn't feel like that dramatic and that the revenue guidance is worse. You're probably going to be doing a couple percent per annum less revenue growth, and therefore, you've got to find a bit more cost to take out, yet we're changing the Chief Executive. And I'm just wondering if there's something else that's sort of broader strategic, and I know you've mentioned a few things, but a more sort of strategic view which maybe John did not agree with. And therefore, this is -- we are going to see some change in direction, whether it's Wealth Management growth or -- I just wondered if there's something more to it that you can add -- Mark, maybe you can add some more color to it.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [18]

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Yes. So on NIM, look, it may be unsurprising if -- as HIBOR goes up, that you would see some shift there of on-demand in current accounts into savings product. So I think the nature of how that migrates through the remainder of the year will depend very much on the direction of interest rates. I think in the U.K., there are a few things going on. There was a deposit campaign at some point. We had also, as I said earlier, we're continuing to issue MREL, and the U.K. ring-fenced bank had very nondiversified funding because it was only set up recently, so we started a few wholesale funding programs as well.

Just a word on cost, and then I'll hand over to Mark on the strategic point. I mean you alluded to the fact of lower cost growth. I mean I think previously, we've guided to sort of low- to mid-single-digit cost growth. I think if you were to read that today, I would change low to very low and mid- to low, so very low- to low-cost growth from here is what we're targeting.

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [19]

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Tom, yes, let me give you a sense and I think starting with the clear point that there has been no disagreement with -- on strategy. I think everybody in the company is clearly aligned on these high-level strategic priorities. I think the element of where we have work to do is how we go about realizing those priorities. And I think across a number of elements of which Ewen has covered somewhat already, amongst growth, how we make the most of our opportunities, be it regionally or locally, looking at the trade side, particularly how we extract value where we're strong.

On resource allocation, again, how we best allocate people and capital, which again Ewen has clearly spelled out. And against execution, again, simplifying and speeding up execution. Those are the elements where I think going into an environment which we feel will become increasingly complex and challenging, we feel Noel will bring the right perspective and experience to this. And we will give him full accountability and responsibility for taking the group forward.

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Operator [20]

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Our next question comes from the line of Edward Firth from KBW.

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Edward Hugo Anson Firth, Keefe, Bruyette & Woods Limited, Research Division - Analyst [21]

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I guess this is a question for Mark, and it's partly an area that's been covered. But you've talked a lot in the past about how the U.S. business and, I guess, the European business as well is -- we shouldn't look at it as a loan because actually there's a lot of interlinking businesses elsewhere, particularly in Asia, which actually make it a far more acceptable return than we might think. I suppose my first question is, do you still believe that? Do you agree with that as a sort of broad concept?

And I guess as a second point then, if that is the case, what can you point to which can make us assume that these businesses can get any better? Because it must be now 10 years since either of those businesses have made anywhere near that cost of equity return, but there must have been 4 or 5 management teams in each of them. And it's not obvious to me in this environment what we can see that -- or what you can point to us which makes you believe that these will get to a cost of equity return.

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [22]

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Besides, I mean I think that's sort of a joint question, Ed, in terms of how Ewen and I can answer. I mean I think in terms of belief in the network, belief in the exporting of opportunities across that network, the U.S. is a massive exporter of business across the network and I think is the most significant element of the group in terms of exporting value. And I think the power of the group and the network and the interlinkages, the understanding of trade corridors is absolutely fundamental and I think is -- gives us an advantage that no other bank on the planet has. And therefore, it's something that we do view as a material strength, and we can get better at it in terms of how we think about some of the different elements of region, how we think about the trade, how we think of extracting value where we're strong.

But fundamentally, I think here the point you make in terms of Europe and the U.S. in terms of destruction of value are 2 areas of immense focus for us. I think Ewen has taken you through the U.S. and I think can take you through Europe. I think there are many elements that we can do better in terms of both resource allocation and execution, which I think we're on the path to do, and I think we need to speed some of this stuff up.

Ewen, just talk about Europe a little bit as opposed to the U.S.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [23]

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Yes. I mean, so Europe, well, the non-ring-fenced bank is a combination of U.K. European wholesale and retail Commercial Banking in France and Commercial Banking elsewhere, largely France and Germany in Continental Europe. I mean the first thing I'd say about Europe is we're not alone. I mean you all know that returns for our European banking are weak, not helped by the interest rate outlook. We do think that there is significant upside from where we're currently sitting in returns. Yes, there is a significant cost issue in the non-ring-fenced bank that we are looking hard at. It's got a cost/income ratio in the mid-80s. We think we can reduce that materially.

There is a customer selection issue that I think we have in Europe where many of the customer relationships are running well below cost of capital returns. And we need to be harder with those relationships and either reprice them or exit those relationships. And I think we need to stay very, very focused on where we have a right to win and a right to be great, which is customers in Europe who want to do business elsewhere in the world, particularly in the Middle East and Asia, and vice versa. When we look at the travails of a number of our European peers, we're confident that we can drive a business to higher returns where we have some unique competitive advantages. But as I said, it's not going to be quick, but I think we recognize that current returns are unacceptable and we need to improve them.

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Edward Hugo Anson Firth, Keefe, Bruyette & Woods Limited, Research Division - Analyst [24]

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Great. Okay. I mean is there any way at some point you can give us greater clarity on some numbers around what, let's say, the U.S. franchise creates in the group as a whole or customers in the U.S. create in the group as a whole? Because it's very difficult externally to really have any...

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [25]

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Yes. No, I'm sure we can -- yes, I'll talk to Richard O'Connor and the IR team. I'm sure there's stuff that we can do to help explain that better.

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Operator [26]

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We will now take our next question from the line of Guy Stebbings from Exane BNP Paribas.

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Guy Stebbings, Exane BNP Paribas, Research Division - Analyst of Banks [27]

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First question, if I just come back to the CEO and the changes there because I'm struggling a little bit to really understand what has specifically changed. And if it's just execution and resource allocation, why John couldn't have delivered against that? And why the interim change and role for Noel sort of changes what he can contribute from his current position, if you like? I mean can we read anything into the fact that Global Banking and Markets was probably the weaker-performing division in the period and most other areas were perhaps better than expected? Is that a focus? Or is it more around much of the focus on costs?

And then just a second question was on buyback. The $1 billion won't neutralize the scrip on an annualized basis, and I think you mentioned uncertainties around Brexit as a factor. If we were to see a more positive outlook regarding Brexit, should we take your comments to mean your view on capital such that you should be able to do further buybacks at that stage and underlying capital generation is still sufficient to neutralize the scrip?

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [28]

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Okay, thanks. Thanks, Guy. I mean let me take the first part and clearly hand the second to Noel (sic) [Ewen]. I think we go back to what we've said. I think we're in a strong position to deliver on strategy, but the environment is changing, in our view, materially, becoming more complex, becoming more challenging. And we feel that a change -- and again, both we and John feel a change is needed to really take most of the opportunity -- make the most of the opportunities ahead of us. And this is a decision about the future of how we see the future and the realizing of those high-level strategic priorities, we feel, needs a different approach. And I think the element that Noel can bring to that, we view, are significant and different enough to warrant where we -- the action we've taken.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [29]

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Yes. On the buyback, look, we openly ignored the $1 billion buyback where we're insufficient this year to neutralize the scrip for this year. I guess what we said is we remain committed to the medium-term target to neutralize it. I don't think you should expect if we wake up at end of third quarter -- third quarter results with a more favorable Brexit outcome that we'll be back doing more buybacks this year. I think we'll take another view in the beginning of 2020 as part of full year results.

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Operator [30]

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We will now take our next question from Manus Costello from Autonomous.

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Manus James Macgregor Costello, Autonomous Research LLP - Founding Partner and Managing Partner [31]

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I had a couple of questions, please. Given the -- firstly, given the focus on growth which you talked about, do you think your payout ratio of over 70% is still appropriate? We've seen a number of banks with payout ratios in that area look to cut it. I wonder if that was part of the strategic briefing that you might have with the new CEO if the focus is going to be on growth and RWA efficiencies start to fade.

My second question is around the complex environment that you're talking about. There's been some press reports that HSBC could be placed on the list of unreliable entities by the Chinese government. I wondered if you think there's any risk of that for HSBC and if that plays into your thinking about the complex environment which you're concerned about.

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [32]

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Yes. I think Ewen is probably best to talk about a payout ratio and growth.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [33]

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Yes. So look, on the payout ratio, $0.51 per share is a high payout ratio. I mean it was over 100, and we're migrating down from that from a few years ago. We -- that's why we've been very deliberate in our language of saying we expect to keep the dividend stable. And as returns improve, we expect that payout ratio to fall materially and to fall to a level where we think we can both fund the dividend, neutralize the scrip and continue to grow in the way that we want to grow.

I think the balancing item at the moment is the fact that we still see significant opportunity to both improve models and optimize RWAs with some customer relationships. We do expect in the second half of this year to keep RWAs neutral while still growing credit assets. And we still think we've got potential over 2020 and '21 to see further material RWA mitigation actions. At that point, we'll have returns higher, and that will allow us to both fund the $0.51 dividend and grow in the way that we want to grow.

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [34]

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Let me take the second part. I think, as you know, we've been in China for over 153 years, and we have a clear and long-term commitment to China. And if you look at what we're doing in terms of China's growth priorities, we're actively participating in the opening of China's financial markets. We're actively participating in the Belt and Road initiative. We're actively participating in the development of the Greater Bay Area. We're actively participating in the internationalization of the renminbi. And we're actively participating in the growth of green finance. And we look forward to continuing to support China's growth and economic prosperity. Our business operations in China continue as normal, Manus. And we are confident about our China business, and we don't comment on speculation.

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Operator [35]

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We'll take our next question from Alastair Ryan from Bank of America.

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Alastair William Ryan, BofA Merrill Lynch, Research Division - Co-Head of European Banks Equity Research [36]

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A question for the Chairman, really. What's the risk of a -- while you're trying to move things forward in the longer term, there's an extended period of something of a hiatus between a new CEO coming in now, getting a seat at the table and then possibly somebody different over a few months in there, which takes some time to get their feet under the table. How does one avoid that risk?

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [37]

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Thank you. I think in our view, that's not a risk. Noel has been given full authority to take things forward in a way that allow him the flexibility to make the decisions that he and the executive team view as the best for the business. So on that basis, there should be no risk that there's going to be any hiatus period. I think we're going to get stayed in, and Noel understands that this -- we need to move with pace, ambition and decisiveness.

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Operator [38]

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Our next question comes from Raul Sinha of JPMorgan.

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Raul Sinha, JP Morgan Chase & Co, Research Division - Analyst [39]

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I hope you don't mind if I ask 3. The first one, I was wondering if you could comment a little bit on Hong Kong in terms of the outlook for the second half. And also, your July performance, if there's anything there. It doesn't seem like there's anything in the numbers itself that would prompt it, but it would be useful to get a comment along those lines.

The second one is on the RoTE and the decision to continue to target above 11% in 2020. Obviously, as you know, consensus is around 10% in the first half of the year. If you take the gains out, you're obviously well below the 11% on my numbers, and obviously, you're flagging a difficult second half. So I was just wondering, again, what I might be missing on the 11%.

The third one, maybe more for Ewen. Actually, on the Basel III reform, I mean you are now quite different from your peers in the sense that we don't actually get any indication about the potential RWA inflation for HSBC. And I was wondering if you might be able to put a range, at least, in terms of how much we can expect.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [40]

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Yes. So look, on Hong Kong, as you've observed, you don't really see it at all in the first half numbers. Numbers were good. Second quarter was good. Revenues were up significantly. Profits were up significantly. Yes, until we expect some impact in the second half, yes, inevitably, it will be. If the current situation continues for a prolonged period of time, it will impact confidence. It probably will have some impact on the retail sector. Yes, a big driver of profitability though in the second half will be where does HIBOR go. And at the moment, it's remaining sort of comfortably higher than where it was in first quarter, which flowed through into good second quarter results. So it's difficult to sort of put all that together and say what does that mean for Hong Kong profitability in the second half. But yes, for the time being, we're continuing to see decent growth and decent profit growth.

On the RoTE, a few things. I think it's slightly unfair just to back out the Saudi dilution gain in the first half. If you do that, you should probably add back the PPI charge and add back the severance costs, which broadly get you back to the same point. However, that wasn't the bank levy, as you know, that hits in Q4. Yes, as we look at consensus, you're right, consensus is currently sitting below 10%. I think as you think about the mix, that there's a slightly different -- yes, we're more bullish, I think, on revenue growth than The Street currently, particularly in noninterest income and volumes.

On costs, I think as you can see today, we're settling a much more rigorous approach on cost management. I'm pretty pleased with the progress we've made in the first half. We took cost growth down by 2 percentage points from the run rate last year. And as I said earlier, I think we're managing for now a very low to low-cost growth from here over the next 18 months.

There's a technical thing on the tax rate. I think we're continuing to generate more of our earnings in lower tax jurisdictions. So the effective tax rate being modeled by The Street is probably 1 to 2 percentage points too high. And I think there's a partial offset in the interest rate environment. We think where probably 2020 consensus on credit cost currently is potentially sitting marginally too high as well, which is an offset to the lower interest rate environment and the impact on NIM. But I don't know, I think you can do the maths and figure out that we're obviously substantially more bullish across a number of those lines to get to the gap between 10% and 11%.

On Basel III reform, I've sort of openly acknowledged we've been a bit shy on this. It really is quite a complex story for us. Yes, we operate in 65 markets. We're dependent on an enormous amount of national discretions. We don't know whether in Europe here, we're solving in the U.K. for U.K. national discretion or European national discretion until we understand the course of Brexit. As we look at large parts of Global Banking and Markets that are impacted by Basel reform, I think as time goes by, we get increasingly more confident about being able to offset some of the more negative impacts of Basel reform.

So look, as soon as we feel sort of confident within a range, we'll tell you. We would continue to say we do expect some impact of Basel reform, so please don't take from my comments that this is going to be an answer of 0. We don't think it will be. But relative to even when I joined 6 months ago, I think we've become more confident about our ability to offset some of the more negative impacts of Basel. But as soon as we feel confident about a range, we'll tell you. My concern at the moment is we'd just be misleading you.

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Operator [41]

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We'll take our next question from the line of Fahed Kunwar from Redburn.

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Fahed Irshad Kunwar, Redburn (Europe) Limited, Research Division - Research Analyst [42]

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So the question on the [audited] reforms and the payout ratio. I think you've given a number before of around -- I think it was like $12 billion or $13 billion of model optimization that was sitting with the PRA ready for approval. Is it these optimizations that are coming through in the second half of the year to give you confidence that your risk weights will be flat and whilst still growing the credit book?

And as a second question on that kind of more high level. How many more optimizations are through? Because it feels like as margins are coming kind of down or at least under pressure, growing your balance sheet is going to be a key, key way of kind of hitting that revenue target, which you say you're more bullish on than consensus. But obviously, you're stuck on quite a high payout ratio as well. I think the previous CEO was kind of very much wedded to the dividend. If it came to a point of thinking about a high payout ratio, dividend versus loan growth, how do you think about which one you would prioritize if margins stay as difficult as they are at the moment?

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [43]

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Yes. Look, on the last point, I don't think we feel we need to have that discussion for the moment, so we're not having it. On RWA growth, I think modeling improvements is part of the answer. There's also a significant part which is to do with recycling RWAs out of customer relationships where we're not achieving acceptable returns. We're continuing to run off a considerably smaller legacy credit portfolio. So it's not just all model improvements, and those model improvements are not just with the PRA. They sit across a number of regulators globally. But overall, it's something that I -- we track religiously. Yes, I run a meeting every month where we go through all of the RWA mitigation actions and have a pretty confident view about our ability to deliver within -- accepting that some of that is obviously beyond our control, such as timing of regulatory approval.

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Fahed Irshad Kunwar, Redburn (Europe) Limited, Research Division - Research Analyst [44]

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Sorry, on the first question, can I just add one second? Can I just ask -- I know you won't give the answer to this. On the payout ratio, obviously, you want to grow into a lower payout ratio. I understand that. How long would you accept the payout ratio as high as it is right now before you would ask that question and have that discussion?

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [45]

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Well, I think as you can see, this year, we've continued to maintain the payout ratio that we're maintaining, and we've grown our core Tier 1 ratio by 30 basis points. So we think for the time being, we can continue to commit to the $0.51 dividend, and it's not a topic that we spend any time debating internally.

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Operator [46]

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We'll now take our final question from the line of Magdalena Stoklosa from Morgan Stanley.

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Magdalena Lucja Stoklosa, Morgan Stanley, Research Division - MD [47]

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Three quick questions from me. The first one is about the details of your efficiency program. We have kind of seen the announcement, $650 million to $700 million. Could you give us a sense where it's coming from and how much of it would you consider kind of business as usual and how much of it would you consider as more ambitious restructuring and, to a degree, whether you see that program potentially being bigger as the revenue pressures come through? So that's the question number one.

Question number two. Your investment spend that you have shown us kind of this -- still has a lot of digitalization kind of business investment, but it also has a lot of regulatory investments there, too. If you were to guess your kind of next investment cycle, would you see that amount of regulatory kind of spend, too? Or do you think you're kind of at the kind of end of that kind of tremendous regulatory inflation you've seen over the last couple of years and continuously investing in?

And my last one is really a little bit kind of coming back to Hong Kong. Of course, we have seen the results given where the HIBOR was. But when you actually look at your kind of underlying client activity over the last quarter and now kind of what do you see transactionally from the perspective of the pipelines? Can you kind of already see the declines of confidence, the less of the activity given what the GDP has done and, of course, what is happening politically?

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [48]

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Okay. Well, just look, on the last one, if you look at underlying growth trends, I mean loan growth was 7% in the first half, so that doesn't feel like it's customer activity has been particularly impacted at this point. If you look at our new peer-to-peer PayMe, yes, we think we're now getting over 50% of peer-to-peer wallet share. We've just launched the B2C version of that. We've got over 3,000 merchants signed up. So it doesn't feel like in Hong Kong that the underlying volume growth has been unduly affected. Look, in context, in terms of the operational impacts on the business, there's been a few localized brand closures for very short periods of time. So fundamentally, I think Hong Kong remains robust.

On investment spend. Firstly, just to note, investment spend in the first 6 months was up 17% on the first 6 months of last year. Regulatory spend, look, I would love to sit here and say we're now at peak regulatory spend. I mean I do generally think that's probably the case. But I've been proven wrong on that in the past. But if we look at the sort of big reform programs we have ahead of us at the moment, I guess things like FRTB, Basel III reform, a new IFRS 17 accounting policy coming, we've got LIBOR transition, those are all -- and I think still ongoing work on recovery and resolution planning. There doesn't seem to be anything new getting added to the pipe. But certainly, for the next 2 to 3 years, I think we're going to continue to be in peak regulatory spend until we're through the bulk of some of those programs.

And on the efficiency program, I think the bulk of it I would describe as non-BAU. That's why we're taking $650 million to $700 million of severance costs. Remember, across most parts of our business, we have 5% to 10% natural attrition rate, so we can manage headcount down normally through just being much more selective on rehiring. This program is about 4% of our overall wage cost for less than 2% of the headcount. So you can read into that, that it is at the more senior levels of the organization and, therefore, more strategic in terms of its focus. And I wouldn't pick out any particular area of the bank. It's been a pretty broad program impacting most parts of the bank. Most of the people who are subject to this program have been notified but not all and, hence, our sort of reluctance to go into sort of specific details on specific areas at this point.

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Magdalena Lucja Stoklosa, Morgan Stanley, Research Division - MD [49]

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But Ewen, is it fair to say that it is -- that there's a disproportionate level which is impacting the business headcount or more of the central functions headcount?

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [50]

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Yes. I mean I think it's been across the piece. In my own area, we've done some. Most areas of the bank have been involved in cutting headcount. But I mean, overall, I think we recognized several months ago that the revenue outlook that we had anticipated in June last year when we set up the strategy was going to be different, and therefore, we needed to get to the 11% in a very different way. We needed to assume that revenue growth was going to be lower, and therefore, we needed to materially shift down the cost growth. So we grew costs in 2018 at 5.6%. And we're now signaling the fact that we expect, for the next 18 months, we expect cost growth to be in the very to low single digits. So we do think we have taken pretty decisive action to shift that cost run rate.

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Mark Edward Tucker, HSBC Holdings plc - Non-Executive Group Chairman of the Board [51]

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Let me just say a few words to end the call. Clearly, thank you, everybody, for being on the call. I think this is a great organization. As you've heard today, we have a strong business. We have committed people. And we have incredible opportunities. The Board believes a change is needed to make the most of those opportunities ahead, and it's the role of the Board to make those decisions. And I think we have acted in a way clearly and decisively from a position of strength with agreement with good results behind us with a clear strategy with very good bench strength. But this is a decision, as I said earlier on, about the future. And we believe that with Noel coming in, he brings pace, ambition, decisiveness, which are absolutely essential to capitalize on the opportunities ahead.

So thank you again for your time this morning. Thank you for your questions. And I'm sure there'll be other follow-ups.

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Ewen James Stevenson, HSBC Holdings plc - Group CFO & Executive Director [52]

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Thanks a lot, and thanks, Michaela.

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Operator [53]

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Thank you. Ladies and gentlemen, that concludes the call for the HSBC Holdings plc Interim Results 2019. You may now disconnect.