Information  X 
Enter a valid email address

HSBC Holdings PLC (HSBA)

  Print      Mail a friend       Annual reports

Tuesday 23 February, 2021

HSBC Holdings PLC

Annual Financial Report - Part 8

RNS Number : 0680Q
HSBC Holdings PLC
23 February 2021
 

Financial statements

 

267 Independent auditors' report to the members of HSBC Holdings plc

278 Financial statements

288 Notes on the financial statements

 

 

 

 

 

 

Supporting our customers through transition finance

We are supporting our customers to make progress towards their commitments to cut greenhouse gas emissions, in line with the goals of the Paris Agreement on climate change. We played a key role in the world's first 'transition' Islamic bond, known as a sukuk, to help reduce carbon emissions in the aviation industry. Etihad Airways will use the $600m proceeds for energy-efficient aircraft and research and development into sustainable aviation fuel.

This sukuk included a commitment from Etihad to purchase a set amount of carbon offsets if it fails to meet its short-term target to reduce the carbon intensity of its passenger fleet.

We acted as joint global coordinator and joint sustainability structuring agent on the deal, as well as joint bookrunner and dealer manager.

 

Independent auditors' report to the members of HSBC Holdings plc

Report on the audit of the financial statements

Opinion

In our opinion, HSBC Holdings plc's ('HSBC') group financial statements1 and company financial statements (the 'financial statements'):

give a true and fair view of the state of the group's and of the company's affairs as at 31 December 2020 and of the group's and company's profit and the group's and company's cash flows for the 12 month period (the "year") then ended;

have been properly prepared in accordance with international accounting standards in conformity with the requirements of the Companies Act 2006; and

have been prepared in accordance with the requirements of the Companies Act 2006.

Our opinion is consistent with our reporting to the Group Audit Committee ('GAC').

Separate opinion in relation to international financial reporting standards adopted pursuant to Regulation (EC) No 1606/2002 as it applies in the European Union

As explained in note 1.1(a) to the financial statements, the group, in addition to applying international accounting standards in conformity with the requirements of the Companies Act 2006, has also applied international financial reporting standards adopted pursuant to Regulation (EC) No 1606/2002 as it applies in the European Union.

In our opinion, the group financial statements have been properly prepared in accordance with international financial reporting standards adopted pursuant to Regulation (EC) No 1606/2002 as it applies in the European Union.

Separate opinion in relation to IFRSs as issued by the IASB

As explained in note 1.1(a) to the financial statements, the group, in addition to applying international accounting standards in conformity with the requirements of Companies Act 2006, has also applied IFRSs as issued by the International Accounting Standards Board (IASB).

In our opinion, the group financial statements have been properly prepared in accordance with IFRSs as issued by the IASB.

Basis for opinion

We conducted our audit in accordance with International Standards on Auditing (UK) ('ISAs (UK)') and applicable law. Our responsibilities under ISAs (UK) are further described in the Auditors' responsibilities for the audit of the financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Independence

We remained independent of the group in accordance with the ethical requirements that are relevant to our audit of the financial statements in the UK, which includes the FRC's Ethical Standard, as applicable to listed public interest entities, and we have fulfilled our other ethical responsibilities in accordance with these requirements.

To the best of our knowledge and belief, we declare that non-audit services prohibited by the FRC's Ethical Standard were not provided to the group.

Other than those disclosed in note 6 to the financial statements, we have provided no non-audit services to the group in the period under audit.

Our audit approach

Overview

This was the second year that it has been my responsibility to form this opinion on behalf of PricewaterhouseCoopers LLP ('PwC'), who you first appointed on 31 March 2015 in relation to that year's audit. In addition to forming this opinion, in this report we have also provided information on how we approached the audit, how it changed from the previous year and details of the significant discussions that we had with the GAC.

Given the impact of Covid-19, substantially all of our interactions were undertaken virtually, including those between the engagement team, with the teams for Significant Subsidiaries and Operations Centres, and with HSBC Board members and management. Similarly, substantially all of our audit testing was performed remotely. For further details around the impact of Covid-19 on our audit, please see the 'Impact of Covid-19' key audit matter below.

Materiality

Overall group materiality: $900m (2019: $1,000m) based on 5% of an adjusted profit before tax for the last three years.

Overall company materiality: $855m (2019: $900m) being an amount capped below the overall group materiality.

1  We have audited the financial statements, included within the Annual Report and Accounts (the 'Annual Report'), which comprise: the consolidated and company balance sheets as at 31 December 2020, the consolidated and company income statements and the consolidated and company statements of comprehensive income for the year then ended, the consolidated and company statements of cash flows for the year then ended, the consolidated and company statements of changes in equity for the year then ended, and the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. Certain notes to the financial statements have been presented elsewhere in the Annual Report and Accounts 2020, rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as '(Audited)'. The relevant disclosures are included in the Risk review section on pages 113 to 194 and the Directors' remuneration report disclosures on pages 239 to 249.

 

 

Audit scope

The scope of our audit and the nature, timing and extent of audit procedures performed were determined based on our risk assessment, taking into account changes from the prior year, the financial significance of subsidiaries and other qualitative factors. We executed the planned approach and concluded based on the results of our testing, ensuring that sufficient audit evidence had been obtained to support our opinion.

 

Key audit matters

Impact of Covid-19 (group and company)

Expected credit losses - Impairment of loans and advances (group)

Investment in associate - Bank of Communications Company, Limited ('BoCom') (group)

Impairment of goodwill and intangible assets (group)

Valuation of financial instruments (group)

Impairment of investments in subsidiaries (company)

Valuation of defined benefit pensions obligations (group)

IT access management (group)

 

The scope of our audit

As part of designing our audit, we determined materiality and assessed the risks of material misstatement in the financial statements. In particular, we looked at where the directors made subjective judgements, for example in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain.

 

Capability of the audit in detecting irregularities, including fraud

Irregularities, including fraud, are instances of non-compliance with laws and regulations. We design procedures in line with our responsibilities, outlined in the Auditors' responsibilities for the audit of the financial statements section, to detect material misstatements in respect of irregularities, including fraud. The extent to which our procedures are capable of detecting irregularities, including fraud, is detailed below.

Based on our understanding of the group and industry, we identified that the principal risks of non-compliance with laws and regulations related to breaches of financial crime laws & regulations and regulatory compliance, including conduct of business, and we considered the extent to which non-compliance might have a material effect on the financial statements. We also considered those laws and regulations that have a direct impact on the preparation of the financial statements, such as the Companies Act 2006 and the UK and Hong Kong listing rules. We evaluated management's incentives and opportunities for fraudulent manipulation of the financial statements (including the risk of override of controls), and determined that the principal risks were related to posting inappropriate journal entries to increase revenue or reduce costs, creating fictitious trades to hide losses or to improve financial performance, and management bias in accounting estimates. The group engagement team shared this risk assessment with the component auditors so that they could include appropriate audit procedures in response to such risks in their work. Audit procedures performed by the group engagement team and/or component auditors included:

Review of correspondence with and reports to the regulators, including the Prudential Regulation Authority ('PRA') and Financial Conduct Authority ('FCA');

Reviewed reporting to the GAC and GRC in respect of compliance and legal matters;

Review a sample of legal correspondence with legal advisors;

Enquiries of management and review of internal audit reports in so far as they related to the financial statements;

Obtain legal confirmations from legal advisors relating to material litigation and compliance matters;

Assessment of matters reported on the group's whistleblowing and 'Speak up' programmes and the results of management's investigation of such matters; in so far as they related to the financial statements;

Challenging assumptions and judgements made by management in its significant accounting estimates, in particular in relation to the determination of expected credit losses, and the impairment assessments of goodwill, intangible assets, the investment in BoCom, valuation of financial instruments, valuation of defined benefit pensions obligations and investment in subsidiaries (see related key audit matters below);

Obtaining confirmations from third parties to confirm the existence of a sample of transactions; and

Identifying and testing journal entries, including those posted with certain descriptions, posted and approved by the same individual, backdated journals or posted by infrequent and unexpected users.

There are inherent limitations in the audit procedures described above. We are less likely to become aware of instances of non-compliance with laws and regulations that are not closely related to events and transactions reflected in the financial statements. Also, the risk of not detecting a material misstatement due to fraud is higher than the risk of not detecting one resulting from error, as fraud may involve deliberate concealment by, for example, forgery or intentional misrepresentations, or through collusion.

 

Key audit matters

Key audit matters are those matters that, in the auditors' professional judgement, were of most significance in the audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by the auditors, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. These matters, and any comments we make on the results of our procedures thereon, were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. This is not a complete list of all risks identified by our audit.

The impact of Covid-19 and valuation of financial instruments are new key audit matters this year. Otherwise, the key audit matters below are consistent with last year.

Impact of Covid-19 (group and company)

 

The impact of the Covid-19 pandemic has resulted in unprecedented economic conditions and resulting government support programmes and regulatory interventions to support businesses and people. The Covid-19 pandemic has also changed the way that companies operate their businesses, with one of the most substantial impacts being the transition to remote working.

A substantial proportion of HSBC's employees have been working remotely during 2020, with some consequential changes on their processes and the control environment, some of which were relevant for financial reporting purposes. Our audit team has also been working remotely for most of 2020, as have most of our teams auditing the Significant Subsidiaries and operational centres.

The impact of the Covid-19 pandemic and resulting uncertainty has impacted a number of the estimates in the group financial statements and company financial statements. The impact on the most significant accounting judgements and our audit is set out in the following other key audit matters in this opinion:

Expected credit losses - Impairment on loans and advances to customers;

Investment in associate - BoCom;

Impairment of goodwill and intangible assets;

Valuation of financial instruments; and

Impairment of investment in subsidiaries.

 

We discussed our assessment of the impact of Covid-19 on HSBC's operations and control environment with the GAC. We also explained how we planned to execute our audit with substantially all of our audit team working remotely.

 

We engaged with the Board and management at HSBC in a manner consistent with our previous audits, albeit remotely using video and telephone calls. Substantially all of the information and audit evidence we need for the HSBC audit is provided in electronic format. We shared information, including the audit evidence provided to us by HSBC, using share-screen functionality in video calls and our secure encrypted information sharing software. Where we would have previously inspected physical evidence, for example our stock counts of precious metals, these audit procedures were performed virtually.

We understood and assessed the transition of HSBC employees to working remotely on the control environment relevant to financial reporting, and reflected this in our audit approach for new or changed processes and controls.

Where the group undertook new business activities as a result of Covid-19, for example, the government sponsored lending programmes, we assessed the audit risks and designed appropriate audit procedures.

We were not able to visit any of the audit teams for the Significant Subsidiaries and operational centres during our 2020 audit. However, consistent with our experience with HSBC, we engaged with and directed these teams in a manner consistent with our previous audits using video conferencing and telephone calls. This included 'virtual visits' to certain locations, in which we met with both the audit teams and local management. To ensure we were satisfied with the audits performed by the audit teams for the Significant Subsidiaries, we evaluated and reviewed audit evidence by remotely reviewing electronic audit files or using share-screen functionality in video conferencing.

 

GAC Report, page 218.

 

Expected credit losses - Impairment of loans and advances (group)

 

Determining expected credit losses ('ECL') involves management judgement and is subject to a high degree of estimation uncertainty, both of which have significantly increased as a result of Covid-19.

Management makes various assumptions when estimating ECL. The significant assumptions that we focus on in our audit included those with greater levels of management judgement and for which variations had the most significant impact on ECL. Specifically these included,

forward looking economic scenarios and their likelihoods;

customer risk ratings ('CRRs'), and probability of defaults; and

the recoverability of credit impaired wholesale exposures.

The modelling methodologies that use these assumptions, as well as other data, to estimate ECL are complex and not standardised. The modelling methodologies are developed using historical experience, which can result in limitations in their reliability to appropriately estimate ECL. These limitations are often addressed with adjustments, which are inherently judgemental and subject to estimation uncertainty.

The impact of the Covid-19 pandemic has resulted in unprecedented economic conditions that vary across countries and industry sectors. Covid-19 related government support programmes and regulatory interventions have impacted economic factors such as GDP and unemployment, and consequently the extent and timing of customer defaults.

These factors have increased the uncertainty around judgements made in determining the severity and likelihood of macroeconomic variable ('MEV') forecasts across the different economic scenarios used in ECL models. Furthermore, these conditions are outside the bounds of historical experience used to develop the models and where models produce plausible results, resulting in significantly greater limitations in their reliability to estimate ECLs.

Management has made significant adjustments to ECL to address these limitations through management judgemental adjustments to modelled outcomes. The nature and extent of these limitations and the resulting changes to ECL varies across retail and wholesale portfolios globally. In addition, certain models have been redeveloped during 2020.

The determination of CRRs is based on quantitative scorecards, with qualitative adjustments for relevant factors. The extent of qualitative adjustments has increased due to Covid-19. The uncertainty caused by Covid-19 also increases judgement involved in estimating expected cash flows and collateral valuations for specific impairments on credit impaired wholesale exposures.

 

We held discussions with the GAC covering governance and controls over ECL, with a significant focus on the impact of Covid-19. We also discussed a number of other areas, including:

the severity and likelihood of MEV forecasts in economics scenarios, across countries for the impact of Covid-19, and specifically for the UK and Hong Kong in relation to the geopolitical risks relating to the UK's withdrawal from the EU and US-China relations;

the determination and migration of customer risk ratings;

assumptions around the recoverability of significant wholesale exposures;

the identification and assessment of model limitations and resulting changes and adjustments to ECL, in particular for approaches adopted in response to Covid-19;

models that were redeveloped during the year;

model validation and monitoring; and

the disclosures made to explain ECL, in particular the impact of Covid-19 on determining ECL and the resulting estimation uncertainty.

 

We assessed the design of governance and controls over the estimation of ECLs, as well as testing how effectively they operated. We observed management's review and challenge governance forums for (1) the determination of MEV forecasts and their likelihood for different economic scenarios, and (2) the assessment of ECL for Retail and Wholesale portfolios, including the assessment of model limitations and approval of any resulting adjustments to modelled outcomes.

We also tested controls over:

model validation and monitoring;

credit reviews that determine CRRs for wholesale customers;

the input of critical data into source systems and the flow and transformation of critical data from source systems to the impairment models; and

the calculation and approval of management judgemental adjustments to modelled outcomes.

We involved our economic experts in assessing the reasonableness of the severity and likelihood of MEV forecasts. These assessments considered the sensitivity of ECLs to variations in the severity and likelihood of MEVs for different economic scenarios.

We involved our modelling experts in assessing the appropriateness of modelling methodologies that were redeveloped during the year, and for a sample of those models, we independently reperformed the modelling for certain aspects of the ECL calculation. We also assessed the appropriateness of modelling methodologies that did not change during the year, giving specific consideration to Covid-19 and whether management judgemental adjustments were needed. In addition, we performed testing over:

the compliance of ECL methodologies and assumptions with the requirements of IFRS9;

a sample of critical data used in the year end ECL calculation and to estimate management judgemental adjustments;

critical data, assumptions and discounted cash flows for a sample of credit impaired wholesale exposures; and

a sample of CRRs applied to wholesale exposures, including our credit experts assessing a sample by comparing to external sources.

We evaluated and tested the Credit Risk disclosures made in the Annual Report and Accounts 2020.

 

Credit risk disclosures, page 119.

GAC Report, page 220.

Note 1.2(d): Financial instruments measured at amortised cost, page 292.

Note 1.2(i): Impairment of amortised cost and FVOCI financial assets, page 293.

 

 

 

Investment in associate - BoCom (group)

 

At 31 December 2020, the market value of the investment in BoCom, based on the share price, was $13.7bn lower than the carrying value of $21.2bn. This is an indicator of potential impairment. An impairment test was performed by management, with supporting sensitivity analysis, using a value in use ('VIU') model. The VIU was $0.6bn in excess of the carrying value. On this basis, management concluded no impairment was required and the share of BoCom's profits has been recognised in the consolidated income statement.

The methodology in the VIU model is dependent on various assumptions, both short term and long term in nature. These assumptions, which are subject to estimation uncertainty, are derived from a combination of management's judgement, analysts' forecasts and market data. The significant assumptions that we focused our audit on were those with greater levels of management judgement and for which variations had the most significant impact on the VIU. Specifically, these included

discount rates;

forecast operating income;

long term growth rates;

future expected credit losses;

effective tax rates; and

regulatory capital requirements.

 

We discussed the appropriateness of the VIU methodology and significant assumptions with the GAC, giving consideration to the macroeconomic environment, as well as Covid-19 and the outlook for the Chinese banking market. We considered reasonably possible alternatives for the significant assumptions. We also discussed the disclosures made in relation to BoCom, including the use of sensitivity analysis to explain estimation uncertainty and the conditions that would result in an impairment being recognised.

 

We tested controls in place over significant assumptions and the model used to determine the VIU. We assessed the appropriateness of the methodology used, and the mathematical accuracy of the calculations, to estimate the VIU. In respect of the significant assumptions, our testing included the following:

Challenging the basis for determining significant assumptions and, where relevant, their interrelationships;

Obtaining and evaluating evidence where available for critical data relating to significant assumptions, from a combination of historic experience, external market information, third-party sources including analyst reports, information from BoCom management and historical publicly available BoCom financial information;

Assessing the sensitivity of the VIU to reasonable variations in significant assumptions, both individually and in aggregate; and

Determining a reasonable range for the discount rate used within the model, with the assistance of our valuation experts, and comparing it to the discount rate used by management.

We observed meetings in April, May, September and November 2020 between management and senior BoCom executive management, held specifically to identify facts and circumstances impacting assumptions relevant to the determination of the VIU.

We evaluated and tested the disclosures made in the Annual Report and Accounts 2020 in relation to BoCom.

 

GAC Report, page 221.

Note 1.2(a): Critical accounting estimates and judgements, page 291.

Note 18 Interests in associates and joint ventures, page 331.

 

 

Impairment of goodwill and intangible assets (group)

 

The impact of the Covid-19 pandemic has resulted in unprecedented economic conditions, impacting the performance of HSBC in both 2020 and the outlook into 2021 and beyond. This is considered by management to be an indicator of impairment.

An impairment test was performed by management, with supporting sensitivity analysis, using the higher of value in use ('VIU') and fair value less cost to sell. Management predominantly used VIU in its impairment tests, unless it believed that fair value less cost to sell would result in a higher recoverable amount for any cash generating unit ('CGU'). The impairment test resulted in impairment charges of $1.3bn and $41m for software intangibles and goodwill being recognised respectively for certain CGUs. For the remaining CGUs, where the recoverable amount was higher than the carrying value, no impairment was recorded. The remaining goodwill and software intangibles on the balance sheet at 31 December 2020 are $5.9bn and $4.5bn respectively.

The methodology in the models is dependent on various assumptions, both short term and long term in nature. These assumptions, which are subject to estimation uncertainty, are derived from a combination of management's judgement, experts engaged by management and market data. The significant assumptions that we focused our audit on were those with greater levels of management judgement and for which variations had the most significant impact on the recoverable amount. Specifically, these included HSBC's annual operating plan (AOP) for 2021 to 2025 including revenue forecasts and cost reduction targets, regulatory capital requirements, long term growth rates and discount rates.

 

We discussed the appropriateness of methodologies used and significant assumptions with the GAC, giving consideration to the macroeconomic environment, as well as Covid-19 and HSBC's strategy. We considered reasonably possible alternatives for significant assumptions. We also discussed the disclosures made in relation to goodwill and software intangibles, including the use of sensitivity analysis to explain estimation uncertainty and the conditions that would result in an impairment being recognised.

 

We tested controls in place over significant assumptions and the model used to determine VIUs and fair values. We assessed the appropriateness of the CGUs and the methodology used, and the mathematical accuracy of the calculations, to estimate the recoverable amounts. In respect of the significant assumptions, our testing included the following:

challenging the achievability of management's AOP and the prospects for HSBC's businesses;

obtaining and evaluating evidence where available for critical data relating to significant assumptions, from a combination of historic experience and external market and other financial information;

assessing whether the cash flows included in the model were in accordance with the relevant accounting standard;

assessing the sensitivity of the VIU to reasonable variations in significant assumptions, both individually and in aggregate; and

determining a reasonable range for the discount rate used within the model, with the assistance of our valuation experts, and comparing it to the discount rate used by management.

We evaluated and tested the disclosures made in the Annual Report and Accounts 2020 in relation to goodwill and software intangibles.

 

GAC Report, page 221.

Note 1.2(a): Critical accounting estimates and judgements, page 290.

Note 1.2(n): Critical accounting estimates and judgements, page 299.

Note 21: Goodwill and intangible assets, page 338.

 

 

Valuation of financial instruments (group)

 

The financial instruments held by the group range from those that are traded daily on active markets with quoted prices, to more complex and bespoke positions. The valuation of financial instruments can require the use of prices or inputs which are not readily observable in the market. Where significant pricing inputs are unobservable, the financial instruments are classified as Level 3 (L3), per the IFRS 13 fair value hierarchy. Determining unobservable inputs in fair value measurement involves management judgement and is subject to a high degree of estimation uncertainty.
The most material L3 financial instruments which are dependent on unobservable inputs are the group's holding of $11.0bn of private equity (PE) investments held by the Global Banking and Markets and the Insurance businesses. The group also holds $758m of similar investments in the pension scheme assets for HSBC (UK) Bank plc. Covid-19 has resulted in markets being more volatile.  The level of judgement surrounding the valuation of PE investments increases in times of heightened market volatility.
Fair value of the group's PE investments is estimated using commonly accepted valuation methodologies, which are set out in the International Private Equity and Venture Capital Valuation Guidelines and includes the use of net asset value (NAV) statements from fund managers, the price of recent investments, the use of market comparables or discounted cash flow models. The fair value of most PE investments are based on NAV statements provided by fund managers.

 

We discussed with the GAC the appropriateness of the PE valuation approaches for PE investments. We also discussed the governance and controls over determining fair values, in particular, when markets are more volatile.

 

We tested controls in place, including those relating to the assessment of valuations based on NAV statements and the fund managers that provide them.

For fair values based on NAV statements from fund managers, we inspected NAV statements and engaged our valuation experts to test management's assessment of the reliability of those valuations. For these valuations, we also:

compared fair value movements to movements in relevant market information, such as industry indices;

agreed NAV statements from fund managers to audited fund financial statements where they were available; and

performed back testing of fair values to any recent transactions.

We evaluated the adequacy and extent of disclosures made in the Annual Report and Accounts 2020 in relation to valuation of L3 financial instruments.

 

GAC Report, page 221.

Note 1.2(c): Critical accounting estimates and judgements, page 292.

Note 12: Fair values of financial instruments carried at fair value, page 314.

 

Impairment of investments in subsidiaries (company)

 

The impact of the Covid-19 pandemic has resulted in unprecedented economic conditions, impacting the performance of HSBC in both 2020 and the outlook into 2021 and beyond. This is considered by management to be an indicator of impairment on the investment in subsidiaries.

Management compared the net assets to the carrying value of each subsidiary. Where the net assets did not support the carrying value or the subsidiary made a loss during the period, management estimated the recoverable amount using the higher of value in use ('VIU') or fair value less cost to sell. Management predominantly used VIU in its impairment tests, unless it believed that fair value would result in a higher recoverable amount for any subsidiary. The impairment test resulted in impairment charges of $435m in relation to HSBC Overseas Holdings (UK) limited. The remaining investment in subsidiaries was $158bn at 31 December 2020.

The methodology in the models used to estimate the recoverable amount is dependent on various assumptions, both short term and long term in nature. These assumptions, which are subject to estimation uncertainty, are derived from a combination of management's judgement, experts engaged by management and market data. The significant assumptions that we focused our audit on were those with greater levels of management judgement and for which variations had the most significant impact on the recoverable amount. Specifically, these included HSBC's AOP for 2021 to 2025 including revenue forecasts and cost reduction targets, regulatory capital requirements, long term growth rates and discount rates.

 

 

We discussed the appropriateness of methodologies used and significant assumptions with the GAC, giving consideration to the macroeconomic environment, as well as Covid-19 and HSBC's strategy. We considered reasonably possible alternatives for significant assumptions. We also discussed the disclosures made in relation to investment in subsidiaries, including the use of sensitivity analysis to explain estimation uncertainty and the conditions that would result in an impairment being recognised.

 

We tested controls in place over significant assumptions and the model used to determine the recoverable amounts. We assessed the appropriateness of the methodology used, and the mathematical accuracy of the calculations, to estimate the recoverable amounts. In respect of the significant assumptions, our testing included the following:

challenging the achievability of management's AOP and the prospects for HSBC's businesses;

obtaining and evaluating evidence where available for critical data relating to significant assumptions, from a combination of historic experience and external market and other financial information;

assessing whether the cash flows included in the model were in accordance with the relevant accounting standard;

assessing the sensitivity of the VIU to reasonable variations in significant assumptions, both individually and in aggregate; and

determining a reasonable range for the discount rate used within the model, with the assistance of our valuation experts, and comparing it to the discount rate used by management.

We evaluated and tested the disclosures made in the Annual Report and Accounts 2020 in relation to investment in subsidiaries.

 

Note 19: Investments in subsidiaries, page 335.

 

Valuation of defined benefit pensions obligations (group)

 

The group has a defined benefit obligation of $44bn, of which $33bn relates to HSBC Bank (UK) pension scheme. 
The valuation of the defined benefit obligation for HSBC Bank (UK) is dependent on a number of actuarial assumptions. Management uses an actuarial expert to determine the valuation of the defined benefit obligation. The expert uses a valuation methodology that requires a number of market based inputs and other financial and demographic assumptions. The significant assumptions that we focused our audit on were those with greater levels of management judgement and for which variations had the most significant impact on the liability. Specifically, these included the discount rate, inflation rate and mortality rate.

 

We discussed with the GAC the methodologies and significant assumptions used by management to determine the value of the defined benefit obligation.

 

We tested controls in place over the methodologies and the significant assumptions. We also evaluated the objectivity and competence of management's expert involved in the valuation of the defined benefit obligation.
We assessed the appropriateness of the methodology used, and the mathematical accuracy of the calculations, to estimate the liability. In respect of the significant assumptions, our actuarial experts understood the judgements made by management and management's actuarial expert in determining the significant assumptions, and compared these assumptions to our independently compiled expected ranges based on market observable indices and our market experience. We also tested the members data used in calculating the obligation.
We evaluated and tested the disclosures made in the Annual Report and Accounts 2020 in relation to defined benefit pension obligation.

 

GAC Report, page 221.

Note 1.2(k): Critical accounting estimates and judgements, page 298.

Note 5: Employee compensation and benefits, page 301.

 

IT access management (group)

 

HSBC has operations across a number of countries supporting a wide range of products and services, resulting in an IT environment that is large, complex and increasingly reliant on third parties. HSBC's financial reporting processes rely upon a significant element of this IT environment, both within Finance and the business and operations more broadly.
Access management controls are an important part of the IT environment to ensure both access and changes made to systems and data are appropriate. Our audit approach planned to rely extensively on the effectiveness of IT access management controls.
As part of our audit work in prior periods, control deficiencies were identified in relation to IT access management for systems and data relevant to financial reporting. Management has an ongoing remediation programme to address these matters.

 

The significance of IT access management to our audit was discussed at GAC meetings during the year, as well as progress on management's remediation programme, control deficiencies identified and our related audit responses.

 

IT access management controls were tested for systems and data relevant to financial reporting that we planned to rely upon as part of our audit. Specifically we tested controls over:

authorising new access requests;

the timely removal of access rights;

periodic monitoring of the appropriateness of access rights to systems and data;

restricting highly privileged access to appropriate personnel;

the accuracy of information about IT users to facilitate access management;

segregation of access across IT and business functions;

changes made to systems and data; and

understanding and assessing reliance on third parties, including Service Organisation controls reports. 

We also independently assessed password policies and system configurations, and performed substantive audit procedures in relation to access right removal, privileged access, IT user information and segregation of duties.

We performed further testing where control deficiencies were identified, including:

where inappropriate access was identified, we understood and assessed the nature of the access, and obtained additional evidence on the appropriateness of activities performed; and,

we identified and tested compensating business controls and performed other audit procedures where IT compensating controls were not sufficient to address the audit risk.

 

Effectiveness of internal controls, page 260.

 

Materiality

The scope of our audit was influenced by our application of materiality. We set certain quantitative thresholds for materiality. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures on the individual financial statement line items and disclosures and in evaluating the effect of misstatements, both individually and in aggregate on the financial statements as a whole.

 

Based on our professional judgement, we determined materiality for the financial statements as a whole as follows:

 

 

 

Overall materiality

$900m (2019: $1,000m).

$855m (2019: $900m).

How we determined it

5% of a three year average of adjusted profit before tax.

0.75% of total assets. This would result in an overall materiality of $1.9bn and was therefore reduced below this materiality for the group.

Rationale for benchmark applied

We believe a standard benchmark of 5% of adjusted profit before tax is an appropriate quantitative indicator of materiality, although certain items could also be material for qualitative reasons. This benchmark is standard for listed entities and consistent with the wider industry.

We selected adjusted profit because, as discussed on page 77, management believes it better reflects the performance of the group. We excluded the adjustments made by management on page 311 for certain customer redress programmes and fair value movements of financial instruments, as in our opinion they are recurring items that form part of ongoing business performance.Whilst adjusted profit before tax is still considered the most suitable benchmark, we have used a three year average to reflect the significant impact Covid-19 has had on performance in 2020.

A benchmark of total assets has been used as the company's primary purpose is to act as a holding company with investments in the group's subsidiaries, not to generate operating profits and therefore a profit based measure is not relevant.

 

We use performance materiality to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds overall materiality. Specifically, we use performance materiality in determining the scope of our audit and the nature and extent of our testing of account balances, classes of transactions and disclosures, for example in determining sample sizes. Our performance materiality was 75% of overall materiality, amounting to $675m (2019: $750m) for the group financial statements and $641m (2019: $675m) for the company financial statements. In determining the performance materiality, we considered a number of factors - the history of misstatements, our risk assessment and aggregation risk, and the effectiveness of controls.

For each component in the scope of our group audit, we allocated a materiality that is less than our overall group materiality. The range of materiality allocated across components was between $60m and $855m. Certain components were audited to a local statutory audit materiality that was less than the materiality we allocated them.

We agreed with the GAC that we would report to them misstatements identified during our group and company audit above $45m (2019: $50m), as well as misstatements below those amounts that, in our view, warranted reporting for qualitative reasons.

How we tailored the audit scope

We tailored the scope of our audit to ensure that we performed enough work to be able to give an opinion on the financial statements as a whole, reflecting the structure of the group and the company, the processes and controls relevant to financial reporting, and the industry in which they operate. Our audit approach incorporated a number of key aspects:

(1) Audit approach to HSBC's global businesses

We designed audit approaches for the products and services that substantially make up HSBC's global businesses, such as lending, deposits and derivatives. These global business approaches were designed by partners and team members who are specialists in the relevant businesses. These approaches were provided to the audit partners and teams around the world that contributed to the group audit.

(2) Audit work for Significant Subsidiaries:

Through our risk assessment and scoping we identified certain entities (collectively the Significant Subsidiaries) for which we obtained audit opinions. We obtained full scope audit opinions for Hongkong and Shanghai Banking Corporation Limited, HSBC Bank plc, HSBC UK Bank plc, HSBC North America Holdings Ltd, HSBC Bank Canada and HSBC Mexico S.A. We obtained audit opinions over specific balances for HSBC Global Services (UK) Limited and HSBC Group Management Services Limited and HSBC Bank Middle East Limited - UAE Operations. The audits for HSBC Bank plc, HSBC UK Bank plc, HSBC Global Services (UK) Limited and HSBC Group Management Services Limited were performed by other PwC teams in the UK. All other audits were performed by other PwC network firms.

We worked with the Significant Subsidiaries in 2020 to develop an approach for rotating certain smaller locations in and out of scope over a number of reporting periods. These locations, which are subject to local external audits, are individually relatively small compared to the group. Notwithstanding their size, the rotational approach is designed to ensure that over time these locations are subject to audit work as part of the group audit. India was removed from the scope of the Hongkong and Shanghai Banking Corporation audit for 2020 and Singapore was included.

We asked the partners and teams reporting to us on the Significant Subsidiaries to work to assigned materiality levels reflecting the size of the operations they audited. The performance materiality levels ranged from $45m to $641m. Certain Significant Subsidiaries were audited to a local statutory audit materiality that was less than our overall group materiality.

We were in active dialogue throughout the year with the partners and teams responsible for the audits of the Significant Subsidiaries. This included consideration of how they planned and performed their work, including their use of the global business approaches. We attended Audit Committee meetings for some of Significant Subsidiaries. We also attended meetings with management in each of these Significant Subsidiaries at the year-end.

The audit of The Hongkong and Shanghai Banking Corporation in Hong Kong relied upon work performed by other teams in Hong Kong and the PwC network firms in Malaysia, mainland China and Singapore. Similarly, the audit of HSBC Bank plc and HSBC UK Bank plc in the UK relied upon work performed by other teams in the UK and the PwC network firms in France and Germany. We considered how the audit partners and teams for the Significant Subsidiaries instructed and provided oversight to the work performed in these locations. Collectively, PwC network firms completed audit procedures covering 88% of assets and 73% of total operating income.

(3) Audit work performed at Operations Centres

A significant amount of the operational processes and controls which are critical to financial reporting are undertaken in operations centres run by Digital Business Services ('DBS') across 12 different locations. Financial reporting processes are performed in HSBC's four Finance Operations Centres. We coordinated and provided oversight on the audit work performed by PwC teams in the UK, Poland, China, Sri Lanka, Malaysia, India and the Philippines. This work was relied upon by us, as well as the PwC teams auditing the Significant Subsidiaries.

(4)  Audit procedures undertaken at a group level and on the company

We ensured that appropriate further work was undertaken for the HSBC group and company. This work included auditing, for example, the impairment assessment of goodwill and intangible assets, the consolidation of the group's results, the preparation of the financial statements, certain disclosures within the Directors' remuneration report, litigation provisions and exposures, taxation, and management's entity level and oversight controls relevant to financial reporting. Subsidiaries' balances that were not identified as part of a Significant Subsidiary were subject to procedures which mitigated the risk of material misstatement, including testing of entity level controls, information technology general controls, testing at the Operations Centre, analytical review procedures and understanding and assessing the outcome of local external audits.

(5) Using the work of others

We continued to make use of evidence provided by others. This included testing of controls performed by Global Internal Audit and management themselves in some low risk areas. We used the work of PwC experts, for example, valuation experts for our work around the assumptions used in the impairment assessment over goodwill and actuaries on the estimates used in determining pension liabilities. An increasing number of controls are operated on behalf of HSBC by third parties. We rely on audit evidence that is scoped and provided by other auditors that are engaged by those third parties. For example, we obtain a report evidencing the testing of external systems and controls supporting HSBC's payroll and HR processes.

Conclusions relating to going concern

Our evaluation of the directors' assessment of the group's and the company's ability to continue to adopt the going concern basis of accounting included:

Performing a risk assessment to identify factors that could impact the going concern basis of accounting, including the impact of Covid-19 and geopolitical risks.

Understanding and evaluating the group's financial forecasts and the group's stress testing of liquidity and regulatory capital, including the severity of the stress scenarios that were used.

Reading and evaluating the adequacy of the disclosures made in the financial statements in relation to going concern.

Based on the work we have performed, we have not identified any material uncertainties relating to events or conditions that, individually or collectively, may cast significant doubt on the group's and the company's ability to continue as a going concern for a period of at least twelve months from when the financial statements are authorised for issue.

In auditing the financial statements, we have concluded that the directors' use of the going concern basis of accounting in the preparation of the financial statements is appropriate.

However, because not all future events or conditions can be predicted, this conclusion is not a guarantee as to the group's and the company's ability to continue as a going concern.

In relation to the group's and the company's reporting on how they have applied the UK Corporate Governance Code, we have nothing material to add or draw attention to in relation to the directors' statement in the financial statements about whether the directors considered it appropriate to adopt the going concern basis of accounting.

Our responsibilities and the responsibilities of the directors with respect to going concern are described in the relevant sections of this report.

Reporting on other information

The other information comprises all of the information in the Annual Report other than the financial statements and our auditors' report thereon. The directors are responsible for the other information. Our opinion on the financial statements does not cover the other information and, accordingly, we do not express an audit opinion or, except to the extent otherwise explicitly stated in this report, any form of assurance thereon.

In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If we identify an apparent material inconsistency or material misstatement, we are required to perform procedures to conclude whether there is a material misstatement of the financial statements or a material misstatement of the other information. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report based on these responsibilities.

With respect to the Strategic Report and Report of the Directors', we also considered whether the disclosures required by the UK Companies Act 2006 have been included.

Based on our work undertaken in the course of the audit, the Companies Act 2006 requires us also to report certain opinions and matters as described below.

Strategic Report and Report of the Directors

In our opinion, based on the work undertaken in the course of the audit, the information given in the Strategic Report and Report of the Directors' for the year ended 31 December 2020 is consistent with the financial statements and has been prepared in accordance with applicable legal requirements.

In light of the knowledge and understanding of the group and company and their environment obtained in the course of the audit, we did not identify any material misstatements in the Strategic Report and Report of the Directors.

Directors' Remuneration

In our opinion, the part of the Directors' Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006.

 Corporate governance statement

The Listing Rules require us to review the directors' statements in relation to going concern, longer-term viability and that part of the corporate governance statement relating to the company's compliance with the provisions of the UK Corporate Governance Code specified for our review. Our additional responsibilities with respect to the corporate governance statement as other information are described in the Reporting on other information section of this report.

Based on the work undertaken as part of our audit, we have concluded that each of the following elements of the corporate governance statement is materially consistent with the financial statements and our knowledge obtained during the audit and we have nothing material to add or draw attention to in relation to:

The directors' confirmation that they have carried out an assessment of the emerging and principal risks;

The disclosures in the Annual Report and Accounts that describe those principal risks, what procedures are in place to identify emerging risks and an explanation of how these are being managed or mitigated;

The directors' statement in the financial statements about whether they considered it appropriate to adopt the going concern basis of accounting in preparing them, and their identification of any material uncertainties to the group's and company's ability to continue to do so over a period of at least twelve months from the date of approval of the financial statements;

The directors' explanation as to their assessment of the group's and company's prospects, the period this assessment covers and why the period is appropriate; and

The directors' statement as to whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of its assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions.

Our review of the directors' statement regarding the longer-term viability of the group was substantially less in scope than an audit and only consisted of making inquiries and considering the directors' process supporting their statement; checking that the statement is in alignment with the relevant provisions of the UK Corporate Governance Code; and considering whether the statement is consistent with the financial statements and our knowledge and understanding of the group and company and their environment obtained in the course of the audit.

In addition, based on the work undertaken as part of our audit, we have concluded that each of the following elements of the corporate governance statement is materially consistent with the financial statements and our knowledge obtained during the audit:

The directors' statement that they consider the Annual Report, taken as a whole, is fair, balanced and understandable, and provides the information necessary for the members to assess the group's and company's position, performance, business model and strategy;

The section of the Annual Report that describes the review of effectiveness of risk management and internal control systems; and

The section of the Annual Report describing the work of the GAC.

We have nothing to report in respect of our responsibility to report when the directors' statement relating to the company's compliance with the Code does not properly disclose a departure from a relevant provision of the Code specified under the Listing Rules for review by the auditors.

Responsibilities for the financial statements and the audit

Responsibilities of the directors for the financial statements

As explained more fully in the Directors' responsibilities statement, the directors are responsible for the preparation of the financial statements in accordance with the applicable framework and for being satisfied that they give a true and fair view. The directors are also responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the financial statements, the directors are responsible for assessing the group's and the company's ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the group or the company or to cease operations, or have no realistic alternative but to do so.

Auditors' responsibilities for the audit of the financial statements

Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors' report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.

Our audit testing might include testing complete populations of certain transactions and balances, possibly using data auditing techniques. However, it typically involves selecting a limited number of items for testing, rather than testing complete populations. We will often seek to target particular items for testing based on their size or risk characteristics. In other cases, we will use audit sampling to enable us to draw a conclusion about the population from which the sample is selected.

A further description of our responsibilities for the audit of the financial statements is located on the FRC's website at: www.frc.org.uk/auditorsresponsibilities. This description forms part of our auditors' report.

Use of this report

This report, including the opinions, has been prepared for and only for the 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 save where expressly agreed by our prior consent in writing.

Other required reporting

 Companies Act 2006 exception reporting

Under the Companies Act 2006 we are required to report to you if, in our opinion:

we have not obtained all the information and explanations we require for our audit; or

adequate accounting records have not been kept by the company, or returns adequate for our audit have not been received from branches not visited by us; or

certain disclosures of directors' remuneration specified by law are not made; or

the financial statements and the part of the Directors' Remuneration Report to be audited are not in agreement with the accounting records and returns.

We have no exceptions to report arising from this responsibility.

 

Appointment

Following the recommendation of the GAC, we were appointed by the members on 31 March 2015 to audit the financial statements for the year ended 31 December 2015 and subsequent financial periods. The period of total uninterrupted engagement is six years, covering the years ended 31 December 2015 to 31 December 2020.

 

 

 

 

 

Scott Berryman   (Senior Statutory Auditor)

for and on behalf of PricewaterhouseCoopers LLP

Chartered Accountants and Statutory Auditors

London

23 February 2021

 

Financial statements

 

Page

Consolidated income statement

278

Consolidated statement of comprehensive income

279

Consolidated balance sheet

280

Consolidated statement of cash flows

281

Consolidated statement of changes in equity

283

HSBC Holdings income statement

284

HSBC Holdings statement of comprehensive income

284

HSBC Holdings balance sheet

285

HSBC Holdings statement of cash flows

286

HSBC Holdings statement of changes in equity

287

 

 

Consolidated income statement

for the year ended 31 December

 

 

2020

2019

2018

 

Notes*

$m

$m

$m

Net interest income

 

27,578 

 

30,462 

 

30,489 

 

-  interest income1,2

 

41,756 

 

54,695 

 

49,609 

 

-  interest expense3

 

(14,178)

 

(24,233)

 

(19,120)

 

Net fee income

2

11,874 

 

12,023 

 

12,620 

 

-  fee income

 

15,051 

 

15,439 

 

16,044 

 

-  fee expense

 

(3,177)

 

(3,416)

 

(3,424)

 

Net income from financial instruments held for trading or managed on a fair value basis

3

9,582 

 

10,231 

 

9,531 

 

Net income/(expense) from assets and liabilities of insurance businesses, including related derivatives, measured at fair value through profit or loss

3

2,081 

 

3,478 

 

(1,488)

 

Changes in fair value of designated debt and related derivatives4

3

231 

 

90 

 

(97)

 

Changes in fair value of other financial instruments mandatorily measured at fair value through profit or loss

3

455 

 

812 

 

695 

 

Gains less losses from financial investments

 

653 

 

335 

 

218 

 

Net insurance premium income

4

10,093 

 

10,636 

 

10,659 

 

Other operating income

 

527 

 

2,957 

 

960 

 

Total operating income

 

63,074 

 

71,024 

 

63,587 

 

Net insurance claims and benefits paid and movement in liabilities to policyholders

4

(12,645)

 

(14,926)

 

(9,807)

 

Net operating income before change in expected credit losses and other credit impairment charges

 

50,429 

 

56,098 

 

53,780 

 

Change in expected credit losses and other credit impairment charges

 

(8,817)

 

(2,756)

 

(1,767)

 

Net operating income

 

41,612 

 

53,342 

 

52,013 

 

Employee compensation and benefits

5

(18,076)

 

(18,002)

 

(17,373)

 

General and administrative expenses

 

(11,115)

 

(13,828)

 

(15,353)

 

Depreciation and impairment of property, plant and equipment and right-of-use assets5

 

(2,681)

 

(2,100)

 

(1,119)

 

Amortisation and impairment of intangible assets

 

(2,519)

 

(1,070)

 

(814)

 

Goodwill impairment

21

(41)

 

(7,349)

 

 

Total operating expenses

 

(34,432)

 

(42,349)

 

(34,659)

 

Operating profit

 

7,180 

 

10,993 

 

17,354 

 

Share of profit in associates and joint ventures

18

1,597 

 

2,354 

 

2,536 

 

Profit before tax

 

8,777 

 

13,347 

 

19,890 

 

Tax expense

7

(2,678)

 

(4,639)

 

(4,865)

 

Profit for the year

 

6,099 

 

8,708 

 

15,025 

 

Attributable to:

 

 

 

 

-  ordinary shareholders of the parent company

 

3,898 

 

5,969 

 

12,608 

 

-  preference shareholders of the parent company

 

90 

 

90 

 

90 

 

-  other equity holders

 

1,241 

 

1,324 

 

1,029 

 

-  non-controlling interests

 

870 

 

1,325 

 

1,298 

 

Profit for the year

 

6,099 

 

8,708 

 

15,025 

 

 

 

$

$

$

Basic earnings per ordinary share

9

0.19 

 

0.30 

 

0.63 

 

Diluted earnings per ordinary share

9

0.19 

 

0.30 

 

0.63 

 

*  For Notes on the financial statements, see page 288.

1  Interest income includes $35,293m (2019: $45,708m) of interest recognised on financial assets measured at amortised cost and $5,614m (2019: $8,259m) of interest recognised on financial assets measured at fair value through other comprehensive income.

2  Interest revenue calculated using the effective interest method comprises interest recognised on financial assets measured at either amortised cost or fair value through other comprehensive income.

3  Interest expense includes $12,426m (2019: $21,922m) of interest on financial instruments, excluding interest on financial liabilities held for trading or designated or otherwise mandatorily measured at fair value.

4  The debt instruments, issued for funding purposes, are designated under the fair value option to reduce an accounting mismatch.

5  Includes depreciation of the right-of-use assets of $1,029m (2019: $912m). Right-of-use assets have been recognised from 1 January 2019 following the adoption of IFRS 16. Comparatives have not been restated.

 

Consolidated statement of comprehensive income

for the year ended 31 December

 

2020

2019

2018

 

$m

$m

$m

Profit for the year

6,099 

 

8,708 

 

15,025 

 

Other comprehensive income/(expense)

 

 

 

Items that will be reclassified subsequently to profit or loss when specific conditions are met:

 

 

 

Debt instruments at fair value through other comprehensive income

1,750 

 

1,152 

 

(243)

 

-  fair value gains/(losses)

2,947 

 

1,793 

 

(168)

 

-  fair value gains transferred to the income statement on disposal

(668)

 

(365)

 

(95)

 

-  expected credit (recoveries)/losses recognised in the income statement

48 

 

109 

 

(94)

 

-  income taxes

(577)

 

(385)

 

114 

 

Cash flow hedges

471 

 

206 

 

19 

 

-  fair value gains/(losses)

(157)

 

551 

 

(267)

 

-  fair value (gains)/losses reclassified to the income statement

769 

 

(286)

 

317 

 

-  income taxes

(141)

 

(59)

 

(31)

 

Share of other comprehensive income/(expense) of associates and joint ventures

(73)

 

21 

 

(64)

 

-  share for the year

(73)

 

21 

 

(64)

 

Exchange differences

4,855 

 

1,044 

 

(7,156)

 

Items that will not be reclassified subsequently to profit or loss:

 

 

 

Remeasurement of defined benefit asset/liability

834 

 

13 

 

(329)

 

-  before income taxes

1,223 

 

(17)

 

(388)

 

-  income taxes

(389)

 

30 

 

59 

 

Changes in fair value of financial liabilities designated at fair value upon initial recognition arising from changes in own credit risk

167 

 

(2,002)

 

2,847 

 

-  before income taxes

190 

 

(2,639)

 

3,606 

 

-  income taxes

(23)

 

637 

 

(759)

 

Equity instruments designated at fair value through other comprehensive income

212 

 

366 

 

(27)

 

-  fair value gains/(losses)

212 

 

364 

 

(71)

 

-  income taxes

 

 

44 

 

Effects of hyperinflation

193 

 

217 

 

283 

 

Other comprehensive income/(expense) for the period, net of tax

8,409 

 

1,017 

 

(4,670)

 

Total comprehensive income for the year

14,508 

 

9,725 

 

10,355 

 

Attributable to:

 

 

 

-  ordinary shareholders of the parent company

12,146 

 

6,838 

 

8,083 

 

-  preference shareholders of the parent company

90 

 

90 

 

90 

 

-  other equity holders

1,241 

 

1,324 

 

1,029 

 

-  non-controlling interests

1,031 

 

1,473 

 

1,153 

 

Total comprehensive income for the year

14,508 

 

9,725 

 

10,355 

 

 

 

Consolidated balance sheet

 

 

At

 

 

31 Dec

31 Dec

 

 

2020

2019

 

Notes*

$m

$m

Assets

 

 

 

Cash and balances at central banks

 

304,481 

 

154,099 

 

Items in the course of collection from other banks

 

4,094 

 

4,956 

 

Hong Kong Government certificates of indebtedness

 

40,420 

 

38,380 

 

Trading assets

11

231,990 

 

254,271 

 

Financial assets designated and otherwise mandatorily measured at fair value through profit or loss

14

45,553 

 

43,627 

 

Derivatives

15

307,726 

 

242,995 

 

Loans and advances to banks

 

81,616 

 

69,203 

 

Loans and advances to customers

 

1,037,987 

 

1,036,743 

 

Reverse repurchase agreements - non-trading

 

230,628 

 

240,862 

 

Financial investments

16

490,693 

 

443,312 

 

Prepayments, accrued income and other assets

22

156,412 

 

136,680 

 

Current tax assets

 

954 

 

755 

 

Interests in associates and joint ventures

18

26,684 

 

24,474 

 

Goodwill and intangible assets

21

20,443 

 

20,163 

 

Deferred tax assets

7

4,483 

 

4,632 

 

Total assets

 

2,984,164 

 

2,715,152 

 

Liabilities and equity

 

 

 

Liabilities

 

 

 

Hong Kong currency notes in circulation

 

40,420 

 

38,380 

 

Deposits by banks

 

82,080 

 

59,022 

 

Customer accounts

 

1,642,780 

 

1,439,115 

 

Repurchase agreements - non-trading

 

111,901 

 

140,344 

 

Items in the course of transmission to other banks

 

4,343 

 

4,817 

 

Trading liabilities

23

75,266 

 

83,170 

 

Financial liabilities designated at fair value

24

157,439 

 

164,466 

 

Derivatives

15

303,001 

 

239,497 

 

Debt securities in issue

25

95,492 

 

104,555 

 

Accruals, deferred income and other liabilities

26

128,624 

 

118,156 

 

Current tax liabilities

 

690 

 

2,150 

 

Liabilities under insurance contracts

4

107,191 

 

97,439 

 

Provisions

27

3,678 

 

3,398 

 

Deferred tax liabilities

7

4,313 

 

3,375 

 

Subordinated liabilities

28

21,951 

 

24,600 

 

Total liabilities

 

2,779,169 

 

2,522,484 

 

Equity

 

 

 

Called up share capital

31

10,347 

 

10,319 

 

Share premium account

31

14,277 

 

13,959 

 

Other equity instruments

 

22,414 

 

20,871 

 

Other reserves

 

8,833 

 

2,127 

 

Retained earnings

 

140,572 

 

136,679 

 

Total shareholders' equity

 

196,443 

 

183,955 

 

Non-controlling interests

 

8,552 

 

8,713 

 

Total equity

 

204,995 

 

192,668 

 

Total liabilities and equity

 

2,984,164 

 

2,715,152 

 

*  For Notes on the financial statements, see page 288.

The accompanying notes on pages 288 to 370 and the audited sections in: 'Risk' on pages 106 to 194 (including 'Measurement uncertainty and sensitivity analysis of ECL estimates' on pages 127 to 135), and 'Directors' remuneration report' on pages 229 to 255 form an integral part of these financial statements.

These financial statements were approved by the Board of Directors on 23 February 2021 and signed on its behalf by:

 

 

 

Mark E Tucker

 

Ewen Stevenson

Group Chairman

 

Group Chief Financial Officer

 

 

Consolidated statement of cash flows

for the year ended 31 December

 

2020

2019

2018

 

$m

$m

$m

Profit before tax

8,777 

 

13,347 

 

19,890 

 

Adjustments for non-cash items:

 

 

 

Depreciation, amortisation and impairment

5,241 

 

10,519 

 

1,933 

 

Net gain from investing activities

(541)

 

(399)

 

(126)

 

Share of profits in associates and joint ventures

(1,597)

 

(2,354)

 

(2,536)

 

Gain on disposal of subsidiaries, businesses, associates and joint ventures

 

(929)

 

 

Change in expected credit losses gross of recoveries and other credit impairment charges

9,096 

 

3,012 

 

2,280 

 

Provisions including pensions

1,164 

 

2,423 

 

1,944 

 

Share-based payment expense

433 

 

478 

 

450 

 

Other non-cash items included in profit before tax

(906)

 

(2,297)

 

(1,303)

 

Elimination of exchange differences1

(25,749)

 

(3,742)

 

4,930 

 

Changes in operating assets and liabilities

 

 

 

Change in net trading securities and derivatives

13,150 

 

(18,910)

 

20,855 

 

Change in loans and advances to banks and customers

(14,131)

 

(53,760)

 

(44,071)

 

Change in reverse repurchase agreements - non-trading

9,950 

 

(7,390)

 

(25,399)

 

Change in financial assets designated and otherwise mandatorily measured at fair value

(1,962)

 

(2,308)

 

(1,515)

 

Change in other assets

(19,610)

 

(21,863)

 

6,766 

 

Change in deposits by banks and customer accounts

226,723 

 

79,163 

 

(5,745)

 

Change in repurchase agreements - non-trading

(28,443)

 

(25,540)

 

35,882 

 

Change in debt securities in issue

(9,075)

 

19,268 

 

18,806 

 

Change in financial liabilities designated at fair value

(6,630)

 

20,068 

 

4,500 

 

Change in other liabilities

20,323 

 

23,124 

 

(2,187)

 

Dividends received from associates

761 

 

633 

 

910 

 

Contributions paid to defined benefit plans

(495)

 

(533)

 

(332)

 

Tax paid

(4,259)

 

(2,267)

 

(3,417)

 

Net cash from operating activities

182,220 

 

29,743 

 

32,515 

 

Purchase of financial investments

(496,669)

 

(445,907)

 

(399,458)

 

Proceeds from the sale and maturity of financial investments

476,990 

 

413,186 

 

386,056 

 

Net cash flows from the purchase and sale of property, plant and equipment

(1,446)

 

(1,343)

 

(1,196)

 

Net cash flows from purchase/(disposal) of customer and loan portfolios

1,362 

 

1,118 

 

(204)

 

Net investment in intangible assets

(2,064)

 

(2,289)

 

(1,848)

 

Net cash flow from acquisition and disposal of subsidiaries, businesses, associates and joint ventures

(603)

 

(83)

 

 

Net cash from investing activities

(22,430)

 

(35,318)

 

(16,646)

 

Issue of ordinary share capital and other equity instruments

1,497 

 

 

6,001 

 

Cancellation of shares

 

(1,000)

 

(1,998)

 

Net sales/(purchases) of own shares for market-making and investment purposes

(181)

 

141 

 

133 

 

Redemption of preference shares and other equity instruments

(398)

 

 

(6,078)

 

Subordinated loan capital repaid2

(3,538)

 

(4,210)

 

(4,077)

 

Dividends paid to shareholders of the parent company and non-controlling interests

(2,023)

 

(9,773)

 

(10,762)

 

Net cash from financing activities

(4,643)

 

(14,842)

 

(16,781)

 

Net increase/(decrease) in cash and cash equivalents

155,147 

 

(20,417)

 

(912)

 

Cash and cash equivalents at 1 Jan

293,742 

 

312,911 

 

323,718 

 

Exchange differences in respect of cash and cash equivalents

19,434 

 

1,248 

 

(9,895)

 

Cash and cash equivalents at 31 Dec3

468,323 

 

293,742 

 

312,911 

 

Cash and cash equivalents comprise:

 

 

 

-  cash and balances at central banks

304,481 

 

154,099 

 

162,843 

 

-  items in the course of collection from other banks

4,094 

 

4,956 

 

5,787 

 

-  loans and advances to banks of one month or less

51,788 

 

41,626 

 

39,460 

 

-  reverse repurchase agreements with banks of one month or less

65,086 

 

65,370 

 

74,702 

 

-  treasury bills, other bills and certificates of deposit less than three months

30,023 

 

20,132 

 

21,685 

 

-  cash collateral and net settlement accounts

17,194 

 

12,376 

 

14,075 

 

-  less: items in the course of transmission to other banks

(4,343)

 

(4,817)

 

(5,641)

 

Cash and cash equivalents at 31 Dec3

468,323 

 

293,742 

 

312,911 

 

 

Interest received was $45,578m (2019: $58,627m; 2018: $45,291m), interest paid was $17,740m (2019: $27,384m; 2018: $14,172m) and dividends received (excluding dividends received from associates, which are presented separately above) were $1,158m (2019: $2,369m; 2018: $1,702m).

1  Adjustment to bring changes between opening and closing balance sheet amounts to average rates. This is not done on a line-by-line basis, as details cannot be determined without unreasonable expense.

2   Subordinated liabilities changes during the year are attributable to repayments of $(3.5)bn (2019: $(4.2)bn; 2018: $(4.1)bn) of securities. Non-cash changes during the year included foreign exchange gains/(losses) of $0.5bn (2019: $0.6bn; 2018: $(0.6)bn) and fair value gains/(losses) of $1.1bn (2019: $1.4bn; 2018: $(1.4)bn).

3   At 31 December 2020, $41,912m (2019: $35,735m; 2018: $26,282m) was not available for use by HSBC, of which $16,935m (2019: $19,353m; 2018: $19,755m) related to mandatory deposits at central banks.

 

 

 

 

Consolidated statement of changes in equity

for the year ended 31 December

 

 

 

 

Other reserves

 

 

 

 

Called up
share
capital
and
share
premium

Other
equity
instru-ments

Retained

earnings3,4

Financial
assets
at
FVOCI
reserve

Cash
flow
hedging
reserve

Foreign
exchange
reserve

Merger

and other

reserves4,5

Total
share-
holders'
equity

Non-
controlling
interests

Total
equity

 

$m

$m

$m

$m

$m

$m

$m

$m

$m

$m

At 1 Jan 2020

24,278 

 

20,871 

 

136,679 

 

(108)

 

(2)

 

(25,133)

 

27,370 

 

183,955 

 

8,713 

 

192,668 

 

Profit for the year

 

 

5,229 

 

 

 

 

 

5,229 

 

870 

 

6,099 

 

Other comprehensive income (net of tax)

 

 

1,118 

 

1,913 

 

459 

 

4,758 

 

 

8,248 

 

161 

 

8,409 

 

-  debt instruments at fair value through other comprehensive income

 

 

 

1,746 

 

 

 

 

1,746 

 

 

1,750 

 

-  equity instruments designated at fair value through other comprehensive income

 

 

 

167 

 

 

 

 

167 

 

45 

 

212 

 

-  cash flow hedges

 

 

 

 

459 

 

 

 

459 

 

12 

 

471 

 

-  changes in fair value of financial liabilities designated at fair value upon initial recognition arising from changes in own credit risk

 

 

167 

 

 

 

 

 

167 

 

 

167 

 

-  remeasurement of defined benefit asset/liability

 

 

831 

 

 

 

 

 

831 

 

 

834 

 

-  share of other comprehensive income of associates and joint ventures

 

 

(73)

 

 

 

 

 

(73)

 

 

(73)

 

-  effects of hyperinflation

 

 

193 

 

 

 

 

 

193 

 

 

193 

 

-  exchange differences

 

 

 

 

 

4,758 

 

 

4,758 

 

97 

 

4,855 

 

Total comprehensive income for the year

 

 

6,347 

 

1,913 

 

459 

 

4,758 

 

 

13,477 

 

1,031 

 

14,508 

 

Shares issued under employee remuneration and share plans

346 

 

 

(339)

 

 

 

 

 

 

 

 

Capital securities issued1

 

1,500 

 

(3)

 

 

 

 

 

1,497 

 

 

1,497 

 

Dividends to shareholders

 

 

(1,331)

 

 

 

 

 

(1,331)

 

(692)

 

(2,023)

 

Redemption of securities2

 

 

(1,450)

 

 

 

 

 

(1,450)

 

 

(1,450)

 

Transfers6

 

 

435 

 

 

 

 

(435)

 

 

 

 

Cost of share-based payment arrangements

 

 

434 

 

 

 

 

 

434 

 

 

434 

 

Other movements

 

43 

 

(200)

 

11 

 

 

 

 

(146)

 

(500)

 

(646)

 

At 31 Dec 2020

24,624 

 

22,414 

 

140,572 

 

1,816 

 

457 

 

(20,375)

 

26,935 

 

196,443 

 

8,552 

 

204,995 

 

 

 

 

 

 

 

 

 

 

 

 

At 1 Jan 2019

23,789 

 

22,367 

 

138,191 

 

(1,532)

 

(206)

 

(26,133)

 

29,777 

 

186,253 

 

7,996 

 

194,249 

 

Profit for the year

 

 

7,383 

 

 

 

 

 

7,383 

 

1,325 

 

8,708 

 

Other comprehensive income (net of tax)

 

 

(1,759)

 

1,424 

 

204 

 

1,000 

 

 

869 

 

148 

 

1,017 

 

-  debt instruments at fair value through other comprehensive income

 

 

 

1,146 

 

 

 

 

1,146 

 

 

1,152 

 

equity instruments designated at fair value through other comprehensive income

 

 

 

278 

 

 

 

 

278 

 

88 

 

366 

 

-  cash flow hedges

 

 

 

 

204 

 

 

 

204 

 

 

206 

 

-  changes in fair value of financial liabilities designated at fair value upon initial recognition arising from changes in own credit risk

 

 

(2,002)

 

 

 

 

 

(2,002)

 

 

(2,002)

 

-  remeasurement of defined benefit asset/liability

 

 

 

 

 

 

 

 

 

13 

 

-  share of other comprehensive income of associates and joint ventures

 

 

21 

 

 

 

 

 

21 

 

 

21 

 

-  effects of hyperinflation

 

 

217 

 

 

 

 

 

217 

 

 

217 

 

-  exchange differences

 

 

 

 

 

1,000 

 

 

1,000 

 

44 

 

1,044 

 

Total comprehensive income for the year

 

 

5,624 

 

1,424 

 

204 

 

1,000 

 

 

8,252 

 

1,473 

 

9,725 

 

Shares issued under employee remuneration and share plans

557 

 

 

(495)

 

 

 

 

 

62 

 

 

62 

 

Shares issued in lieu of dividends and amounts arising thereon

 

 

2,687 

 

 

 

 

 

2,687 

 

 

2,687 

 

Dividends to shareholders

 

 

(11,683)

 

 

 

 

 

(11,683)

 

(777)

 

(12,460)

 

Redemption of securities2

 

(1,496)

 

(12)

 

 

 

 

 

(1,508)

 

 

(1,508)

 

Transfers6

 

 

2,475 

 

 

 

 

(2,475)

 

 

 

 

Cost of share-based payment arrangements

 

 

478 

 

 

 

 

 

478 

 

 

478 

 

Cancellation of shares7

(68)

 

 

(1,000)

 

 

 

 

68 

 

(1,000)

 

 

(1,000)

 

Other movements

 

 

414 

 

 

 

 

 

414 

 

21 

 

435 

 

At 31 Dec 2019

24,278 

 

20,871 

 

136,679 

 

(108)

 

(2)

 

(25,133)

 

27,370 

 

183,955 

 

8,713 

 

192,668 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated statement of changes in equity (continued)

for the year ended 31 December

 

 

 

 

Other reserves

 

 

 

 

Called up
share
capital and
share
premium

Other
equity
instru-ments

Retained

earnings3,4

Financial
assets at
FVOCI
reserve

Cash
flow
hedging
reserve

Foreign
exchange
reserve

Merger

and other

reserves5

Total
share-
holders'
equity

Non-
controlling
interests

Total
equity

 

$m

$m

$m

$m

$m

$m

$m

$m

$m

$m

At 1 Jan 2018

20,337 

 

22,250 

 

139,414 

 

(1,371)

 

(222)

 

(19,072)

 

27,308 

 

188,644 

 

7,580 

 

196,224 

 

Profit for the year

 

 

13,727 

 

 

 

 

 

13,727 

 

1,298 

 

15,025 

 

Other comprehensive income (net of tax)

 

 

2,765 

 

(245)

 

16 

 

(7,061)

 

 

(4,525)

 

(145)

 

(4,670)

 

-  debt instruments at fair value through other comprehensive income

 

 

 

(245)

 

 

 

 

(245)

 

 

(243)

 

-  equity instruments designated at fair value through other comprehensive income

 

 

 

 

 

 

 

 

(27)

 

(27)

 

-  cash flow hedges

 

 

 

 

16 

 

 

 

16 

 

 

19 

 

-  changes in fair value of financial liabilities designated at fair value due to movement in own credit risk

 

 

2,847 

 

 

 

 

 

2,847 

 

 

2,847 

 

-  remeasurement of defined benefit asset/liability

 

 

(301)

 

 

 

 

 

(301)

 

(28)

 

(329)

 

-  share of other comprehensive income of associates and joint ventures

 

 

(64)

 

 

 

 

 

(64)

 

 

(64)

 

-  effects of hyperinflation

 

 

283 

 

 

 

 

 

283 

 

 

283 

 

-  exchange differences

 

 

 

 

 

(7,061)

 

 

(7,061)

 

(95)

 

(7,156)

 

Total comprehensive income for the year

 

 

16,492 

 

(245)

 

16 

 

(7,061)

 

 

9,202 

 

1,153 

 

10,355 

 

Shares issued under employee remuneration and share plans

721 

 

 

(610)

 

 

 

 

 

111 

 

 

111 

 

Shares issued in lieu of dividends and amounts arising thereon

 

 

1,494 

 

 

 

 

 

1,494 

 

 

1,494 

 

Capital securities issued1

 

5,968 

 

 

 

 

 

 

5,968 

 

 

5,968 

 

Dividends to shareholders

 

 

(11,547)

 

 

 

 

 

(11,547)

 

(710)

 

(12,257)

 

Redemption of securities2

 

(5,851)

 

(237)

 

 

 

 

 

(6,088)

 

 

(6,088)

 

Transfers6

 

 

(2,200)

 

 

 

 

2,200 

 

 

 

 

Cost of share-based payment arrangements

 

 

450 

 

 

 

 

 

450 

 

 

450 

 

Cancellation of shares7

2,731 

 

 

(4,998)

 

 

 

 

269 

 

(1,998)

 

 

(1,998)

 

Other movements

 

 

(67)

 

84 

 

 

 

 

17 

 

(27)

 

(10)

 

At 31 Dec 2018

23,789 

 

22,367 

 

138,191 

 

(1,532)

 

(206)

 

(26,133)

 

29,777 

 

186,253 

 

7,996 

 

194,249 

 

1  During 2020 HSBC Holdings issued $1,500m of perpetual subordinated contingent convertible securities. In 2018, HSBC Holdings issued $4,150m, £1,000m and SGD750m of perpetual subordinated contingent convertible capital securities on which there were $60m of external issuance costs, $49m of intra-Group issuance costs and $11m of tax benefits. Under IFRSs these issuance costs and tax benefits are classified as equity.

2  During 2020, HSBC Holdings called $1,450m 6.20% non-cumulative US dollar preference shares. For further details, see Note 31 in the Annual Report and Accounts 2020. In 2019, HSBC Holdings redeemed $1,500m 5.625% perpetual subordinated capital securities on which there were $12m of external issuance costs. In 2018, HSBC Holdings redeemed $2,200m 8.125% perpetual subordinated capital securities and its $3,800m 8.000% perpetual subordinated capital securities, Series 2, on which there were $172m of external issuance costs and $23m of intra-Group issuance costs wound down. Under IFRSs external issuance costs are classified as equity.

3  At 31 December 2020, retained earnings included 509,825,249 treasury shares (2019: 432,108,782; 2018: 379,926,645). In addition, treasury shares are also held within HSBC's Insurance business retirement funds for the benefit of policyholders or beneficiaries within employee trusts for the settlement of shares expected to be delivered under employee share schemes or bonus plans, and the market-making activities in Global Markets.

4  Cumulative goodwill amounting to $5,138m has been charged against reserves in respect of acquisitions of subsidiaries prior to 1 January 1998, including $3,469m charged against the merger reserve arising on the acquisition of HSBC Bank plc. The balance of $1,669m has been charged against retained earnings.

5  Statutory share premium relief under section 131 of the Companies Act 1985 (the 'Act') was taken in respect of the acquisition of HSBC Bank plc in 1992, HSBC Continental Europe in 2000 and HSBC Finance Corporation in 2003, and the shares issued were recorded at their nominal value only. In HSBC's consolidated financial statements, the fair value differences of $8,290m in respect of HSBC Continental Europe and $12,768m in respect of HSBC Finance Corporation were recognised in the merger reserve. The merger reserve created on the acquisition of HSBC Finance Corporation subsequently became attached to HSBC Overseas Holdings (UK) Limited ('HOHU'), following a number of intra-Group reorganisations. During 2009, pursuant to section 131 of the Companies Act 1985, statutory share premium relief was taken in respect of the rights issue and $15,796m was recognised in the merger reserve. 

6  Permitted transfers from the merger reserve to retained earnings were made when the investment in HSBC Overseas Holdings (UK) Limited was previously impaired. In 2018, a part reversal of this impairment resulted in a transfer from retained earnings back to the merger reserve of $2,200m. In 2019, an additional impairment of $2,475m was recognised and a permitted transfer of this amount was made from the merger reserve to retained earnings. During 2020, a further impairment of $435m was recognised and a permitted transfer of this amount was made from the merger reserve to retained earnings.

7  For further details, see Note 31 in the Annual Report and Accounts 2020. In August 2019, HSBC announced a share buy-back of up to $1.0bn, which was completed in September 2019. In May 2018, HSBC announced a share buy-back of up to $2.0bn, which was completed in August 2018.

 

 

HSBC Holdings income statement

for the year ended 31 December

 

 

2020

2019

2018

 

Notes*

$m

$m

$m

Net interest expense

 

(2,632)

 

(2,554)

 

(1,112)

 

-  interest income

 

473 

 

1,249 

 

2,193 

 

-  interest expense

 

(3,105)

 

(3,803)

 

(3,305)

 

Fee (expense)/income

 

(12)

 

(2)

 

 

Net income from financial instruments held for trading or managed on a fair value basis

3

801 

 

1,477 

 

245 

 

Changes in fair value of designated debt and related derivatives1

3

(326)

 

(360)

 

(77)

 

Changes in fair value of other financial instruments mandatorily measured at fair value through profit or loss

3

1,141 

 

1,659 

 

43 

 

Gains less losses from financial investments

 

 

 

 

Dividend income from subsidiaries2

 

8,156 

 

15,117 

 

55,304 

 

Other operating income

 

1,889 

 

1,293 

 

960 

 

Total operating income

 

9,017 

 

16,630 

 

55,367 

 

Employee compensation and benefits

5

(56)

 

(37)

 

(37)

 

General and administrative expenses

 

(4,276)

 

(4,772)

 

(4,507)

 

Impairment of subsidiaries

 

(435)

 

(2,562)

 

2,064 

 

Total operating expenses

 

(4,767)

 

(7,371)

 

(2,480)

 

Profit before tax

 

4,250 

 

9,259 

 

52,887 

 

Tax (charge)/credit

 

(165)

 

(218)

 

(62)

 

Profit for the year

 

4,085 

 

9,041 

 

52,825 

 

*  For Notes on the financial statements, see page 288.

1  The debt instruments, issued for funding purposes, are designated under the fair value option to reduce an accounting mismatch.

2  The 2018 year included $44,893m (2020 and 2019: nil) return on capital from HSBC Finance (Netherlands) resulting from restructuring the Group's Asia operation to meet resolution and recovery requirements.

 

 

HSBC Holdings statement of comprehensive income

for the year ended 31 December

 

2020

2019

2018

 

$m

$m

$m

Profit for the year

4,085 

 

9,041 

 

52,825 

 

Other comprehensive income/(expense)

 

 

 

Items that will not be reclassified subsequently to profit or loss:

 

 

 

Changes in fair value of financial liabilities designated at fair value upon initial recognition arising from changes in own credit risk

176 

 

(396)

 

865 

 

-  before income taxes

176 

 

(573)

 

1,090 

 

-  income taxes

 

177 

 

(225)

 

Other comprehensive income/(expense) for the year, net of tax

176 

 

(396)

 

865 

 

Total comprehensive income for the year

4,261 

 

8,645 

 

53,690 

 

 

 

HSBC Holdings balance sheet

 

 

31 Dec 2020

31 Dec 2019

 

Notes*

$m

$m

Assets

 

 

 

Cash and balances with HSBC undertakings

 

2,913 

 

2,382 

 

Financial assets with HSBC undertakings designated and otherwise mandatorily measured at fair value

 

65,253 

 

61,964 

 

Derivatives

15

4,698 

 

2,002 

 

Loans and advances to HSBC undertakings

 

10,443 

 

10,218 

 

Financial investments

 

17,485 

 

16,106 

 

Prepayments, accrued income and other assets

 

1,445 

 

559 

 

Current tax assets

 

 

203 

 

Investments in subsidiaries

 

160,660 

 

161,473 

 

Intangible assets

 

276 

 

333 

 

Total assets at 31 Dec

 

263,173 

 

255,240 

 

Liabilities and equity

 

 

 

Liabilities

 

 

 

Amounts owed to HSBC undertakings

 

330 

 

464 

 

Financial liabilities designated at fair value

24

25,664 

 

30,303 

 

Derivatives

15

3,060 

 

2,021 

 

Debt securities in issue

25

64,029 

 

56,844 

 

Accruals, deferred income and other liabilities

 

4,865 

 

1,915 

 

Subordinated liabilities

28

17,916 

 

18,361 

 

Current tax liabilities

 

71 

 

 

Deferred tax liabilities

 

438 

 

288 

 

Total liabilities

 

116,373 

 

110,196 

 

Equity

 

 

 

Called up share capital

31

10,347 

 

10,319 

 

Share premium account

 

14,277 

 

13,959 

 

Other equity instruments

 

22,414 

 

20,743 

 

Merger and other reserves

 

34,757 

 

37,539 

 

Retained earnings

 

65,005 

 

62,484 

 

Total equity

 

146,800 

 

145,044 

 

Total liabilities and equity at 31 Dec

 

263,173 

 

255,240 

 

*  For Notes on the financial statements, see page 288.

 

The accompanying notes on pages 288 to 370 and the audited sections in: 'Risk' on pages 106 to 194 (including 'Measurement uncertainty and sensitivity analysis of ECL estimates' on pages 127 to 135), and 'Directors' remuneration report' on pages 229 to 255 form an integral part of these financial statements.

These financial statements were approved by the Board of Directors on 23 February 2021 and signed on its behalf by:

 

 

 

 

Mark E Tucker

 

Ewen Stevenson

Group Chairman

 

Group Chief Financial Officer

 

 

HSBC Holdings statement of cash flows

for the year ended 31 December

 

2020

2019

2018

 

$m

$m

$m

Profit before tax

4,250 

 

9,259 

 

52,887 

 

Adjustments for non-cash items

442 

 

2,657 

 

(46,878)

 

-  depreciation, amortisation and impairment/expected credit losses

87 

 

72 

 

70 

 

-  share-based payment expense

 

 

 

-  other non-cash items included in profit before tax1

354 

 

2,584 

 

(46,948)

 

Changes in operating assets and liabilities

 

 

 

Change in loans to HSBC undertakings

(327)

 

41,471 

 

7,293 

 

Change in financial assets with HSBC undertakings designated and otherwise mandatorily measured at fair value

(3,289)

 

(38,451)

 

(7,305)

 

Change in net trading securities and net derivatives

(1,657)

 

(1,433)

 

758 

 

Change in other assets

(633)

 

(437)

 

231 

 

Change in financial investments

449 

 

(70)

 

 

Change in debt securities in issue

3,063 

 

1,899 

 

(1,094)

 

Change in financial liabilities designated at fair value

1,258 

 

1,227 

 

(740)

 

Change in other liabilities

1,366 

 

437 

 

(1,883)

 

Tax received

270 

 

459 

 

301 

 

Net cash from operating activities

5,192 

 

17,018 

 

3,570 

 

Purchase of financial investments

(11,652)

 

(19,293)

 

 

Proceeds from the sale and maturity of financial investments

9,342 

 

6,755 

 

 

Net cash outflow from acquisition of or increase in stake of subsidiaries

(2,558)

 

(3,721)

 

(8,992)

 

Repayment of capital from subsidiaries

1,516 

 

 

3,627 

 

Net investment in intangible assets

(33)

 

(44)

 

(121)

 

Net cash from investing activities

(3,385)

 

(16,303)

 

(5,486)

 

Issue of ordinary share capital and other equity instruments

1,846 

 

500 

 

6,652 

 

Redemption of other equity instruments

 

 

(6,093)

 

Cancellation of shares

 

(1,006)

 

(1,998)

 

Subordinated loan capital repaid

(1,500)

 

(4,107)

 

(1,972)

 

Debt securities issued

15,951 

 

10,817 

 

19,513 

 

Debt securities repaid

(16,577)

 

 

(1,025)

 

Dividends paid on ordinary shares

 

(7,582)

 

(8,693)

 

Dividends paid to holders of other equity instruments

(1,331)

 

(1,414)

 

(1,360)

 

Net cash from financing activities

(1,611)

 

(2,792)

 

5,024 

 

Net increase/(decrease) in cash and cash equivalents

196 

 

(2,077)

 

3,108 

 

Cash and cash equivalents at 1 January

5,980 

 

8,057 

 

4,949 

 

Cash and cash equivalents at 31 Dec

6,176 

 

5,980 

 

8,057 

 

Cash and cash equivalents comprise:

 

 

 

-  cash at bank with HSBC undertakings

2,913 

 

2,382 

 

3,509 

 

-  loans and advances to banks of one month or less

249 

 

102 

 

4,548 

 

-  treasury and other eligible bills

3,014 

 

3,496 

 

 

 

Interest received was $1,952m (2019: $2,216m; 2018: $2,116m), interest paid was $3,166m (2019: $3,819m; 2018: $3,379m) and dividends received were $8,156m (2019: $15,117m; 2018: $10,411m).

1  The 2018 year included $44,893m (2020 and 2019: nil) return on capital from HSBC Finance (Netherlands) resulting from restructuring the Group's Asia operation to meet resolution and recovery requirements.

 

 

HSBC Holdings statement of changes in equity

for the year ended 31 December

 

 

 

 

 

Other reserves

 

 

Called up
share
capital

Share
premium

Other
equity
instruments

Retained

earnings1

Financial
assets at
FVOCI reserve

Merger and other
reserves

Total
shareholders'
equity

 

$m

$m

$m

$m

$m

$m

$m

At 1 Jan 2020

10,319 

 

13,959 

 

20,743 

 

62,484 

 

 

37,539 

 

145,044 

 

Profit for the year

 

 

 

4,085 

 

 

 

4,085 

 

Other comprehensive income (net of tax)

 

 

 

176 

 

 

 

176 

 

-  changes in fair value of financial liabilities designated at fair value due to movement in own credit risk

 

 

 

176 

 

 

 

176 

 

Total comprehensive income for the year

 

 

 

4,261 

 

 

 

4,261 

 

Shares issued under employee share plans

28 

 

318 

 

 

2,540 

 

 

(2,347)

 

539 

 

Capital securities issued

 

 

1,500 

 

(15)

 

 

 

1,485 

 

Dividends to shareholders

 

 

 

(1,331)

 

 

 

(1,331)

 

Redemption of capital securities

 

 

 

(1,450)

 

 

 

(1,450)

 

Transfers4

 

 

 

435 

 

 

(435)

 

 

Other movements5

 

 

171 

 

(1,919)

 

 

 

(1,748)

 

At 31 Dec 2020

10,347 

 

14,277 

 

22,414 

 

65,005 

 

 

34,757 

 

146,800 

 

 

 

 

 

 

 

 

 

At 1 Jan 2019

10,180 

 

13,609 

 

22,231 

 

61,434 

 

 

39,899 

 

147,353 

 

Profit for the year

 

 

 

9,041 

 

 

 

9,041 

 

Other comprehensive income (net of tax)

 

 

 

(396)

 

 

 

(396)

 

-  changes in fair value of financial liabilities designated at fair value due to movement in own credit risk

 

 

 

(396)

 

 

 

(396)

 

Total comprehensive income for the year

 

 

 

8,645 

 

 

 

8,645 

 

Shares issued under employee share plans

36 

 

521 

 

 

(56)

 

 

 

501 

 

Shares issued in lieu of dividends and amounts arising thereon

171 

 

(171)

 

 

2,687 

 

 

 

2,687 

 

Cancellation of shares2

(68)

 

 

 

(1,000)

 

 

68 

 

(1,000)

 

Capital securities issued

 

 

 

 

 

 

 

Dividends to shareholders

 

 

 

(11,683)

 

 

 

(11,683)

 

Redemption of capital securities

 

 

(1,488)

 

(20)

 

 

 

(1,508)

 

Transfers4

 

 

 

2,475 

 

 

(2,475)

 

 

Other movements

 

 

 

 

 

47 

 

49 

 

At 31 Dec 2019

10,319 

 

13,959 

 

20,743 

 

62,484 

 

 

37,539 

 

145,044 

 

 

 

 

 

 

 

 

 

At 31 Dec 2017

10,160 

 

10,177 

 

22,107 

 

23,903 

 

59 

 

37,381 

 

103,787 

 

Impact on transition to IFRS 9

 

 

 

949 

 

(59)

 

 

890 

 

At 1 Jan 2018

10,160 

 

10,177 

 

22,107 

 

24,852 

 

 

37,381 

 

104,677 

 

Profit for the year

 

 

 

52,825 

 

 

 

52,825 

 

Other comprehensive income (net of tax)

 

 

 

865 

 

 

 

865 

 

-  changes in fair value of financial liabilities designated at fair value due to movement in own credit risk

 

 

 

865 

 

 

 

865 

 

Total comprehensive income for the year

 

 

 

53,690 

 

 

 

53,690 

 

Shares issued under employee share plans

42 

 

679 

 

 

 

 

 

721 

 

Shares issued in lieu of dividends and amounts arising thereon

83 

 

(83)

 

 

1,494 

 

 

 

1,494 

 

Cancellation of shares3

(105)

 

2,836 

 

 

(4,998)

 

 

269 

 

(1,998)

 

Capital securities issued

 

 

5,967 

 

 

 

 

5,967 

 

Dividends to shareholders

 

 

 

(11,547)

 

 

 

(11,547)

 

Redemption of capital securities

 

 

(5,843)

 

(236)

 

 

 

(6,079)

 

Transfers4

 

 

 

(2,200)

 

 

2,200 

 

 

Other movements

 

 

 

379 

 

 

49 

 

428 

 

At 31 Dec 2018

10,180 

 

13,609 

 

22,231 

 

61,434 

 

 

39,899 

 

147,353 

 

 

Dividends per ordinary share at 31 December 2020 were nil (2019: $0.51; 2018: $0.51).

1  At 31 December 2020, retained earnings includ ed 326,766,253 ($2,521m) treasury shares (2019: 326,191,804 ($2,543m); 2018: 326,503,319 ($2,546m)).

2  In August 2019, HSBC announced a share buy-back of up to $1.0bn, which was completed in September 2019.

3  The 2018 year included a re-presentation of the cancellation of shares to retained earnings and capital redemption reserve in respect of the 2018 share buy-back, under which retained earnings has been reduced by $3,000m, share premium increased by $2,836m and other reserves increased by $164m. 

4  At 31 December 2020, an impairment of $435m of HSBC Overseas Holdings (UK) Limited (2019: $2,475m) was recognised and a permitted transfer of $435m (2019: $2,475m) was made from the merger reserve to retained earnings. In 2018, a part reversal of the impairment of HSBC Overseas Holdings (UK) Limited resulted in a transfer from retained earnings back to the merger reserve of $2,200m.

5  Includes an adjustment to retained earnings for a repayment of capital by a subsidiary of $1,650m, which had been recognised as dividend income in 2019.

 

Notes on the financial statements

 

 

Page

 

 

 

Page

1

Basis of preparation and significant accounting policies

288

 

21

Goodwill and intangible assets

352

2

Net fee income

304

 

22

Prepayments, accrued income and other assets

355

3

Net income/(expense) from financial instruments measured at fair value through profit or loss

305

 

23

Trading liabilities

355

 

24

Financial liabilities designated at fair value

355

4

Insurance business

305

 

25

Debt securities in issue

356

5

Employee compensation and benefits

307

 

26

Accruals, deferred income and other liabilities

356

6

Auditors' remuneration

313

 

27

Provisions

357

7

Tax

313

 

28

Subordinated liabilities

358

8

Dividends

315

 

29

Maturity analysis of assets, liabilities and off-balance sheet commitments

362

9

Earnings per share

317

 

10

Segmental analysis

318

 

30

Offsetting of financial assets and financial liabilities

367

11

Trading assets

321

 

31

Called up share capital and other equity instruments

368

12

Fair values of financial instruments carried at fair value

321

 

32

Contingent liabilities, contractual commitments and guarantees

370

13

Fair values of financial instruments not carried at fair value

329

 

33

Finance lease receivables

372

14

Financial assets designated and otherwise mandatorily measured at fair value through profit or loss

331

 

34

Legal proceedings and regulatory matters

372

 

35

Related party transactions

376

15

Derivatives

332

 

36

Events after the balance sheet date

378

16

Financial investments

339

 

37

HSBC Holdings' subsidiaries, joint ventures and associates

378

17

Assets pledged, collateral received and assets transferred

341

 

 

 

 

18

Interests in associates and joint ventures

342

 

 

 

 

19

Investments in subsidiaries

347

 

 

 

 

20

Structured entities

349

 

 

 

 

 

 

1

Basis of preparation and significant accounting policies

 

 

1.1  Basis of preparation

(a)  Compliance with International Financial Reporting Standards

The consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings comply with international accounting standards in conformity with the requirements of the Companies Act 2006 and have also applied international financial reporting standards adopted pursuant to Regulation (EC) No 1606/2002 as it applies in the European Union. These financial statements are also prepared in accordance with International Financial Reporting Standards ('IFRSs') as issued by the International Accounting Standards Board ('IASB'), including interpretations issued by the IFRS Interpretations Committee, as there are no applicable differences from IFRSs as issued by the IASB for the periods presented. 'Interest Rate Benchmark Reform - Phase 2', which amends IFRS 9, IAS 39 'Financial Instruments,' IFRS 7 'Financial Instruments,' IFRS 4 'Insurance Contracts' and IFRS 16 'Leases', was adopted for use in the UK and the EU in January 2021 and has been early adopted as set out below. Therefore, there were no unendorsed standards effective for the year ended 31 December 2020 affecting these consolidated and separate financial statements.

 

Standards adopted during the year ended 31 December 2020

 Interest Rate Benchmark Reform - Phase 2

Interest Rate Benchmark Reform Phase 2: Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16 issued in August 2020 represents the second phase of the IASB's project on the effects of interest rate benchmark reform, addressing issues affecting financial statements when changes are made to contractual cash flows and hedging relationships as a result of the reform.

Under these amendments, changes made to a financial instrument measured at other than fair value through profit or loss that are economically equivalent and required by interest rate benchmark reform do not result in the derecognition or a change in the carrying amount of the financial instrument, but instead require the effective interest rate to be updated to reflect the change in the interest rate benchmark. In addition, hedge accounting will not be discontinued solely because of the replacement of the interest rate benchmark if the hedge meets other hedge accounting criteria.

These amendments apply from 1 January 2021 with early adoption permitted. HSBC adopted the amendments from 1 January 2020 and  made the additional disclosures as required by the amendments. Further information is included in Note 15 and in 'Financial instruments impacted by Ibor reform' on page 113.

Other changes

In addition, HSBC adopted a number of interpretations and amendments to standards, which had an insignificant effect on the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings.

In 2018, HSBC adopted IFRS 9 and made voluntary presentation changes, including to certain financial liabilities, which contain both deposit and derivative components, and to cash collateral, margin and settlement accounts. The impact of this is included in the HSBC Holdings statement of changes in equity for that year end.

Other than as noted above, accounting policies have been consistently applied.

(b)  Differences between IFRSs and Hong Kong Financial Reporting Standards

There are no significant differences between IFRSs and Hong Kong Financial Reporting Standards in terms of their application to HSBC, and consequently there would be no significant differences had the financial statements been prepared in accordance with Hong Kong Financial Reporting Standards. The 'Notes on the financial statements', taken together with the 'Report of the Directors', include the aggregate of all disclosures necessary to satisfy IFRSs and Hong Kong reporting requirements.

 

(c)  Future accounting developments

Minor amendments to IFRSs

The IASB has not published any minor amendments effective from 1 January 2021 that are applicable to HSBC. However, the IASB has published a number of minor amendments to IFRSs that are effective from 1 January 2022 and 1 January 2023. HSBC expects they will have an insignificant effect, when adopted, on the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings.

New IFRSs

IFRS 17 'Insurance Contracts'

IFRS 17 'Insurance Contracts' was issued in May 2017, with amendments to the standard issued in June 2020. The standard sets out the requirements that an entity should apply in accounting for insurance contracts it issues and reinsurance contracts it holds. Following the amendments, IFRS 17 is effective from 1 January 2023. The Group is in the process of implementing IFRS 17. Industry practice and interpretation of the standard are still developing. Therefore, the likely numerical impact of its implementation remains uncertain. However, we have the following expectations as to the impact compared with the Group's current accounting policy for insurance contracts, which is set out in policy 1.2(j) below:

Under IFRS 17, there will be no PVIF asset recognised; rather the estimated future profit will be included in the measurement of the insurance contract liability as the contractual service margin ('CSM') and gradually recognised in revenue as services are provided over the duration of the insurance contract. The PVIF asset will be eliminated to equity on transition, together with other adjustments to assets and liabilities to reflect IFRS 17 measurement requirements and any consequential amendments to financial assets in the scope of IFRS 9;

IFRS 17 requires increased use of current market values in the measurement of insurance liabilities. Depending on the measurement model, changes in market conditions for certain products (measured under the General Measurement Approach) are immediately recognised in profit or loss, while for other products (measured under the Variable Fee Approach) they will be included in the measurement of CSM.

In accordance with IFRS 17, directly attributable costs will be included in the results of insurance services as profit is recognised over the duration of insurance contracts. Costs that are not directly attributable will remain in operating expenses. This will result in a reduction in operating expenses compared with the current accounting policy.

(d)  Foreign currencies

HSBC's consolidated financial statements are presented in US dollars because the US dollar and currencies linked to it form the major currency bloc in which HSBC transacts and funds its business. The US dollar is also HSBC Holdings' functional currency because the US dollar and currencies linked to it are the most significant currencies relevant to the underlying transactions, events and conditions of its subsidiaries, as well as representing a significant proportion of its funds generated from financing activities.

Transactions in foreign currencies are recorded at the rate of exchange on the date of the transaction. Assets and liabilities denominated in foreign currencies are translated at the rate of exchange at the balance sheet date, except non-monetary assets and liabilities measured at historical cost, which are translated using the rate of exchange at the initial transaction date. Exchange differences are included in other comprehensive income or in the income statement depending on where the gain or loss on the underlying item is recognised. In the consolidated financial statements, the assets and liabilities of branches, subsidiaries, joint ventures and associates whose functional currency is not US dollars are translated into the Group's presentation currency at the rate of exchange at the balance sheet date, while their results are translated into US dollars at the average rates of exchange for the reporting period. Exchange differences arising are recognised in other comprehensive income. On disposal of a foreign operation, exchange differences previously recognised in other comprehensive income are reclassified to the income statement.

(e)  Presentation of information

Certain disclosures required by IFRSs have been included in the sections marked as ('Audited') in this Annual Report and Accounts 2020 as follows:

disclosures concerning the nature and extent of risks relating to insurance contracts and financial instruments are included in the 'Risk review' on pages 106 to 194;

the 'Own funds disclosure' included in the 'Risk review' on page 174; and

disclosures relating to HSBC's securitisation activities and structured products are included in the 'Risk review' on pages 106 to 194.

HSBC follows the UK Finance Disclosure Code ('the UKF Disclosure Code'). The UKF Disclosure Code aims to increase the quality and comparability of UK banks' disclosures and sets out five disclosure principles together with supporting guidance agreed in 2010. In line with the principles of the UKF Disclosure Code, HSBC assesses good practice recommendations issued from time to time by relevant regulators and standard setters, and will assess the applicability and relevance of such guidance, enhancing disclosures where appropriate.

(f)  Critical accounting estimates and judgements

The preparation of financial information requires the use of estimates and judgements about future conditions. In view of the inherent uncertainties and the high level of subjectivity involved in the recognition or measurement of items, highlighted as the 'critical accounting estimates and judgements' in section 1.2 below (including impairment of non-financial assets for the first time), it is possible that the outcomes in the next financial year could differ from those on which management's estimates are based. This could result in materially different estimates and judgements from those reached by management for the purposes of these financial statements. Management's selection of HSBC's accounting policies that contain critical estimates and judgements reflects the materiality of the items to which the policies are applied and the high degree of judgement and estimation uncertainty involved.

(g)  Segmental analysis

HSBC's Chief Operating Decision Maker is the Group Chief Executive, who is supported by the rest of the Group Executive Committee ('GEC'), which operates as a general management committee under the direct authority of the Board. Operating segments are reported in a manner consistent with the internal reporting provided to the Group Chief Executive and the GEC.

Measurement of segmental assets, liabilities, income and expenses is in accordance with the Group's accounting policies. Segmental income and expenses include transfers between segments, and these transfers are conducted at arm's length. Shared costs are included in segments on the basis of the actual recharges made.

(h)  Going concern

The financial statements are prepared on a going concern basis, as the Directors are satisfied that the Group and parent company have the resources to continue in business for the foreseeable future. In making this assessment, the Directors have considered a wide range of information relating to present and future conditions, including future projections of profitability, cash flows, capital requirements and capital resources. These considerations include stressed scenarios that reflect the increasing uncertainty that the global Covid-19 outbreak has had on HSBC's operations, as well as considering potential impacts from other top and emerging risks, and the related impact on profitability, capital and liquidity.

 

1.2  Summary of significant accounting policies

(a)  Consolidation and related policies

Investments in subsidiaries

Where an entity is governed by voting rights, HSBC consolidates when it holds - directly or indirectly - the necessary voting rights to pass resolutions by the governing body. In all other cases, the assessment of control is more complex and requires judgement of other factors, including having exposure to variability of returns, power to direct relevant activities, and whether power is held as agent or principal.

Business combinations are accounted for using the acquisition method. The amount of non-controlling interest is measured either at fair value or at the non-controlling interest's proportionate share of the acquiree's identifiable net assets. This election is made for each business combination.

HSBC Holdings' investments in subsidiaries are stated at cost less impairment losses.

Goodwill

Goodwill is allocated to cash-generating units ('CGUs') for the purpose of impairment testing, which is undertaken at the lowest level at which goodwill is monitored for internal management purposes. HSBC's CGUs are based on geographical regions subdivided by global business, except for Global Banking and Markets, for which goodwill is monitored on a global basis.

Impairment testing is performed at least once a year, or whenever there is an indication of impairment, by comparing the recoverable amount of a CGU with its carrying amount.

Goodwill is included in a disposal group if the disposal group is a CGU to which goodwill has been allocated or it is an operation within such a CGU. The amount of goodwill included in a disposal group is measured on the basis of the relative values of the operation disposed of and the portion of the CGU retained.

Critical accounting estimates and judgements

The review of goodwill and non-financial assets (see Note 1.2(n)) for impairment reflects management's best estimate of the future cash flows of the CGUs and the rates used to discount these cash flows, both of which are subject to uncertain factors as follows:

 

 

The accuracy of forecast cash flows is subject to a high degree of uncertainty in volatile market conditions. Where such circumstances are determined to exist, management re-tests goodwill for impairment more frequently than once a year when indicators of impairment exist. This ensures that the assumptions on which the cash flow forecasts are based continue to reflect current market conditions and management's best estimate of future business prospects

The future cash flows of the CGUs are sensitive to the cash flows projected for the periods for which detailed forecasts are available and to assumptions regarding the long-term pattern of sustainable cash flows thereafter. Forecasts are compared with actual performance and verifiable economic data, but they reflect management's view of future business prospects at the time of the assessment

The rates used to discount future expected cash flows can have a significant effect on their valuation, and are based on the costs of capital assigned to individual CGUs. The cost of capital percentage is generally derived from a capital asset pricing model, which incorporates inputs reflecting a number of financial and economic variables, including the risk-free interest rate in the country concerned and a premium for the risk of the business being evaluated. These variables are subject to fluctuations in external market rates and economic conditions beyond management's control

Key assumptions used in estimating goodwill and non-financial asset impairment are described in Note 21

 

HSBC sponsored structured entities

HSBC is considered to sponsor another entity if, in addition to ongoing involvement with the entity, it had a key role in establishing that entity or in bringing together relevant counterparties so the transaction that is the purpose of the entity could occur. HSBC is generally not considered a sponsor if the only involvement with the entity is merely administrative.

Interests in associates and joint arrangements

Joint arrangements are investments in which HSBC, together with one or more parties, has joint control. Depending on HSBC's rights and obligations, the joint arrangement is classified as either a joint operation or a joint venture. HSBC classifies investments in entities over which it has significant influence, and that are neither subsidiaries nor joint arrangements, as associates.

HSBC recognises its share of the assets, liabilities and results in a joint operation. Investments in associates and interests in joint ventures are recognised using the equity method. The attributable share of the results and reserves of joint ventures and associates is included in the consolidated financial statements of HSBC based on either financial statements made up to 31 December or pro-rated amounts adjusted for any material transactions or events occurring between the date the financial statements are available and 31 December.

Investments in associates and joint ventures are assessed at each reporting date and tested for impairment when there is an indication that the investment may be impaired. Goodwill on acquisitions of interests in joint ventures and associates is not tested separately for impairment, but is assessed as part of the carrying amount of the investment.

 

Critical accounting estimates and judgements

The most significant critical accounting estimates relate to the assessment of impairment of our investment in Bank of Communications Co. Limited ('BoCom'), which involves estimations of value in use:

 

 

 

Management's best estimate of BoCom's earnings are based on management's explicit forecasts over the short to medium term and the capital maintenance charge, which is management's forecast of the earnings that need to be withheld in order for BoCom to meet regulatory requirements over the forecast period, both of which are subject to uncertain factors

Key assumptions used in estimating BoCom's value in use, the sensitivity of the value in use calculations to different assumptions and a sensitivity analysis that shows the changes in key assumptions that would reduce the excess of value in use over the carrying amount (the 'headroom') to nil are described in Note 18

 

(b)  Income and expense

Operating income

Interest income and expense

Interest income and expense for all financial instruments, excluding those classified as held for trading or designated at fair value, are recognised in 'Interest income' and 'Interest expense' in the income statement using the effective interest method. However, as an exception to this, interest on debt instruments issued by HSBC for funding purposes that are designated under the fair value option to reduce an accounting mismatch and on derivatives managed in conjunction with those debt instruments is included in interest expense.

Interest on credit-impaired financial assets is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss.

Non-interest income and expense

HSBC generates fee income from services provided at a fixed price over time, such as account service and card fees, or when HSBC delivers a specific transaction at a point in time, such as broking services and import/export services. With the exception of certain fund management and performance fees, all other fees are generated at a fixed price. Fund management and performance fees can be variable depending on the size of the customer portfolio and HSBC's performance as fund manager. Variable fees are recognised when all uncertainties are resolved. Fee income is generally earned from short-term contracts with payment terms that do not include a significant financing component.

HSBC acts as principal in the majority of contracts with customers, with the exception of broking services. For most brokerage trades, HSBC acts as agent in the transaction and recognises broking income net of fees payable to other parties in the arrangement.

HSBC recognises fees earned on transaction-based arrangements at a point in time when it has fully provided the service to the customer. Where the contract requires services to be provided over time, income is recognised on a systematic basis over the life of the agreement.

Where HSBC offers a package of services that contains multiple non-distinct performance obligations, such as those included in account service packages, the promised services are treated as a single performance obligation. If a package of services contains distinct performance obligations, such as those including both account and insurance services, the corresponding transaction price is allocated to each performance obligation based on the estimated stand-alone selling prices.

Dividend income is recognised when the right to receive payment is established. This is the ex-dividend date for listed equity securities, and usually the date when shareholders approve the dividend for unlisted equity securities.

Net income/(expense) from financial instruments measured at fair value through profit or loss includes the following:

'Net income from financial instruments held for trading or managed on a fair value basis': This comprises net trading income, which includes all gains and losses from changes in the fair value of financial assets and financial liabilities held for trading and other financial instruments managed on a fair value basis, together with the related interest income, expense and dividends, excluding the effect of changes in the credit risk of liabilities managed on a fair value basis. It also includes all gains and losses from changes in the fair value of derivatives that are managed in conjunction with financial assets and liabilities measured at fair value through profit or loss.

'Net income/(expense) from assets and liabilities of insurance businesses, including related derivatives, measured at fair value through profit or loss': This includes interest income, interest expense and dividend income in respect of financial assets and liabilities measured at fair value through profit or loss; and those derivatives managed in conjunction with the above that can be separately identifiable from other trading derivatives.

'Changes in fair value of designated debt instruments and related derivatives': Interest paid on debt instruments and interest cash flows on related derivatives is presented in interest expense where doing so reduces an accounting mismatch.

'Changes in fair value of other financial instruments mandatorily measured at fair value through profit or loss': This includes interest on instruments that fail the solely payments of principal and interest test, see (d) below.

The accounting policies for insurance premium income are disclosed in Note 1.2(j).

(c)  Valuation of financial instruments

All financial instruments are initially recognised at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of a financial instrument on initial recognition is generally its transaction price (that is, the fair value of the consideration given or received). However, if there is a difference between the transaction price and the fair value of financial instruments whose fair value is based on a quoted price in an active market or a valuation technique that uses only data from observable markets, HSBC recognises the difference as a trading gain or loss at inception (a 'day 1 gain or loss'). In all other cases, the entire day 1 gain or loss is deferred and recognised in the income statement over the life of the transaction until the transaction matures, is closed out, the valuation inputs become observable or HSBC enters into an offsetting transaction. The fair value of financial instruments is generally measured on an individual basis. However,

in cases where HSBC manages a group of financial assets and liabilities according to its net market or credit risk exposure, the fair value of the group of financial instruments is measured on a net basis but the underlying financial assets and liabilities are presented separately in the financial statements, unless they satisfy the IFRS offsetting criteria.

Critical accounting estimates and judgements

The majority of valuation techniques employ only observable market data. However, certain financial instruments are classified on the basis of valuation techniques that feature one or more significant market inputs that are unobservable, and for them, the measurement of fair value is more judgemental:

 

 

An instrument in its entirety is classified as valued using significant unobservable inputs if, in the opinion of management, a significant proportion of the instrument's inception profit or greater than 5% of the instrument's valuation is driven by unobservable inputs

'Unobservable' in this context means that there is little or no current market data available from which to determine the price at which an arm's length transaction would be likely to occur. It generally does not mean that there is no data available at all upon which to base a determination of fair value (consensus pricing data may, for example, be used)

Details on the Group's level 3 financial instruments and the sensitivity of their valuation to the effect of applying reasonable possible alternative assumptions in determining their fair value are set out in Note 12

 

(d)  Financial instruments measured at amortised cost

Financial assets that are held to collect the contractual cash flows and which contain contractual terms that give rise on specified dates to cash flows that are solely payments of principal and interest are measured at amortised cost. Such financial assets include most loans and advances to banks and customers and some debt securities. In addition, most financial liabilities are measured at amortised cost. HSBC accounts for regular way amortised cost financial instruments using trade date accounting. The carrying value of these financial assets at initial recognition includes any directly attributable transactions costs. If the initial fair value is lower than the cash amount advanced, such as in the case of some leveraged finance and syndicated lending activities, the difference is deferred and recognised over the life of the loan through the recognition of interest income.

HSBC may commit to underwriting loans on fixed contractual terms for specified periods of time. When the loan arising from the lending commitment is expected to be held for trading, the commitment to lend is recorded as a derivative. When HSBC intends to hold the loan, the loan commitment is included in the impairment calculations set out below.

Non-trading reverse repurchase, repurchase and similar agreements

When debt securities are sold subject to a commitment to repurchase them at a predetermined price ('repos'), they remain on the balance sheet and a liability is recorded in respect of the consideration received. Securities purchased under commitments to resell ('reverse repos') are not recognised on the balance sheet and an asset is recorded in respect of the initial consideration paid. Non-trading repos and reverse repos are measured at amortised cost. The difference between the sale and repurchase price or between the purchase and resale price is treated as interest and recognised in net interest income over the life of the agreement.

Contracts that are economically equivalent to reverse repo or repo agreements (such as sales or purchases of debt securities entered into together with total return swaps with the same counterparty) are accounted for similarly to, and presented together with, reverse repo or repo agreements.

(e)  Financial assets measured at fair value through other comprehensive income

Financial assets held for a business model that is achieved by both collecting contractual cash flows and selling and which contain contractual terms that give rise on specified dates to cash flows that are solely payments of principal and interest are measured at fair value through other comprehensive income ('FVOCI'). These comprise primarily debt securities. They are recognised on the trade date when HSBC enters into contractual arrangements to purchase and are normally derecognised when they are either sold or redeemed. They are subsequently remeasured at fair value and changes therein (except for those relating to impairment, interest income and foreign currency exchange gains and losses) are recognised in other comprehensive income until the assets are sold. Upon disposal, the cumulative gains or losses in other comprehensive income are recognised in the income statement as 'Gains less losses from financial instruments'. Financial assets measured at FVOCI are included in the impairment calculations set out below and impairment is recognised in profit or loss.

(f)  Equity securities measured at fair value with fair value movements presented in other comprehensive income

The equity securities for which fair value movements are shown in other comprehensive income are business facilitation and other similar investments where HSBC holds the investments other than to generate a capital return. Gains or losses on the derecognition of these equity securities are not transferred to profit or loss. Otherwise, equity securities are measured at fair value through profit or loss (except for dividend income, which is recognised in profit or loss).

(g)  Financial instruments designated at fair value through profit or loss

Financial instruments, other than those held for trading, are classified in this category if they meet one or more of the criteria set out below and are so designated irrevocably at inception:

the use of the designation removes or significantly reduces an accounting mismatch;

a group of financial assets and liabilities or a group of financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy; and

the financial liability contains one or more non-closely related embedded derivatives.

Designated financial assets are recognised when HSBC enters into contracts with counterparties, which is generally on trade date, and are normally derecognised when the rights to the cash flows expire or are transferred. Designated financial liabilities are recognised when HSBC enters into contracts with counterparties, which is generally on settlement date, and are normally derecognised when extinguished. Subsequent changes in fair values are recognised in the income statement in 'Net income from financial instruments held for trading or managed on a fair value basis' or 'Net income/(expense) from assets and liabilities of insurance businesses, including related derivatives, measured at fair value through profit or loss' except for the effect of changes in the liabilities' credit risk, which is presented in 'Other comprehensive income', unless that treatment would create or enlarge an accounting mismatch in profit or loss.

Under the above criterion, the main classes of financial instruments designated by HSBC are:

Debt instruments for funding purposes that are designated to reduce an accounting mismatch: The interest and/or foreign exchange exposure on certain fixed-rate debt securities issued has been matched with the interest and/or foreign exchange exposure on certain swaps as part of a documented risk management strategy.

Financial assets and financial liabilities under unit-linked and non-linked investment contracts: A contract under which HSBC does not accept significant insurance risk from another party is not classified as an insurance contract, other than investment contracts with discretionary participation features ('DPF'), but is accounted for as a financial liability. Customer liabilities under linked and certain non-linked investment contracts issued by insurance subsidiaries are determined based on the fair value of the assets held in the linked funds. If no fair value designation was made for the related assets, at least some of the assets would otherwise be measured at either fair value through other comprehensive income or amortised cost. The related financial assets and liabilities are managed and reported to management on a fair value basis. Designation at fair value of the financial assets and related liabilities allows changes in fair values to be recorded in the income statement and presented in the same line.

Financial liabilities that contain both deposit and derivative components: These financial liabilities are managed and their performance evaluated on a fair value basis.

(h)  Derivatives

Derivatives are financial instruments that derive their value from the price of underlying items such as equities, interest rates or other indices. Derivatives are recognised initially and are subsequently measured at fair value through profit or loss. Derivatives are classified as assets when their fair value is positive or as liabilities when their fair value is negative. This includes embedded derivatives in financial liabilities, which are bifurcated from the host contract when they meet the definition of a derivative on a stand-alone basis.

Where the derivatives are managed with debt securities issued by HSBC that are designated at fair value, the contractual interest is shown in 'Interest expense' together with the interest payable on the issued debt.

Hedge accounting

When derivatives are not part of fair value designated relationships, if held for risk management purposes they are designated in hedge accounting relationships where the required criteria for documentation and hedge effectiveness are met. HSBC uses these derivatives or, where allowed, other non-derivative hedging instruments in fair value hedges, cash flow hedges or hedges of net investments in foreign operations as appropriate to the risk being hedged.

Fair value hedge

Fair value hedge accounting does not change the recording of gains and losses on derivatives and other hedging instruments, but results in recognising changes in the fair value of the hedged assets or liabilities attributable to the hedged risk that would not otherwise be recognised in the income statement. If a hedge relationship no longer meets the criteria for hedge accounting, hedge accounting is discontinued and the cumulative adjustment to the carrying amount of the hedged item is amortised to the income statement on a recalculated effective interest rate, unless the hedged item has been derecognised, in which case it is recognised in the income statement immediately.

Cash flow hedge

The effective portion of gains and losses on hedging instruments is recognised in other comprehensive income and the ineffective portion of the change in fair value of derivative hedging instruments that are part of a cash flow hedge relationship is recognised immediately in the income statement within 'Net income from financial instruments held for trading or managed on a fair value basis'. The accumulated gains and losses recognised in other comprehensive income are reclassified to the income statement in the same periods in which the hedged item affects profit or loss. When a hedge relationship is discontinued, or partially discontinued, any cumulative gain or loss recognised in other comprehensive income remains in equity until the forecast transaction is recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss previously recognised in other comprehensive income is immediately reclassified to the income statement.

Net investment hedge

Hedges of net investments in foreign operations are accounted for in a similar way to cash flow hedges. The effective portion of gains and losses on the hedging instrument is recognised in other comprehensive income and other gains and losses are recognised immediately in the income statement. Gains and losses previously recognised in other comprehensive income are reclassified to the income statement on the disposal, or part disposal, of the foreign operation.

Derivatives that do not qualify for hedge accounting

Non-qualifying hedges are derivatives entered into as economic hedges of assets and liabilities for which hedge accounting was not applied.

(i)  Impairment of amortised cost and FVOCI financial assets

Expected credit losses ('ECL') are recognised for loans and advances to banks and customers, non-trading reverse repurchase agreements, other financial assets held at amortised cost, debt instruments measured at FVOCI, and certain loan commitments and financial guarantee contracts. At initial recognition, allowance (or provision in the case of some loan commitments and financial guarantees) is required for ECL resulting from default events that are possible within the next 12 months, or less, where the remaining life is less than 12 months ('12-month ECL'). In the event of a significant increase in credit risk, allowance (or provision) is required for ECL resulting from all possible default events over the expected life of the financial instrument ('lifetime ECL'). Financial assets where
12-month ECL is recognised are considered to be 'stage 1'; financial assets that are considered to have experienced a significant increase in credit risk are in 'stage 2'; and financial assets for which there is objective evidence of impairment so are considered to be in default or otherwise credit impaired are in 'stage 3'. Purchased or originated credit-impaired financial assets ('POCI') are treated differently, as set out below.

Credit impaired (stage 3)

HSBC determines that a financial instrument is credit impaired and in stage 3 by considering relevant objective evidence, primarily whether:

contractual payments of either principal or interest are past due for more than 90 days;

there are other indications that the borrower is unlikely to pay, such as when a concession has been granted to the borrower for economic or legal reasons relating to the borrower's financial condition; and

the loan is otherwise considered to be in default.

If such unlikeliness to pay is not identified at an earlier stage, it is deemed to occur when an exposure is 90 days past due, even where regulatory rules permit default to be defined based on 180 days past due. Therefore, the definitions of credit impaired and default are aligned as far as possible so that stage 3 represents all loans that are considered defaulted or otherwise credit impaired.

Interest income is recognised by applying the effective interest rate to the amortised cost amount, i.e. gross carrying amount less ECL allowance.

Write-off

Financial assets (and the related impairment allowances) are normally written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, this is generally after receipt of any proceeds from the realisation of security. In circumstances where the net realisable value of any collateral has been determined and there is no reasonable expectation of further recovery, write-off may be earlier.

Renegotiation

Loans are identified as renegotiated and classified as credit impaired when we modify the contractual payment terms due to significant credit distress of the borrower. Renegotiated loans remain classified as credit impaired until there is sufficient evidence to demonstrate a significant reduction in the risk of non-payment of future cash flows and retain the designation of renegotiated until maturity or derecognition.

A loan that is renegotiated is derecognised if the existing agreement is cancelled and a new agreement is made on substantially different terms, or if the terms of an existing agreement are modified such that the renegotiated loan is a substantially different financial instrument. Any new loans that arise following derecognition events in these circumstances are considered to be POCI and will continue to be disclosed as renegotiated loans.

Other than originated credit-impaired loans, all other modified loans could be transferred out of stage 3 if they no longer exhibit any evidence of being credit impaired and, in the case of renegotiated loans, there is sufficient evidence to demonstrate a significant reduction in the risk of non-payment of future cash flows over the minimum observation period, and there are no other indicators of impairment. These loans could be transferred to stage 1 or 2 based on the mechanism as described below by comparing the risk of a default occurring at the reporting date (based on the modified contractual terms) and the risk of a default occurring at initial recognition (based on the original, unmodified contractual terms). Any amount written off as a result of the modification of contractual terms would not be reversed.

Loan modifications other than renegotiated loans

Loan modifications that are not identified as renegotiated are considered to be commercial restructuring. Where a commercial restructuring results in a modification (whether legalised through an amendment to the existing terms or the issuance of a new loan contract) such that HSBC's rights to the cash flows under the original contract have expired, the old loan is derecognised and the new loan is recognised at fair value. The rights to cash flows are generally considered to have expired if the commercial restructure is at market rates and no payment-related concession has been provided. Mandatory and general offer loan modifications that are not borrower-specific, for example market-wide customer relief programmes, have not been classified as renegotiated loans and generally have not resulted in derecognition, but their stage allocation is determined considering all available and supportable information under our ECL impairment policy.

Significant increase in credit risk (stage 2)

An assessment of whether credit risk has increased significantly since initial recognition is performed at each reporting period by considering the change in the risk of default occurring over the remaining life of the financial instrument. The assessment explicitly or implicitly compares the risk of default occurring at the reporting date compared with that at initial recognition, taking into account reasonable and supportable information, including information about past events, current conditions and future economic conditions. The assessment is unbiased, probability-weighted, and to the extent relevant, uses forward-looking information consistent with that used in the measurement of ECL. The analysis of credit risk is multifactor. The determination of whether a specific factor is relevant and its weight compared with other factors depends on the type of product, the characteristics of the financial instrument and the borrower, and the geographical region. Therefore, it is not possible to provide a single set of criteria that will determine what is considered to be a significant increase in credit risk, and these criteria will differ for different types of lending, particularly between retail and wholesale. However, unless identified at an earlier stage, all financial assets are deemed to have suffered a significant increase in credit risk when 30 days past due. In addition, wholesale loans that are individually assessed, which are typically corporate and commercial customers, and included on a watch or worry list, are included in stage 2.

For wholesale portfolios, the quantitative comparison assesses default risk using a lifetime probability of default ('PD'), which encompasses a wide range of information including the obligor's customer risk rating ('CRR'), macroeconomic condition forecasts and credit transition probabilities. For origination CRRs up to 3.3, significant increase in credit risk is measured by comparing the average PD for the remaining term estimated at origination with the equivalent estimation at the reporting date. The quantitative measure of significance varies depending on the credit quality at origination as follows:

 

 

0.1-1.2

15bps

2.1-3.3

30bps

 

For CRRs greater than 3.3 that are not impaired, a significant increase in credit risk is considered to have occurred when the origination PD has doubled. The significance of changes in PD was informed by expert credit risk judgement, referenced to historical credit migrations and to relative changes in external market rates.

For loans originated prior to the implementation of IFRS 9, the origination PD does not include adjustments to reflect expectations of future macroeconomic conditions since these are not available without the use of hindsight. In the absence of this data, origination PD must be approximated assuming through-the-cycle ('TTC') PDs and TTC migration probabilities, consistent with the instrument's underlying modelling approach and the CRR at origination. For these loans, the quantitative comparison is supplemented with additional CRR deterioration-based thresholds, as set out in the table below:

 

 

0.1

5 notches

1.1-4.2

4 notches

4.3-5.1

3 notches

5.2-7.1

2 notches

7.2-8.2

1 notch

8.3

0 notch

 

Further information about the 23-grade scale used for CRR can be found on page 121.

For certain portfolios of debt securities where external market ratings are available and credit ratings are not used in credit risk management, the debt securities will be in stage 2 if their credit risk increases to the extent they are no longer considered investment grade. Investment grade is where the financial instrument has a low risk of incurring losses, the structure has a strong capacity to meet its contractual cash flow obligations in the near term, and adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil their contractual cash flow obligations.

For retail portfolios, default risk is assessed using a reporting date 12-month PD derived from credit scores, which incorporates all available information about the customer. This PD is adjusted for the effect of macroeconomic forecasts for periods longer than
12 months and is considered to be a reasonable approximation of a lifetime PD measure. Retail exposures are first segmented into homogeneous portfolios, generally by country, product and brand. Within each portfolio, the stage 2 accounts are defined as accounts with an adjusted 12-month PD greater than the average 12-month PD of loans in that portfolio 12 months before they become 30 days past due. The expert credit risk judgement is that no prior increase in credit risk is significant. This portfolio-specific threshold identifies loans with a PD higher than would be expected from loans that are performing as originally expected, and higher than what would have been acceptable at origination. It therefore approximates a comparison of origination to reporting date PDs.

Unimpaired and without significant increase in credit risk (stage 1)

ECL resulting from default events that are possible within the next 12 months ('12-month ECL') are recognised for financial instruments that remain in stage 1.

Purchased or originated credit impaired

Financial assets that are purchased or originated at a deep discount that reflects the incurred credit losses are considered to be POCI. This population includes the recognition of a new financial instrument following a renegotiation where concessions have been granted for economic or contractual reasons relating to the borrower's financial difficulty that otherwise would not have been considered. The amount of change-in-lifetime ECL is recognised in profit or loss until the POCI is derecognised, even if the lifetime ECL are less than the amount of ECL included in the estimated cash flows on initial recognition.

Movement between stages

Financial assets can be transferred between the different categories (other than POCI) depending on their relative increase in credit risk since initial recognition. Financial instruments are transferred out of stage 2 if their credit risk is no longer considered to be significantly increased since initial recognition based on the assessments described above. Except for renegotiated loans, financial instruments are transferred out of stage 3 when they no longer exhibit any evidence of credit impairment as described above. Renegotiated loans that are not POCI will continue to be in stage 3 until there is sufficient evidence to demonstrate a significant reduction in the risk of non-payment of future cash flows, observed over a minimum one-year period and there are no other indicators of impairment. For loans that are assessed for impairment on a portfolio basis, the evidence typically comprises a history of payment performance against the original or revised terms, as appropriate to the circumstances. For loans that are assessed for impairment on an individual basis, all available evidence is assessed on a case-by-case basis.

Measurement of ECL

The assessment of credit risk and the estimation of ECL are unbiased and probability-weighted, and incorporate all available information that is relevant to the assessment including information about past events, current conditions and reasonable and supportable forecasts of future events and economic conditions at the reporting date. In addition, the estimation of ECL should take into account the time value of money.

In general, HSBC calculates ECL using three main components: a probability of default, a loss given default ('LGD') and the exposure at default ('EAD').

The 12-month ECL is calculated by multiplying the 12-month PD, LGD and EAD. Lifetime ECL is calculated using the lifetime PD instead. The 12-month and lifetime PDs represent the probability of default occurring over the next 12 months and the remaining maturity of the instrument respectively.

The EAD represents the expected balance at default, taking into account the repayment of principal and interest from the balance sheet date to the default event together with any expected drawdowns of committed facilities. The LGD represents expected losses on the EAD given the event of default, taking into account, among other attributes, the mitigating effect of collateral value at the time it is expected to be realised and the time value of money.

HSBC leverages the Basel II IRB framework where possible, with recalibration to meet the differing IFRS 9 requirements as set out in the following table:
 

 

 

 

PD

Through the cycle (represents long-run average PD throughout a full economic cycle)

The definition of default includes a backstop of 90+ days past due, although this has been modified to 180+ days past due for some portfolios, particularly UK and US mortgages

Point in time (based on current conditions, adjusted to take into account estimates of future conditions that will impact PD)

Default backstop of 90+ days past due for all portfolios

EAD

Cannot be lower than current balance

Amortisation captured for term products

LGD

Downturn LGD (consistent losses expected to be suffered during a severe but plausible economic downturn)

Regulatory floors may apply to mitigate risk of underestimating downturn LGD due to lack of historical data

Discounted using cost of capital

All collection costs included

Expected LGD (based on estimate of loss given default including the expected impact of future economic conditions such as changes in value of collateral)

No floors

Discounted using the original effective interest rate of the loan

Only costs associated with obtaining/selling collateral included

Other

 

Discounted back from point of default to balance sheet date

 

While 12-month PDs are recalibrated from Basel II models where possible, the lifetime PDs are determined by projecting the 12-month PD using a term structure. For the wholesale methodology, the lifetime PD also takes into account credit migration, i.e. a customer migrating through the CRR bands over its life.

The ECL for wholesale stage 3 is determined on an individual basis using a discounted cash flow ('DCF') methodology. The expected future cash flows are based on the credit risk officer's estimates as at the reporting date, reflecting reasonable and supportable assumptions and projections of future recoveries and expected future receipts of interest. Collateral is taken into account if it is likely that the recovery of the outstanding amount will include realisation of collateral based on the estimated fair value of collateral at the time of expected realisation, less costs for obtaining and selling the collateral. The cash flows are discounted at a reasonable approximation of the original effective interest rate. For significant cases, cash flows under four different scenarios are probability-weighted by reference to the economic scenarios applied more generally by the Group and the judgement of the credit risk officer in relation to the likelihood of the workout strategy succeeding or receivership being required. For less significant cases, the effect of different economic scenarios and work-out strategies is approximated and applied as an adjustment to the most likely outcome.

Period over which ECL is measured

Expected credit loss is measured from the initial recognition of the financial asset. The maximum period considered when measuring ECL (be it 12-month or lifetime ECL) is the maximum contractual period over which HSBC is exposed to credit risk. For wholesale overdrafts, credit risk management actions are taken no less frequently than on an annual basis and therefore this period is to the expected date of the next substantive credit review. The date of the substantive credit review also represents the initial recognition of the new facility. However, where the financial instrument includes both a drawn and undrawn commitment and the contractual ability to demand repayment and cancel the undrawn commitment does not serve to limit HSBC's exposure to credit risk to the contractual notice period, the contractual period does not determine the maximum period considered. Instead, ECL is measured over the period HSBC remains exposed to credit risk that is not mitigated by credit risk management actions. This applies to retail overdrafts and credit cards, where the period is the average time taken for stage 2 exposures to default or close as performing accounts, determined on a portfolio basis and ranging from between two and six years. In addition, for these facilities it is not possible to identify the ECL on the loan commitment component separately from the financial asset component. As a result, the total ECL is recognised in the loss allowance for the financial asset unless the total ECL exceeds the gross carrying amount of the financial asset, in which case the ECL is recognised as a provision.

Forward-looking economic inputs

HSBC applies multiple forward-looking global economic scenarios determined with reference to external forecast distributions representative of our view of forecast economic conditions. This approach is considered sufficient to calculate unbiased expected loss in most economic environments. In certain economic environments, additional analysis may be necessary and may result in additional scenarios or adjustments, to reflect a range of possible economic outcomes sufficient for an unbiased estimate. The detailed methodology is disclosed in 'Measurement uncertainty and sensitivity analysis of ECL estimates' on page 127.

Critical accounting estimates and judgements

The calculation of the Group's ECL under IFRS 9 requires the Group to make a number of judgements, assumptions and estimates. The most significant are set out below:

 

 

Defining what is considered to be a significant increase in credit risk

Determining the lifetime and point of initial recognition of overdrafts and credit cards

Selecting and calibrating the PD, LGD and EAD models, which support the calculations, including making reasonable and supportable judgements about how models react to current and future economic conditions

Selecting model inputs and economic forecasts, including determining whether sufficient and appropriately weighted economic forecasts are incorporated to calculate unbiased expected loss

Making management adjustments to account for late breaking events, model and data limitations and deficiencies, and expert credit judgements

The sections marked as audited on pages 127 to 141, 'Measurement uncertainty and sensitivity analysis of ECL estimates' set out the assumptions used in determining ECL and provide an indication of the sensitivity of the result to the application of different weightings being applied to different economic assumptions

 

(j)  Insurance contracts

A contract is classified as an insurance contract where HSBC accepts significant insurance risk from another party by agreeing to compensate that party on the occurrence of a specified uncertain future event. An insurance contract may also transfer financial risk, but is accounted for as an insurance contract if the insurance risk is significant. In addition, HSBC issues investment contracts with discretionary participation features ('DPF'), which are also accounted for as insurance contracts as required by IFRS 4 'Insurance Contracts'.

 

Net insurance premium income

Premiums for life insurance contracts are accounted for when receivable, except in unit-linked insurance contracts where premiums are accounted for when liabilities are established. Reinsurance premiums are accounted for in the same accounting period as the premiums for the direct insurance contracts to which they relate.

Net insurance claims and benefits paid and movements in liabilities to policyholders

Gross insurance claims for life insurance contracts reflect the total cost of claims arising during the year, including claim handling costs and any policyholder bonuses allocated in anticipation of a bonus declaration.

Maturity claims are recognised when due for payment. Surrenders are recognised when paid or at an earlier date on which, following notification, the policy ceases to be included within the calculation of the related insurance liabilities. Death claims are recognised when notified.

Reinsurance recoveries are accounted for in the same period as the related claim.

Liabilities under insurance contracts

Liabilities under non-linked life insurance contracts are calculated by each life insurance operation based on local actuarial principles. Liabilities under unit-linked life insurance contracts are at least equivalent to the surrender or transfer value, which is calculated by reference to the value of the relevant underlying funds or indices.

Future profit participation on insurance contracts with DPF

Where contracts provide discretionary profit participation benefits to policyholders, liabilities for these contracts include provisions for the future discretionary benefits to policyholders. These provisions reflect the actual performance of the investment portfolio to date and management's expectation of the future performance of the assets backing the contracts, as well as other experience factors such as mortality, lapses and operational efficiency, where appropriate. The benefits to policyholders may be determined by the contractual terms, regulation, or past distribution policy.

Investment contracts with DPF

While investment contracts with DPF are financial instruments, they continue to be treated as insurance contracts as required by IFRS 4. The Group therefore recognises the premiums for these contracts as revenue and recognises as an expense the resulting increase in the carrying amount of the liability.

In the case of net unrealised investment gains on these contracts, whose discretionary benefits principally reflect the actual performance of the investment portfolio, the corresponding increase in the liabilities is recognised in either the income statement or other comprehensive income, following the treatment of the unrealised gains on the relevant assets. In the case of net unrealised losses, a deferred participating asset is recognised only to the extent that its recoverability is highly probable. Movements in the liabilities arising from realised gains and losses on relevant assets are recognised in the income statement.

Present value of in-force long-term insurance business

HSBC recognises the value placed on insurance contracts and investment contracts with DPF, which are classified as long-term and in-force at the balance sheet date, as an asset. The asset represents the present value of the equity holders' interest in the issuing insurance companies' profits expected to emerge from these contracts written at the balance sheet date. The present value of in-force business ('PVIF') is determined by discounting those expected future profits using appropriate assumptions in assessing factors such as future mortality, lapse rates and levels of expenses, and a risk discount rate that reflects the risk premium attributable to the respective contracts. The PVIF incorporates allowances for both non-market risk and the value of financial options and guarantees. The PVIF asset is presented gross of attributable tax in the balance sheet and movements in the PVIF asset are included in 'Other operating income' on a gross of tax basis.

 

(k)  Employee compensation and benefits

Share-based payments

HSBC enters into both equity-settled and cash-settled share-based payment arrangements with its employees as compensation for the provision of their services.

The vesting period for these schemes may commence before the legal grant date if the employees have started to render services in respect of the award before the legal grant date, where there is a shared understanding of the terms and conditions of the arrangement. Expenses are recognised when the employee starts to render service to which the award relates.

Cancellations result from the failure to meet a non-vesting condition during the vesting period, and are treated as an acceleration of vesting recognised immediately in the income statement. Failure to meet a vesting condition by the employee is not treated as a cancellation, and the amount of expense recognised for the award is adjusted to reflect the number of awards expected to vest.

Post-employment benefit plans

HSBC operates a number of pension schemes including defined benefit, defined contribution and post-employment benefit schemes.

Payments to defined contribution schemes are charged as an expense as the employees render service.

Defined benefit pension obligations are calculated using the projected unit credit method. The net charge to the income statement mainly comprises the service cost and the net interest on the net defined benefit asset or liability, and is presented in operating expenses. Remeasurements of the net defined benefit asset or liability, which comprise actuarial gains and losses, return on plan assets excluding interest and the effect of the asset ceiling (if any, excluding interest), are recognised immediately in other comprehensive income. The net defined benefit asset or liability represents the present value of defined benefit obligations reduced by the fair value of plan assets (see policy (c)), after applying the asset ceiling test, where the net defined benefit surplus is limited to the present value of available refunds and reductions in future contributions to the plan.

The cost of obligations arising from other post-employment plans are accounted for on the same basis as defined benefit pension plans.

Critical accounting estimates and judgements

The most significant critical accounting estimates relate to the determination of key assumptions applied in calculating the defined benefit pension obligation for the principal plan.

 

 

 

A range of assumptions could be applied, and different assumptions could significantly alter the defined benefit obligation and the amounts recognised in profit or loss or OCI.

The calculation of the defined benefit pension obligation includes assumptions with regard to the discount rate, inflation rate, pension payments and deferred pensions, pay and mortality. Management determines these assumptions in consultation with the plan's actuaries.

Key assumptions used in calculating the defined benefit pension obligation for the principal plan and the sensitivity of the calculation to different assumptions are described in Note 5

 

(l)  Tax

Income tax comprises current tax and deferred tax. Income tax is recognised in the income statement except to the extent that it relates to items recognised in other comprehensive income or directly in equity, in which case the tax is recognised in the same statement as the related item appears.

Current tax is the tax expected to be payable on the taxable profit for the year and on any adjustment to tax payable in respect of previous years. HSBC provides for potential current tax liabilities that may arise on the basis of the amounts expected to be paid to the tax authorities.

Deferred tax is recognised on temporary differences between the carrying amounts of assets and liabilities in the balance sheet, and the amounts attributed to such assets and liabilities for tax purposes. Deferred tax is calculated using the tax rates expected to apply in the periods in which the assets will be realised or the liabilities settled.

Current and deferred tax are calculated based on tax rates and laws enacted, or substantively enacted, by the balance sheet date.

Critical accounting estimates and judgements

The recognition of deferred tax assets depends on judgements

 

 

Assessing the probability and sufficiency of future taxable profits, taking into account the future reversal of existing taxable temporary differences and tax planning strategies including corporate reorganisations

 

 

(m)  Provisions, contingent liabilities and guarantees

Provisions

Provisions are recognised when it is probable that an outflow of economic benefits will be required to settle a present legal or constructive obligation that has arisen as a result of past events and for which a reliable estimate can be made.

Critical accounting estimates and judgements

The recognition and measurement of provisions requires the Group to make a number of judgements, assumptions and estimates. The most significant are set out below:

 

 

Determining whether a present obligation exists. Professional advice is taken on the assessment of litigation and similar obligations

Provisions for legal proceedings and regulatory matters typically require a higher degree of judgement than other types of provisions. When matters are at an early stage, accounting judgements can be difficult because of the high degree of uncertainty associated with determining whether a present obligation exists, and estimating the probability and amount of any outflows that may arise. As matters progress, management and legal advisers evaluate on an ongoing basis whether provisions should be recognised, revising previous estimates as appropriate. At more advanced stages, it is typically easier to make estimates around a better defined set of possible outcomes

Provisions for legal proceedings and regulatory matters remain very sensitive to the assumptions used in the estimate. There could be a wider range of possible outcomes for any pending legal proceedings, investigations or inquiries. As a result it is often not practicable to quantify a range of possible outcomes for individual matters. It is also not practicable to meaningfully quantify ranges of potential outcomes in aggregate for these types of provisions because of the diverse nature and circumstances of such matters and the wide range of uncertainties involved

Provisions for customer remediation also require significant levels of estimation. The amounts of provisions recognised depend on a number of different assumptions, the most significant of which are the uphold rate and average redress for complaints yet to be worked. More information about these assumptions is included in Note 27

 

Contingent liabilities, contractual commitments and guarantees  

Contingent liabilities

Contingent liabilities, which include certain guarantees and letters of credit pledged as collateral security, and contingent liabilities related to legal proceedings or regulatory matters, are not recognised in the financial statements but are disclosed unless the probability of settlement is remote.

Financial guarantee contracts

Liabilities under financial guarantee contracts that are not classified