Annual Financial Report - 45 of 56

RNS Number : 6382S

HSBC Holdings PLC

18 March 2016

 

Directors' Responsibility Statement

The Directors are responsible for preparing the Annual Report and Accounts, the Directors' Remuneration Report and the financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the parent company ('Company') and Group financial statements in accordance with International Financial Reporting Standards ('IFRSs') as adopted by the European Union. In preparing these financial statements, the Directors have also elected to comply with IFRSs, issued by the International Accounting Standards Board ('IASB'). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and Group and of the profit or loss of the Company and Group for that period. In preparing these financial statements, the Directors are required to:

·   select suitable accounting policies and then apply them consistently;

·   make judgements and estimates that are reasonable and prudent;

·   state whether applicable IFRSs as adopted by the European Union and IFRSs issued by IASB have been followed, subject to any material departures disclosed and explained in the financial statements; and

·   prepare the financial statements on a going concern basis unless it is inappropriate to presume that the Company and Group will continue in business.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the financial statements and the Directors' Remuneration Report comply with the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors are responsible for the maintenance and integrity of the Company's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

The Directors consider that the Annual Report and Accounts 2015, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the company's performance, business model and strategy.

Each of the Directors¹, whose names and functions are listed in the 'Report of the Directors: Corporate Governance' section on pages 249 to 255 of the Annual Report and Accounts 2015¹, confirm that, to the best of their knowledge:

·   the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Group; and

·   the management report represented by the Report of the Directors includes a fair review of the development and performance of the business and the position of the Group, together with a description of the principal risks and uncertainties that it faces.

In accordance with Section 418 of the Companies Act 2006, the Directors' report includes a statement, in the case of each Director in office as at the date the Report of the Directors is approved, that:

·   so far as the Director is aware, there is no relevant audit information of which the Company's auditors are unaware; and

·   they have taken all the steps they ought to have taken as a director in order to make themselves aware of any relevant audit information and to establish that the Company's auditors are aware of that information.

On behalf of the Board

Douglas Flint

Group Chairman

22 February 2016

1   Other than Henri de Castries who was not a Director at the time of approval of the Annual Report and Accounts 2015.

Report of the independent auditors to the members of
HSBC Holdings plc

Report on the financial statements

Our opinion on the financial statements

In our opinion HSBC Holdings plc's ('HSBC') Group financial statements and Parent Company financial statements:

·   give a true and fair view of the state of the Group's and Parent Company's affairs at 31 December 2015 and of the Group's and Parent Company's profit and cash flows for the year then ended;

·   have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union ('IFRS'); and

·   have been prepared in accordance with the requirements of the Companies Act 2006, and as regards the Group financial statements, Article 4 of the IAS Regulation.

Performing the audit

On behalf of PricewaterhouseCoopers LLP ('PwC'), it is my responsibility to form these opinions. This was the first year that you have appointed PwC as HSBC's auditors, and I have therefore provided more information on how PwC prepared for the audit together with an explanation of the audit approach applied and details of the significant discussions on accounting issues I, and my colleagues, have had with the Group Audit Committee ('GAC').

Preparing to change auditors

Before commencing audit work in September 2014, PwC member firms, their partners and staff took 12 months to ensure that we were independent of HSBC. This involved ceasing commercial relationships and changing financial arrangements for our partners and more than 2,000 staff who work on the audit of HSBC and its subsidiaries worldwide. During this period, members of my team took the opportunity to meet with HSBC's management team to understand the issues faced by the business, and to gather information which we required to plan our audit.

From September 2014 and throughout the 31 December 2014 year-end process, we worked alongside the former auditors, attending their key meetings with HSBC and understanding the complex or significant audit judgements which they made. We also observed the GAC and Group Risk Committee meetings and met with the primary regulators of HSBC.

In September 2014, I chaired a two day meeting of the partners and staff from PwC member firms who undertake audits of the most significant HSBC subsidiaries. This meeting ensured that we would have one approach to the audit globally, assisted in our determination of the most significant audit risks and provided an opportunity for those partners and staff to hear directly from HSBC management.

We also reviewed the working papers of the former auditors, to help familiarise ourselves with the controls on which they relied for the purposes of issuing their opinion, and to understand the evidence they obtained over key judgements.

How the audit approach was structured

I structured the audit approach to reflect how HSBC is organised. It incorporated four important aspects.

(i)    Risk assessment and audit planning at a Group level, having regard to both regions and HSBC's global businesses

In addition to having partners coordinate the audit in each region, I appointed partners for each global business. These global business partners met regularly with the relevant HSBC management to understand strategy and matters which arose throughout the year that could have impacted the financial reporting. These partners are specialists in the nature of the relevant businesses and were best placed to design an appropriate audit approach for that part of HSBC. They oversaw each PwC member firm involved in the audit of that global business and assisted me in my review of their work.

(ii)   Audit work performed at global shared service centres

A significant amount of HSBC's operational processes which are critical to financial reporting are undertaken in offshore shared service centres across 11 sites in five countries. Working closely with me, a partner coordinated our audit work on shared service centres, building up an end to end picture of the key processes that supported material balances, classes of transactions and disclosures within the HSBC financial statements. We then evaluated the effectiveness of controls over these processes and considered the implications for the remainder of our audit work. 

(iii)  Audit work executed on individual legal entities

We received opinions from PwC member firms which had been appointed as the external auditors of The Hongkong and Shanghai Banking Corporation Limited, HSBC Bank plc, HSBC North America Holdings Inc, HSBC Mexico S.A., HSBC Bank Brasil S.A. - Banco Multiplo, HSBC Vida e Previdência (Brasil) S.A., HSBC Bank Argentina S.A., HSBC Bank Middle East Limited, HSBC Bank Canada, HSBC Private Banking Holdings (Suisse) S.A. and HSBC Insurance (Bermuda) Limited. I was in active dialogue throughout the year with the partners responsible for these audits; this included consideration of how they planned and performed their work. I visited most of these subsidiaries since HSBC's decision to appoint PwC as auditor, as well as businesses in a further 7 countries. I also attended meetings with management in each of these key subsidiaries at the year end.

The audits of these key subsidiaries relied upon work performed by PwC member firms in Germany, France, Turkey, Malta, China, India, Australia, Qatar, Oman, the UAE and Bahrain. I considered how my subsidiary audit teams instructed and reviewed the work undertaken in these locations in order to ensure the quality and adequacy of the work.  Collectively, these teams completed procedures covering 81% of total assets, 77% of total operating income and 88% of profit before tax.

(iv)  Audit procedures undertaken at a Group level and on the Parent Company.

I ensured that appropriate further audit work was undertaken for HSBC as the Parent Company. This work included auditing, for example, the consolidation of the Group's results, the preparation of the financial statements, certain disclosures within the Directors remuneration report, litigation provisions and exposures and management's entity level and oversight controls relevant to financial reporting.

In aggregate, these four areas provided me with the evidence required to form an opinion on the consolidated financial statements of HSBC.

The purpose and scope of my audit

An audit has an important role in providing confidence in the financial statements that are provided by companies to their members. The audit opinion does not provide assurance over any particular number or disclosure, but over the financial statements taken as a whole. It is the Directors' responsibility to prepare the financial statements and to be satisfied that they give a true and fair view. These responsibilities have been recognised on behalf of the Board of Directors on page 322.

The scope of an audit is sometimes not fully understood. I believe that it is important that you understand the scope in order to understand the assurance that my opinion provides. My responsibility is to undertake my work and express my opinion in accordance with applicable law and the International Standards on Auditing (UK and Ireland) as issued by the Financial Reporting Council of the United Kingdom. These standards also require me to comply with the APB's Ethical Standards for auditors. A description of the scope of an audit is provided on the Financial Reporting Council's website at www.frc.org.uk/auditscopeukprivate; I recommend that you read this description carefully. It is also important that you understand the inherent limitations of the audit which are disclosed in the description, for example the possibility that an approach based upon sampling and other audit techniques may not identify all issues.

In order for me to perform my work, I had regard to the concept of materiality. I have determined materiality as follows:

Overall Group materiality	$1,050m.
How I determined it	5% of adjusted profit before tax excluding the debt valuation adjustment and non-qualifying hedges.
Why I believe this is appropriate	Given the geographically dispersed nature of HSBC and the diversity of its banking activities, I believe a standard benchmark of 5% of adjusted profit before tax is an appropriate quantitative indicator of materiality, although of course an item could also be material for qualitative reasons. I selected adjusted profit before tax, because as discussed on page 48, management believes it best reflects the performance of HSBC. I excluded the debt valuation adjustment and non-qualifying hedges as they are recurring items.

When planning the audit, I considered if multiple errors may exist which, when aggregated, could exceed $1,050m. In order to reduce the risk of multiple errors which could aggregate to this amount I used a lower level of materiality, known as performance materiality, of $788m to identify the individual balances, classes of transactions and disclosures that were subject to audit. I asked each of the partners reporting to me on the subsidiaries of HSBC to work to assigned materiality levels reflecting the size of the operations they audited. These ranged from $67m (HSBC Mexico S.A.) to $840m (The Hongkong and Shanghai Banking Corporation Limited).

Where the audit identified some items that were not reflected appropriately in the audited financial information, I considered these items carefully to assess if they were individually or in aggregate material. I reported any such items which exceeded $50m to the GAC, who were responsible for deciding whether adjustments should be made to the financial statements in respect of those items. The Directors have concluded that all items which remained unadjusted were not material to the financial statements, either individually or in aggregate. I agree with their conclusion.

Matters discussed with the GAC

I attended each of the seven GAC meetings held during the year. Part of each meeting involved a discussion with me without management present. I also met with members of the Committee on an ad hoc basis. During these various conversations we discussed my observations on a variety of accounting matters, and initial observations on controls over financial reporting.

In November 2014, the Committee held a special meeting to understand and challenge the audit plan. The plan included the matters which I considered presented the highest risk to the audit and other information on our audit approach such as our approach to the audit of journals, interest income and financial instrument valuation, and where the latest technology would be used to obtain better quality audit evidence. 

The areas of highest risk to the audit and where I focused most effort and resource, were:

•   Access to technology applications and data

•   Carrying value of goodwill

•   Application of hedge accounting

•   Impairment of loans and advances

•   Litigation and conduct

•   Investment in Bank of Communications Co., Ltd ('BoCom')

•   Impact of the deferred prosecution agreement ('DPA')

•   Recoverability of deferred tax assets.

To help you understand their impact on the audit, I have listed them in order of decreasing audit effort. Some of them are common with other international banks, and some are specific to HSBC. I have included at the end of this report an explanation of each item, why it was discussed and how the audit approach was tailored to address the concerns.

Going concern

The Directors have made a statement on page 277 regarding going concern. This statement is based on their belief that the Group and Parent Company intend to, and have sufficient resources to remain in business for 12 months from the date of this report. I am required to review this statement, and in doing so I have considered HSBC's budgets, cash flows, capital plan and stress tests. I have nothing to report as a result of my review. I also have nothing material to add or draw attention to in relation to the statement.

Other reporting

The Annual Report and Accounts also contains a considerable amount of other information that is required by various regulators or standard setters. In respect of this information my responsibilities and my reporting are set out in the table below.

Area of the Annual Report and Accounts 2015	My responsibility	My reporting
Directors Remuneration Report on pages 285 to 321
Those parts of which are clearly marked as audited.	Consider whether the information is properly prepared.	In my opinion, this information has been properly prepared in accordance with the Companies Act 2006.
Other remuneration report disclosures.	Consider whether certain other disclosures specified by the Companies Act have been made.	The other required disclosures have been made.
Other areas
Strategic Report and the Directors' Report.	Consider whether they are consistent with the audited financial statements.	In my opinion, the information in these reports is consistent with the audited financial statements.
Viability statement on page 277 which considers the longer term sustainability of the Group's business model.	Review the statement in the light of the knowledge gathered during the audit.	I have nothing material to draw attention to or to add to the statement.
Directors' confirmation of their robust assessment of principal risks, and disclosures describing those risks and how they are managed or mitigated on page 278.	Review the confirmation and description in the light of the knowledge gathered during the audit.	I have nothing material to draw attention to or to add to the confirmation or description.
GAC Report on page 262.	Consider whether it deals appropriately with those matters that I reported to the GAC.	No exceptions to report.
Directors' statement (on page 322) that they consider the HSBC Annual Report and Accounts 2015, taken as a whole, to be fair, balanced and understandable and provides the information necessary for you to assess HSBC's performance, business model and strategy.	Consider whether any information found during the course of the audit would cause me to disagree.	No disagreements to report.
Corporate governance report (on pages 249 to 284).	Review the remaining 10 provisions of the UK Corporate Governance Code specified for our review by the UK Listing Rules.	Nothing to report following our review.
All other information in the Annual Report aside from the audited financial statements.	Consider whether it is materially inconsistent or materially incorrect based on the knowledge gained in my audit, or otherwise misleading. Consider whether it is materially inconsistent with the audited financial statements.	No exceptions to report.

In addition, I am required to report to you if:

·   I have not received all of the information and explanations required for my audit;

·   Adequate accounting records have not been kept by the Parent Company;

·   Returns adequate for my audit have not been received from branches not visited by PwC;

·   The Parent Company financial statements and the audited part of the Directors' Remuneration Report do not agree with the accounting records and returns.

I have no exceptions to report as a result of any of these responsibilities. 

Use of this report

This report, including the opinions, has been prepared for and only for you, the Parent Company's members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006, and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come except where expressly agreed by our prior written consent.

Richard Oldfield (Senior Statutory Auditor)

for and on behalf of PricewaterhouseCoopers LLP

Chartered Accountants and Statutory Auditors

London, United Kingdom

22 February 2016

Appendix: Matters discussed with the Group Audit Committee ('GAC')

Those areas which presented the greatest risk of material misstatement in the financial statements are required to be discussed with the GAC. They had the greatest effect on the audit, including the allocation of resources and effort and are discussed below together with an explanation of how the audit was tailored to address these specific areas. The first table indicates which segments and businesses were impacted by the matters discussed.

This is not a complete list of all risks identified by the audit.

		Segments					Global businesses
Matters discussed	Group wide	Europe	Asia	North America	Latin America		RBWM	CMB	GB&M	GPB
IT access management	ü
Goodwill and intangible assets		ü		ü	ü				ü	ü
Application of hedge accounting		ü		ü					ü
Impairment of loans and advances		ü		ü	ü		ü	ü
Litigation and conduct		ü		ü			ü	ü	ü	ü
Investment in BoCom			ü					ü
Impact of the DPA	ü
Recoverability of deferred tax assets				ü	ü

IT access management

Nature of the area of focus	Matters discussed with the GAC
Access rights to technology are provided to individuals in order to support their specific roles. These rights are important because they ensure that changes to applications and data are authorised and made in an appropriate manner. Ensuring staff only have appropriate access, and that the access is monitored, are key controls to mitigate the potential for fraud or error as a result of a change to an application or underlying data. During the year, it was identified that controls over access rights to operating systems, applications, and data used in the financial reporting process required improvement to ensure that access was sufficiently monitored, restricted or segregated. All banks are highly dependent on technology due to the significant number of transactions that are processed daily. The audit approach relies extensively on automated controls and therefore procedures are designed to test access and control over IT systems. As a consequence of the control findings, the assessed risk of a material misstatement arising from access to technology was changed to significant. The audit approach was modified, with the extent of testing increased substantially to obtain the necessary evidence that a material error or fraud remained undetected.	A specific pre-year end GAC meeting was held to discuss the control issues identified, and to agree a response. A revised audit approach and plan was presented along with examples of how the application and database findings impacted specific products transacted by HSBC. At the GAC meeting held prior to approving the Annual Report and Accounts 2015, a summary of the findings of the audit work was discussed, together with a consideration of the additional work performed by management to address the issues identified. This included the work undertaken to evidence that access was not used inappropriately, and also detective controls which operated at many levels within HSBC to prevent a material error or fraud remaining undetected.
Procedures performed to support our discussions and conclusions
Access rights were tested over the various aspects of technology relied upon for financial reporting. Specifically, the audit tested that: •     new access requests for joiners were properly reviewed and authorised; •     application user access rights were removed on a timely basis when an individual left or moved role; and •     access rights to applications were periodically monitored for appropriateness. Other areas that were independently assessed included password policies, security configurations, controls over changes to applications and databases and that business users, developers and production support did not have access to change applications, the operating system or databases in the production environment. As a consequence of the findings that were identified a range of other procedures were performed; •     Where possible, the extent of inappropriate access was identified and the changes made with this access assessed to determine that they were appropriate. •     Automated controls in applications impacted were considered as manual, and therefore tested on multiple occasions rather than once. •     Additional substantive testing was performed on the year-end balance sheet and income statement where this was deemed to be effective. •     Where possible, testing was performed on other compensating controls or processes not impacted by systems. •     A list of users with access to systems was obtained and manually compared to other access lists where segregation of duties was deemed to be of higher risk, for example within GB&M.
Relevant references in the Annual Report and Accounts 2015
GAC Report, page 262. Effectiveness of internal controls, page 277.

Goodwill and intangible assets

Nature of the area of focus	Matters discussed with the GAC
Goodwill of $16.3bn has arisen from a number of historic acquisitions. The largest balances are in Europe, North America and Latin America. An assessment is required annually to establish whether this goodwill should continue to be recognised, or if any impairment is required. The assessment was performed for each global business within a region, which is the lowest level at which HSBC could allocate and assess goodwill, which is referred to as a cash generating unit ('CGU'). The impairment assessment relied on the calculation of a value-in-use for each of the CGUs. This calculation was based on estimated future cash flows for each CGU discounted at an appropriate cost of equity rate. HSBC used its Annual Operating Plan as the basis for the first 5 years of cash flows and then extrapolated returns into perpetuity using a terminal growth factor. Cost of equity discount rates were based on the investment rates used within the global business and approved by the Board of Directors. The estimation of future cash flows and the level to which they are discounted is inherently uncertain and requires significant judgement. The extent of judgement and the size of the goodwill, resulted in this matter being identified as an area of audit focus.	The judgements used by management were most important when the calculated value-in-use was close to the carrying value of the CGU. Reasonably possible alternative assumptions were considered to identify those CGU's which were most sensitive to a change in value in use. During the third quarter, goodwill for GB&M in North America, Latin America and Europe, together with the Global Private Bank in Europe were of most interest in the discussion with the GAC as these four CGUs have low levels of headroom as a proportion of carrying value. Subsequently, at 31 December the goodwill for Global Private Bank Europe and GB&M North America was retested as a result of indications of impairment being present. The discussion with the GAC focused on the key assumptions, both individually and when combined together. During these discussions, management confirmed their view that the forecasts for each CGU remained appropriate. As disclosed on page 410, a small deterioration in either performance or long term growth forecasts, or an increase in the discount rate may lead to impairment in one or more of the CGUs identified.
Procedures performed to support our discussions and conclusions
•     PwC's independent valuation experts critically assessed the discount rate and terminal growth rates used in the discounted cashflow models. The critical challenge was focused on the methodology used to reconcile the discount rates used by each CGU to the overall calculated cost of capital for HSBC; and whether the use of the country GDP growth rates was the most appropriate in determining the terminal growth of cash flows for each CGU. •     The calculations used in the model were re-performed to check accuracy and the key inputs in the model were agreed to approved sources. •     Management's strategic cash flow forecasts used in the model were assessed by: -   testing that the forecasts agreed to the 2015 Annual Operating Plan, which had been approved by the Board of Directors and considering how plans announced in HSBC's strategy update to investors on 9 June 2015 impacted that plan. For Global Private Banking Europe and GB&M North America flows in the forecasted 2016 Annual Operating Plan were agreed to the retest of impairment at 31 December; -   considering current year performance against plan and the reasons for any deviation. This was discussed with management of the Global Businesses for each sensitive CGU; and -   reviewing the historical achievement of the Annual Operating Plan. Given the uncertainties in forecasting, this identified that forecasts have been less accurate for prior periods, and we considered if this was appropriately factored into the discount rates used. •     Independent sensitivity analysis was performed, making adjustments to a number of modelled assumptions simultaneously to identify any further CGUs with a risk of impairment. This identified more CGU's requiring consideration than initially identified by management. •     The appropriateness of disclosures made in relation to goodwill was also reviewed.
Relevant references in the Annual Report and Accounts 2015
GAC Report, page 262. Note 20: Goodwill and intangible assets, page 406.

Application of hedge accounting

Nature of the area of focus	Matters discussed with the GAC
To qualify for hedge accounting, certain criteria must be met including documenting the nature and purpose of the hedge and performing regular testing over its effectiveness. Due to the complex nature of the hedge accounting rules this is often an area of significant risk for banks. However, given the nature of HSBC's business we initially believed the risk to be lower. The audit testing identified a number of instances where hedge accounting was applied, but the accounting rules had not been adequately met. This led to the disqualification for hedge accounting purposes of some macro cash flow hedges in the UK, France and Canada. As a result of these findings, management instigated a full review of all hedge accounting relationships. The audit risk associated with hedge accounting was reassessed to be significant for certain hedges, and the extent of testing increased.	The disqualified hedges resulted in an immaterial adjustment to the income statement. A discussion was held with the GAC about whether the adjustment would have been more appropriate to 2014. Due to the size of the adjustment it was concluded that the adjustment should be recognised in 2015. The control implications of the findings were also discussed. A project team was established by management, which regularly reported progress and proposed a revised control structure be established.
Procedures performed to support our discussions and conclusions
•     Material macro cash flow hedge documentation was examined and the relationships assessed to determine if the hedges had been appropriately designated. This included consideration of the hedge objectives and specific compliance with IFRS. •     A sample of all other hedging relationships was examined and the relationships assessed to determine if they had been appropriately designated. This included consideration of the hedge objectives and specific compliance with IFRS. •     Management's hedge effectiveness reviews, and the measurement and recording of hedge ineffectiveness, were tested for a sample of hedge relationships. •     Understood and tested controls over the documentation and review of the hedge relationships and their initial and ongoing effectiveness. •     Examined the output from management's review of hedge accounting relationships.
Relevant references in the Annual Report and Accounts 2015
GAC Report, page 262. Note 16: Derivatives, page 394.

Impairment of loans and advances

Nature of the area of focus	Matters discussed with the GAC
Impairment allowances represent management's best estimate of the losses incurred within the loan portfolios at the balance sheet date. They are calculated on a collective basis for portfolios of loans of a similar nature and on an individual basis for significant loans. The calculation of both collective and individual impairment allowances is inherently judgemental for any bank. Collective impairment allowances are calculated using statistical models which approximate the impact of current economic and credit conditions on large portfolios of loans. The inputs to these models are subject to management judgement and model overlays are often required. For specific impairments, judgement is required to determine when an impairment event has occurred and then to estimate the expected future cash flows related to that loan. The audit was focused on impairment due to the materiality of the balances and the subjective nature of the calculation. The largest loan portfolios are in Europe and Asia. The most significant impairment allowances are in Europe, North America and Latin America.	The policies and methodologies used by HSBC were discussed with the GAC. The impairment policies and practices applied are consistent with the requirements of IFRS. The methodologies used to calculate collective impairment allowances are relatively standard which means that modelling risk is low but that changes in individual inputs can have a significant bearing on the impairment charge. The discussion covered positive observations around the governance supporting changes to model inputs and our observations on suggested enhancements to documentation. At each GAC and Group Risk Committee meeting there was a discussion on changes to risk factors and other inputs within the collective allowance models as well as discussions on individually significant loan impairments. In light of the further deterioration in the spot price of oil, a specific discussion on the exposures to the oil and gas sector was held with GAC at the year end. This discussion considered the appropriate treatment of the Group's exposure within the collective impairment calculation and the additional $0.2bn increase at the year-end.
Procedures performed to support our discussions and conclusions
•     The controls management has established to support their collective and specific impairment calculations were tested. •     For collective impairment this included controls over the appropriateness of models used to calculate the charge, the process of determining key assumptions and the identification of loans to be included within the calculation. •     For specific impairment charges on individual loans this included controls over the compilation and review of the credit watch list, credit file review processes, approval of external collateral valuation vendors and review controls over the approval of significant individual impairments. •     For collective allowances the appropriateness of the modelling policy and methodology used for material portfolios was independently assessed by reference to the accounting standards and market practices and model calculations were tested through re-performance and code review. •     The appropriateness of management's judgements was also independently considered in respect of calculation methodologies and segmentation, economic factors and judgemental overlays, period of historical loss rates used, loss emergence periods, cure rates for impaired loans and the valuation of recovery assets and collateral. •     For specific allowances the appropriateness of provisioning methodologies and policies was independently assessed for a sample of loans across the portfolio selected on the basis of risk. An independent view was formed on the levels of provisions booked based on the detailed loan and counterparty information in the credit file. Calculations within a sample of discounted cash flow models were re-performed.
Relevant references in the Annual Report and Accounts 2015
Impaired loans, page 128. Areas of special interest, page 116. GAC Report, page 262. Note 1 (j): Impairment of loans and advances, page 354.

Litigation and conduct

Nature of the area of focus	Matters discussed with the GAC
HSBC, like other global banking institutions, is exposed to a significant number of open legal cases and regulatory investigations in a number of its markets. Given the business is geographically dispersed, the same matter could be subject to investigation in multiple jurisdictions. Provisions of $4.5bn have been established to account for legal settlements, regulatory fines, customer redress payments and related operational costs. The most significant provisions relate to Payment Protection Insurance, Jaffe vs Household Inc, tax-related investigations and Foreign Exchange market manipulation. There is an inherent risk that conduct and legal exposures are not identified and considered for financial reporting purposes on a timely basis. Importantly, the decision to recognise a provision and the basis of measurement are judgemental.	Each material provision was discussed with the GAC when established or changed, including whether HSBC's policy had been applied in an appropriate manner. A number of other matters, for which provisions were not established, were discussed to ensure the appropriateness of that decision. Specifically: Legal cases: Group Legal provided to each GAC meeting an update on the status of legal cases. Material matters were discussed during the meeting and the need for changes to provisions considered. These discussions considered whether all related litigation or investigations about a specific matter had been identified. Customer redress payments: The most significant provision has been in relation to PPI. The change in approach to the provision as a result of the FCA consultation paper released in November 2015 was discussed, as well as the judgements made to reflect ongoing claim history.
Procedures performed to support our discussions and conclusions
•     Controls designed to ensure the completeness and adequacy of current legal and regulatory provisions were tested. Regulatory correspondence from material markets was also read, and a sample of legal expenses were reviewed. •     Open legal cases were discussed with Group Legal and in certain instances we obtained and reviewed the relevant regulatory and litigation documents in order to assess the facts and circumstances. •     The range of reasonably possible outcomes was considered for material provisions to independently assess the appropriateness of the judgement made by HSBC. •     The disclosures of conduct and legal exposures and provisions were assessed for completeness and accuracy. •     For customer redress, the provisioning models and underlying assumptions used, were independently assessed. For example, for PPI the inputs examined included customer complaint volumes and response rates. For the material models testing was performed to check that the models were maintained appropriately and relevant calculations within the models were re-performed.
Relevant references in the Annual Report and Accounts 2015
GAC Report, page 262. Note 29: Provisions, page 421. Note 40: Legal proceedings and regulatory matters, page 445.

Investment in BoCom

Nature of the area of focus	Matters discussed with the GAC
HSBC holds 19.03% of the listed equity of BoCom. This investment is accounted for as an associate using the equity method, because of the significant influence that comes from the shareholding. At 31 December, the market value of the investment based on the share price ($9.9bn), was below the carrying value of the investment ($15.3bn). This is considered an indicator of potential impairment under IFRS. An impairment test was performed by HSBC using a value in use model to estimate the investment's value assuming the investment continues to be held rather than sold ($17.0bn). On this basis no impairment was required and the share of BoCom's profits has been recognised in the income statement. The many assumptions used in the model to estimate future profits attributable to HSBC are derived from a combination of analysts' forecasts and management's best estimates and are highly judgemental.	The critical assumptions used by HSBC in the model were discussed with the GAC. For each assumption an independent view was provided of the range of possible alternative inputs that could have been used. The discussion focussed on the long term loan impairment charge ratio and the long term growth rate. These are difficult to substantiate and require management to form a view on future growth in China as well as BoCom's potential future impairment charges.
Procedures performed to support our discussions and conclusions
•     PwC's independent valuation experts reviewed the appropriateness of the model and the inputs selected to calculate the value in use. They independently recalculated the discount rate applied to the cash flows in the model. •     Inputs used in the determination of assumptions for the calculation of the value in use were agreed back to third-party sources, where available, including external data from analysts' reports. •     The controls in place over the model including security access and end user controls were tested. •     The mathematical accuracy of the model was tested. •     The quarterly meeting between senior BoCom executive management and HSBC held specifically to assess the current performance of the business was observed. •     Disclosures made in relation to BoCom were reviewed.
Relevant references in the Annual Report and Accounts 2015
GAC Report, page 262. Note 19: Interests in associates and joint ventures, page 402.

Impact of the DPA

Nature of the area of focus	Matters discussed with the GAC
HSBC and HSBC Bank USA NA entered into a DPA with the US Department of Justice ('DoJ') and Financial Conduct Authority in 2012 regarding non-compliance with the US Bank Secrecy Act, anti-money laundering rules, and sanctions laws. The duration of the DPA is five years. If the DoJ concluded that a breach of the DPA had occurred, there are a number of potential penalties that could be imposed that could have a material adverse effect on HSBC's business. This could include loss of business and withdrawal of funding, restrictions on US dollar clearing functions through HSBC Bank USA or revocation of bank licences. The loss of this ability could have a significant adverse impact on the going concern status of HSBC and its individual subsidiaries in the future.	In considering going concern as the basis of preparation of the financial statements, a discussion was held with the GAC about the progress being made in responding to the requirements of the DPA. The conversation specifically considered the 2015 report of the Monitor. In the report he expressed significant concerns about the pace of progress, instances of potential financial crime and systems and controls deficiencies, whether HSBC is on track to meet its goal to the Monitor's satisfaction within the five-year period and, pending further review and discussion with HSBC, did not certify as to HSBC's implementation of, and adherence to, remedial measures specified in the DPA. Assurances were sought from the Directors that they were not aware of any information to suggest that the DoJ had concluded that the DPA had been breached.
Procedures performed to support our discussions and conclusions
•     The likelihood of the DPA being breached and a restriction to US dollar clearing imposed was independently assessed through: -     Inquiry with the Monitor, whose role is explained on page 116, to understand the status of his work, the outcome of his most recent country reviews, his assessment of management's progress against the requirements of the DPA and his reporting to the DoJ and FCA. -     Reading the 2015 and 2014 Monitor reports and the 9 country reports issued during the year. -     Reading the detailed reports produced by the compliance function that undertook testing of controls and processes related to the DPA, and an assessment of the findings. •     Each Group Risk Committee meeting was attended during the year. At each meeting a report was provided by Group Risk on the status of Global Standards Programme, which aims to address all of the DPA recommendations. The related discussion was observed. •     The papers supporting the Financial System Vulnerabilities Committee meeting at the year-end were reviewed. This meeting discussed the 2015 Monitor report and management's response. •     Compliance with the DPA was discussed with Group Legal and other members of senior management.
Relevant references in the Annual Report and Accounts 2015
Top and emerging risks, page 43. Areas of special interest: the Monitor, page 116. Financial System Vulnerabilities Committee, page 268. Going concern and viability statements, page 277. Note 40: Legal proceedings and regulatory matters, page 445.

Recoverability of deferred tax assets

Nature of the area of focus

Matters discussed with the GAC

HSBC has deferred tax assets of $6.1bn as at 31 December 2015, of which $4.5bn relates to the US. A further $1.2bn net deferred assets are included in Assets Held For Sale and relates to Brazil. These assets have arisen because of historic losses, deferred relief for impairment and other temporary differences. An assessment is required as to whether sufficient future taxable profits are likely to be generated to enable the assets to be realised. The estimation of future taxable profits is inherently judgemental, particularly when this extends beyond the normal planning cycle. In the case of Brazil, this is exacerbated by recent performance not being in accordance with plan.	The carrying value of deferred tax assets in Brazil and the US was discussed several times during the year. HSBC updated performance against forecasts to support the continued recognition of the assets and this was considered during GAC meetings. Brazil: In light of the disposal of the business discussed on page 416, the appropriate basis on which to assess future taxable profits was discussed. HSBC has considered both the internal strategic plan as well as profits implied by the agreed sales price using the Price/Earnings ratios considered appropriate for Brazilian banks. Whilst performance in 2015 has not been in line with the strategic plan, the implicit profit forecast derived from the sales price provides support for the expected profitability of the business. Sufficient taxable profits to support recognition are expected to be earned within 8 years in the best case scenario and within 13 years in the worst case scenario. North America: As at 1 January 2015, the recognition of the US deferred tax asset relied upon capital support from HSBC. Given improved performance and forecasts management considered that it was appropriate to recognise the asset on the basis of future taxable profits. This change led to the recognition of additional deferred tax assets. The change in the basis of recognition, and the increased assets recognised, were discussed with the GAC.
Procedures performed to support our discussions and conclusions
•     The application of tax rules was examined to check they had been appropriately applied and that a loss or deductible temporary difference exists. •     Supporting calculations were tested to check that the valuation of the asset is appropriate based on the temporary differences identified and the tax rates applied. •     The basis for management's assessment of recoverability including the profit projections and underlying assumptions and the calculations performed to arrive at taxable profits from these projections, was challenged using our knowledge of the business, future strategy and past performance. •     The appropriateness and validity of tax planning strategies relied upon to support recognition where relevant was assessed. •     The range of reasonably possible alternative outcomes was assessed for the projections in each market. •     The calculation methodology used to determine the implied profits from the sales price achieved for the Brazilian subsidiary was evaluated. •     The completeness and accuracy of the disclosures was also assessed.
Relevant references in the Annual Report and Accounts 2015
GAC Report, page 262. Note 8: Tax, page 369. Note 23: Assets held for sale and liabilities of disposal groups held for sale, page 416.

Financial Statements
Consolidated income statement		337
Consolidated statement of comprehensive income		338
Consolidated balance sheet		339
Consolidated statement of cash flows		340
Consolidated statement of changes in equity		341
HSBC Holdings balance sheet		343
HSBC Holdings statement of cash flows		344
HSBC Holdings statement of changes in equity		345
Notes on the Financial Statements
1	Basis of preparation and significant accounting policies	347
2	Net income from financial instruments designated at fair value	359
3	Net insurance premium income	359
4	Net insurance claims and benefits paid and movement in liabilities to policyholders	360
5	Operating profit	361
6	Employee compensation and benefits	361
7	Auditors' remuneration	368
8	Tax	369
9	Dividends	371
10	Earnings per share	372
11	Segmental analysis	373
12	Trading assets	377
13	Fair values of financial instruments carried at fair value	378
14	Fair values of financial instruments not carried at fair value	390
15	Financial assets designated at fair value	393
16	Derivatives	394

17	Financial investments	398
18	Assets charged as security for liabilities, assets transferred and collateral accepted as security for assets	401
19	Interests in associates and joint ventures	402
20	Goodwill and intangible assets	406
21	Investments in subsidiaries	414
22	Prepayments, accrued income and other assets	416
23	Assets held for sale and liabilities of disposal groups held for sale	416
24	Trading liabilities	417
25	Financial liabilities designated at fair value	418
26	Debt securities in issue	418
27	Accruals, deferred income and other liabilities	419
28	Liabilities under insurance contracts	419
29	Provisions	421
30	Subordinated liabilities	423
31	Maturity analysis of assets, liabilities and off‑balance sheet commitments	426
32	Offsetting of financial assets and financial liabilities	434
33	Foreign exchange exposures	436
34	Non-controlling interests	436
35	Called up share capital and other equity instruments	437
36	Notes on the statement of cash flows	439
37	Contingent liabilities, contractual commitments and guarantees	441
38	Lease commitments	442
39	Structured entities	442
40	Legal proceedings and regulatory matters	445
41	Related party transactions	454
42	Events after the balance sheet date	457
43	HSBC Holdings' subsidiaries, joint ventures and associates	457

 

END

 

 

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