Stephen Green, Esq.
Group Chairman
HSBC Holdings plc
8 Canada Square
London E14 5HQ

New York, 30 November 2007

Dear Stephen,

We note with interest that the Strategy Update you gave last Friday was different in manyimportant respects from presentations HSBC has given on this subject in the past. Wewelcome these changes and hope that our contribution to the debate has been helpful in theevolution of HSBC’s thinking.

Knight Vinke’s arguments

As you know, the essence of our argument is that HSBC has underperformed the majority ofits peers for many years in terms of total shareholder return (TSR) because it has used its capital to diversify its earnings, both geographically and by product, instead of investing it inareas where it has comparative advantage.

Comparative advantage in financial services depends on a number of factors but we believethat scale, branding and focus are amongst the most important, as well as being well-capitalised. We have argued that some of your businesses benefit more from global or worldwide scale and others more from local or national scale. Not all of HSBC’s businesses derive comparative advantage in the same way and not all benefit from a global approach.

In some businesses such as investment banking and capital markets, institutional assetmanagement, transaction banking, commercial banking for large corporates, private bankingand the upmarket “Premier” retail banking business, customers tend to have an international outlook and are therefore more likely to be attracted by banks with global capabilities and aglobal brand. We agree that many of these customers have a growing interest in theemerging markets and that in this respect HSBC’s emerging markets “connectivity” may be an interesting calling card (to use your words) but this does not amount to comparativeadvantage per se. All of the above-mentioned businesses are inherently global since thecost of building a global network is high and is largely fixed whereas the marginal cost of incremental revenue is low. Other things being equal, this implies that banks which have a worldwide revenue sourcing strategy in these businesses are likely to be more profitable inthese areas than those which do not.

In mass market retail banking and sub-prime lending, which encompass the vast majority ofHSBC’s 120 million customers, we believe that customers tend to seek only the most basic of services at the lowest possible cost and are not interested to the same extent in HSBC’s global presence. (HSBC has, of course, carved out a business for itself serving the needs of immigrant populations, which could be regarded as an exception to the above, but we viewthis as a niche opportunity and question how important it is to PFS profits as a whole.) Thereis clearly a contradiction in HSBC running these sorts of businesses alongside its upmarketretail and private banking businesses, particularly as this is under the same brand.

Comparative advantage in mass market retail banking depends largely on keeping costs to aminimum and the evidence we have suggests that the highest returns are earned by bankswith the largest local market share rather than by banks with the largest global footprint. Thecost reductions that can be secured by taking a global approach in these markets are not to be denied but are in most cases insufficient to offset the higher costs of complexity and theincreased risks associated with lack of focus and management overstretch.Thesebusinesses are fundamentally local and this is why banks with global retail businesses generally underperform their more focused peers, both in terms of ROA and in terms of stock market performance.

Our concern is that HSBC’s strategy of seeking earnings diversification rather than focusingon areas where it has comparative advantage has meant that it has ended up owningbusinesses such as the U.S. sub-prime lending business (which never had any obvious fitwith other group activities), a large number of sub-scale retail banking businesses throughoutthe globe and a low margin investment banking and capital markets business. We believe that HSBC’s returns have been sub-optimal because capital has not been effectively deployed and that this has been tolerated by its management and Board because of poor governance arrangements, including a long term incentive plan for its most senior executives which fails to align shareholder and management interests.

HSBC’s most recent strategy presentation – where we now agree

Having said all this, we are pleased to note that last Friday’s strategy presentation for the firsttime in over a decade made no mention at all of “global diversification” and emphasizedcomparative advantage (or the “right to win”, to use your language) as a key strategic objective. Only two weeks ago, this was still not the case (cf. “Our Vision – Asia Pacific”,November 2007) and we would like to think that we have helped in developing your thinkingon these matters.

We now also appear to be in agreement that global scale and reach in businesses such asCIBM, private banki ng, the top end of commercial banking and the top end of retail banking,all areas where “international connectivity” is of real benefit to your customers, bringcomparative advantage.

With respect to HSBC’s personal financial services (PFS) business, which includes bothmass market retail banking and the “Premier” business, you explain that you believe awinning strategy involves having a presence in emerging markets such as Mexico, Brazil,Turkey, Panama and Saudi Arabia, where you “either have or can build or can acquirescale”, as well as mature markets such as Hong Kong and the U.K., “where HSBC hasscale”. In this respect we appear to be in agreement that local scale matters in retail banking, and particularly mass market retail banking.

You have also explained that in mono-line products, such as credit cards and direct banking,global scale is critical. We do not disagree, but this on its own does not make HSBC’s mass market retail banking businesses global and we would point out that there are several leading credit card companies that do not have retail banking businesses of any kind.

Finally, we note your commitment to invest only where there is a “right to win” (which weassume means only where there is comparative advantage) and to invest in emergingmarkets “where we have or can build scale.” We also agree on these points.

If HSBC delivers on these promises, a significant step will have been made in the rightdirection.

Where we still disagree

There are still some areas where we have issues with your strategy: CIBM, U.S. sub-prime,and China.

First, you continue to argue that CIBM should be “emerging markets-led and financing-focused”. We have grave doubts about whether this is a sustainable value added strategy given the importance of global connectivity in this business and given its revenue and coststructure. Many former employees of CIBM give similar explanations for their loss ofconfidence in the divisional strategy.

In any case, we note that the division’s profits are dominated by trading profits rather than by corporate finance and underwriting fee income from emerging markets customers. Wequestion whether the business would be profitable at all if the trading revenues and relatedcosts were split out. In fact, it would be helpful to your shareholders if at year end you were to report separately not only the revenues but also the costs for each of the major components of the CIBM division: trading, financial investments, corporate finance, securities underwriting and transaction banking, in each case also showing how the interest on groupdebt is allocated.

Secondly, we believe that the U.S. sub-prime business is potentially a much greater problemfor the Group than you appear to believe. The issue we are concerned about is contagion.Sub-prime borrowers are likely to be the hardest hit in the economic downturn which is widely expected and this is likely to affect other sectors of the consumer credit market inwhich HSBC operates. No-one really knows just how bad the situation could become butmany respected analysts foresee the possibility of a severe crisis and it is likely, in any majordownturn, that Household would require significant additional financial support. GoldmanSachs, your house broker, has recently put the figure for additional provisions at US$ 12-15billion, for example.

In this context, your repeated statement that HSBC is “well capitalised” sounds ominously close to saying that HSBC will give unlimited support to these businesses, irrespective of thefinancial return on the investment that is made. In effect, this is very similar to the BritishGovernment’s position with respect to Northern Rock. We believe that any further supportmust be justified on financial grounds even if the Group is well-capitalised.

HSBC’s recent additional investment in Household amounted to only US$ 750 million, whichlooks modest in relation to the Group’s size, but one must remember that, as of 30September 2007, HSBC group companies had also advanced US$ 43 billion to Household.

As you know, we were calling for you to liquidate or dispose of the sub-prime business inJune and were told that this is a business that you liked. The fact that so many of the analysts covering HSBC have downgraded your shares following last week’s Strategy Update suggests that concerns about sub-prime far outweigh the undoubted progress youhave made with respect to HSBC’s future strategy and direction. In our view, the best courseof action now would be for HSBC to “ring-fence” its exposure to Household structurally (asdiscussed below) or by agreeing with the Board strict financial criteria for additional fundingto the business and making these known to the market.

Another area of disagreement is China. Our concern here is that the Hong Kong and Mainland Chinese markets will inevitably converge and HSBC must, therefore, position itselfso as to be able to protect its mass market retail banking franchise in Hong Kong by either acquiring or building a mass market retail business in China. We believe that the strategy you have articulated has a low (and possibly zero) probability of achieving this.

During the course of the Strategy Update, you made it clear that HSBC is positioning itself for head-on competition with the large Mainland Chinese banks in mass market retail banking,via its stake in BoCom, “as, when and if” restrictions on foreign investment are lifted. In the rest of the Chinese market, HSBC’s activities are for the most part limited to building a“Premier” business and developing its credit card business. These initiatives may beattractive as a limited stand-alone strategy, but they do not address the fundamental threatsfaced by HSBC’s retail banking business in Hong Kong.

We believe that the strategy you have articulated is unlikely to work because the Chineseauthorities will not lift the restrictions on foreign investment in mass market retail bankinguntil such time as the large Mainland banks are able to compete with the international banks on an equal footing. In the mean time, there is nothing to prevent the Mainland banks fromcompeting with HSBC in Hong Kong, acquiring Hong Kong based banks or indeed other banks. HSBC has no control over the timing of any market opening, while its domestic competitors in China will increasingly benefit from their much greater scale and acquireexperience overseas.

If HSBC waits for the day the restrictions are lifted, we believe that it will miss the boat withrespect to mass market retail banking in China and will, therefore, also expose its core HongKong franchise to competition as the two markets become one.

It would be a mistake to think of the stake in BoCom as a strategic “option” since by definitionan option must be capable of being exercised to one’s own advantage under certaincircumstances. In the case of BoCom, we do not see any circumstances where this might occur and ask ourselves if this very valuable portfolio asset might not better be sold whileChinese stock market prices are still extraordinarily high.

Possible solutions to consider

This is not the right time to sell banking assets but we believe that you should considerwhether reshaping the business in other ways might not in fact offer an advantageous way ofaddressing the issues we discuss above and enhancing shareholder value.

We believe for example that the following alternatives deserve careful analysis:

1. Spinning off the U.S. retail business to shareholders This would leave shareholders with shares in two listed companies: the U.S. retail business and the rest of HSBC. The advantage of this is that it would ensure thata structural ring-fence would limit the extent to which the rest of HSBC would beat risk for losses in Household and it would therefore reduce the “sub-primeoverhang” on the valuation of the rest of the Group. With a proper management incentive scheme, we have no doubt that the new management of the U.S.business would take whatever steps were necessary to restructure the business and ensure that the value of the business was maximised. The overall increase inthe value of the parts compared with the Group at present could be very significant in our view.
2. Spinning off the retail businesses in the U.S., U.K. and France to shareholders If the above were considered too difficult to implement, an alternative would be tospin off the retail businesses in the U.S., U.K. and France. Again, this would create a structural ring-fence limiting the exposure of the rest of the Group to thesub-prime overhang. This would allow the rest of the business to trade at a much higher multiple, nearer to that of its emerging markets peers, particularly given its strong capital position and excellent growth prospects. We believe that the net positive effect of this spin-off could also be considerable. Once again, we would expect that with a proper incentive structure the management of the businesses being spun out would be well-placed to take whatever steps were necessary toenhance value (including in the U.K., where – by your own admission – greater customer segmentation and product focus will be necessary to maintainprofitability in front of the structural changes taking place).
3. Spinning off the retail business in Hong Kong/Asia to shareholders A third alternative would be to spin-off the retail banking business in HK/Asia.This would have the advantage of limiting the exposure of the HK/Asia business to sub-prime overhang and therefore allow the business to trade at a (higher) multiple nearer to that of its local market peers. A further advantage of this alternative is that it would allow the HK/Asia business to reverse into BoCom and thus capture all the opportunity of competing in China as a Chinese bank. The valuation uplift to HSBC’s shareholders from this spin-off would more thanoffset any loss of Group synergies and would also allow the shareholders tobenefit from owning a share in a business which truly has significant comparativeadvantage in China, particularly compared to HSBC. It would also not precludeHSBC from continuing with its high end retail/private banking strategy in China. As owners of a more focused HSBC and (separately) of a leading Chinese andHong Kong based bank with unrestricted ability to compete in Mainland China, webelieve that HSBC’s shareholders would be substantially better off, both in the short and the long term, and would also be less exposed to the risk that HSBC loses its dominant position in Hong Kong over time.

Clearly, there are other permutations and combinations that may make sense and some ofthe alternatives we suggest above may be combined with others. We believe that, workingwith appropriate external advisers, the Board needs to consider these sorts of solutions toaddress the risks and other issues which are of concern to HSBC’s shareholders.

Conclusion

Your comments about the need to align management incentives and objectives may nothave attracted much public comment but are critical to ensuring a better appreciation of the risks associated with running a leveraged business at times such as these. These risks include the less obvious but nonetheless very real risks associated with doing too little or reacting too slowly.

It is too late for HSBC to reverse its unfortunate decision to enter the mortgage services market, driven by the desire to diversify rather than seeking comparative advantage, andthere are lessons to be learned from the fact that HSBC was the first of its peers to identify the problems but was slow off the mark compared to those of its peers who sold or liquidatedassets when this was still possible. We are long term investors in HSBC and are concernedabout the consequences of not thinking strategically about the future of Hong Kong or insulating this very attractive business from the consequences of a poorly conceived forayinto sub-prime lending, where the Group had no comparative advantage.

We believe that the discernable greater focus and more disciplined approach to capital allocation which underlie last week’s Strategy Update represent a significant step in the rightdirection but there is a pressing need to protect and enhance those parts of HSBC that aremost highly valued by the market. Using HSBC’s secure and highly rated cash flow from Hong Kong to provide unlimited support to its high risk and low rated businesses in NorthAmerica is neither prudent nor value accretive for shareholders. Other global universal banks are reassessing their strategies at the current time and we believe that shareholders will strongly support a willingness by HSBC’s Board and management to grasp the nettle in order to reduce risk and enhance shareholder value.

Yours sincerely,

Eric Knight
Chief Executive

Glen Suarez
Director of Investments