TIDMHSBA
RNS Number : 0929S
HSBC Holdings PLC
06 March 2019
Financial statements
Consolidated statement of comprehensive income
for the year ended 31 December
2018 $m 2017 2016
$m
$m
-------------------------------------------- ------------------------------------ -------------------------- ------------------
Profit for the year 15,025 11,879 3,446
-------------------------------------------- ------------------------------------ -------------------------- ------------------
Other comprehensive income/(expense)
-------------------------------------------- ------------------------------------ -------------------------- ------------------
Items that will be reclassified
subsequently
to profit or loss when specific conditions
are met:
Available-for-sale investments N/A 146 (299)
---------------------------------------------------- ---------------------- ------------------------------------------------
1,227
N/A N/A (1,033) 475 (895)
- fair value gains N/A N/A 93 (141) 71 50
---------------------------------------------------- ---------------------- ---------------------- ------------------------
- fair value gains reclassified to the income
statement
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
- amounts reclassified to the income statement in
respect of impairment losses
----------------------------------------------------
- income taxes
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
Debt instruments at fair value through other (243) N/A N/A
comprehensive
income
---------------------------------------------------- ---------------------- ------------------------------------------------
- fair value losses (168) N/A N/A N/A N/A
(95) (94) N/A N/A N/A N/A
114
---------------------------------------------------- ---------------------- ---------------------- ------------------------
- fair value gain transferred to the income
statement
on disposal
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
- expected credit losses recognised in the income
statement
----------------------------------------------------
- income taxes
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
Cash flow hedges 19 (192) (68)
---------------------------------------------------- ---------------------- ------------------------------------------------
- fair value losses (267) (1,046) (297)
317 833 195
(31) 21 34
---------------------------------------------------- ---------------------- ---------------------- ------------------------
- fair value losses reclassified to the income
statement
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
- income taxes and other movements
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
Share of other comprehensive income/(expense) of
associates and joint ventures (64) (43) 54
---------------------------------------------------- ---------------------- ------------------------------------------------
- share for the year (64) (43) 54
---------------------------------------------------- ---------------------- ---------------------- ------------------------
Exchange differences (7,156) 9,077 (8,092)
---------------------------------------------------- ---------------------- ------------------------------------------------
- foreign exchange gains reclassified to income
statement on disposal of a foreign operation - - 1,894
(7,156) 8,939 (9,791)
- 138 (195)
---------------------------------------------------- ---------------------- ---------------------- ------------------------
- other exchange differences
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
- income tax attributable to exchange differences
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
Items that will not be reclassified subsequently
to profit or loss:
---------------------------------------------------- ---------------------- ------------------------------------------------
Remeasurement of defined benefit asset/liability (329) 2,419 7
---------------------------------------------------- ---------------------- ------------------------------------------------
- before income taxes(7) (388) 3,440 (84)
59 (1,021) 91
---------------------------------------------------- ---------------------- ---------------------- ------------------------
- income taxes
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
Changes in fair value of financial liabilities 2,847 (2,024) N/A
designated
at fair value upon initial recognition arising from
changes in own credit risk
---------------------------------------------------- ---------------------- ------------------------------------------------
- before income taxes 3,606 (2,409) N/A N/A
(759) 385
---------------------------------------------------- ---------------------- ---------------------- ------------------------
- income taxes
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
Equity instruments designated at fair value through (27) N/A N/A
other comprehensive income
---------------------------------------------------- ---------------------- ------------------------------------------------
- fair value losses (71) N/A N/A N/A N/A
44
---------------------------------------------------- ---------------------- ---------------------- ------------------------
- income taxes
---------------------------------------------------- ---------------------- ---- ---------------- -------- --------------
Effects of hyperinflation 283 N/A N/A
---------------------------------------------------- ---------------------- ------------------------------------------------
Other comprehensive income/(expense) for the year, net of
tax
Total comprehensive income/(expense) for the year
Attributable to:
--------------------------------------------------- ------------------- ---------------------------------------
8,083 18,914 (6,968)
90 1,029 90 1,025 90 1,090
- ordinary shareholders of the parent company 1,153 1,233 836
--------------------------------------------------- ------------------- ------------------ -------------------
- preference shareholders of the parent company
--------------------------------------------------- ------------------- ------------------ -------------------
- other equity holders
---------------------------------------------------
- non-controlling interests
--------------------------------------------------- ------------------- ------------------ -------------------
Total comprehensive income/(expense) for the year 10,355 21,262 (4,952)
--------------------------------------------------- ------------------- ---------------------------------------
For footnotes, see page 222.
215 HSBC Holdings plc Annual Report and Accounts 2018
Consolidated balance sheet
At
1 Balances at 1 January 2018 have been prepared in accordance
with accounting policies referred to on page 224. 31 December 2017
balances have not been re-presented. Information regarding the
effects of adoption of IFRS 9 can be found in Note 37.
The accompanying notes on pages 224 to 309, and the audited
sections in: 'Global businesses and regions' on pages 47 to 64;
'Risk' on pages 69 to 147; 'Capital' on pages 148 to 151; and
'Directors' remuneration report' on pages 172 to 206 form an
integral part of these financial statements.
These financial statements were approved by the Board of
Directors on 19 February 2019 and signed on its behalf by:
Mark E Tucker Ewen Stevenson
Group Chairman Group Chief Financial Officer
HSBC Holdings plc Annual Report and Accounts 2018 216
Consolidated statement of changes in equity
for the year ended 31 December
Other comprehensive
income
(net of tax) - - 2,765 (245) 16 (7,061) - (4,525) (145) (4,670)
-------------------------------------------------------------
- - - (245) - - - (245) 2 (243)
* debt instruments at fair value through other - - - - - - - - (27) (27)
comprehensive income
-------------------------------------------------------------
* equity instruments designated at fair value through
other comprehensive income
-------------------------------------------------------------
- cash flow hedges - - - - 16 - - 16 3 19
- - 2,847 - - - - 2,847 - 2,847
- - (301) - - - - (301) (28) (329)
- - (64) - - - - (64) - (64)
-------------------------------------------------------------
* changes in fair value of financial liabilities
designated at fair value upon initial recognition
arising from changes in own credit risk
-------------------------------------------------------------
* remeasurement of defined benefit asset/liability(7)
-------------------------------------------------------------
* share of other comprehensive income of associates and
joint ventures
-------------------------------------------------------------
- effects of hyperinflation - - 283 - - - - 283 - 283
-------------------------------------------------------------
- exchange differences - - - - - (7,061) - (7,061) (95) (7,156)
------------------------------------------------------------- --- --- ------- ------ --- ------- ------- ----- -------
Total comprehensive - - 16,492 (245) 16 (7,061) - 9,202 1,153 10,355
income for the year
------------------------------------------------------------- --------------------------------------------------------------------
HSBC Holdings plc Annual Report and Accounts 2018 218
Financial statements
Consolidated statement of changes in equity (Continued)
Other reserves
Called Other Financial Cash Foreign Merger Total Non-controlling
up equity assets flow exchange and share-holders' interests
share instru-ments(2,3) at FVOCI hedging reserve other equity
capital reserve(8) reserve reserves(6)
and
share Retained Total
premium earnings(4,5) equity
$m $m $m $m $m $m $m $m $m $m
At 1 Jan 2016 22,263 15,112 143,976 (189) 34 (20,044) 27,308
188,460 9,058 197,518
Profit for the year - - 2,479 - - - - 2,479 967 3,446
Other comprehensive income
(net of tax) - - 59 (271) (61) (7,994) - (8,267) (131)
(8,398)
- available-for-sale
investments - - - (271) - - - (271) (28) (299)
- - - - (61) - - (61) (7) (68)
- cash flow hedges
--------------------------
- remeasurement of
defined benefit
asset/liability - - 5 - - - - 5 2 7
----------------------
- share of other
comprehensive income
of
associates and joint
ventures - - 54 - - - - 54 - 54
----------------------
- foreign exchange
reclassified to income
statement on disposal
of a foreign
operation - - - - - 1,894 - 1,894 - 1,894
----------------------
- exchange
differences - - - - - (9,888) - (9,888) (98) (9,986)
---------------------- ---------- ----- ------- -------- ------- ----------- -------- ----------- -------- -------
Total comprehensive
income for
the year - - 2,538 (271) (61) (7,994) - (5,788) 836 (4,952)
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
Shares issued under
employee remuneration
and share plans 452 - (425) - - - - 27 - 27
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
Shares issued in lieu
of dividends and
amounts arising thereon - - 3,040 - - - - 3,040 - 3,040
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
Net increase in treasury
shares(1) - - (2,510) - - - - (2,510) - (2,510)
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
Capital securities
issued - 1,998 - - - - - 1,998 - 1,998
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
Dividends to shareholders - - (11,279) - - - - (11,279) (919) (12,198)
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
Cost of share-based
payment arrangements - - 534 - - - - 534 - 534
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
Other movements - - 921 (17) - - - 904 (1,783) (879)
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
At 31 Dec 2016 22,715 17,110 136,795 (477) (27) (28,038) 27,308 175,386 7,192 182,578
-------------------------- ------ ------ ---------- -------- -------- ---------- -------- -------- ------- -----------
1 For further details, refer to Note 32. In February 2017, HSBC
announced a share buy-back of up to $1.0bn, which was completed in
April 2017. In July 2017, HSBC announced a share buy-back of up to
$2.0bn, which was completed in November 2017. Shares bought back
from these two buy-back programmes have been cancelled. In August
2016, HSBC announced a share buy-back of up to $2.5bn, which was
completed in December 2016 and resulted in a net increase in shares
held in treasury.
2 During 2018, HSBC Holdings issued $4,150m, GBP1,000m 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. In
2017, HSBC Holdings issued $3,000m, SGD1,000m and EUR1,250m of
perpetual subordinated contingent convertible capital securities,
on which there were $14m of external issuance costs, $37m of
intra-Group issuance costs and $10m of tax benefits. In 2016, HSBC
Holdings issued $2,000m of perpetual subordinated contingent
convertible capital securities, after issuance costs of $6m and tax
benefits of $4m. Under IFRSs these issuance costs and tax benefits
are classified as equity.
3 During 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.
4 At 31 December 2018, retained earnings included 379,926,645
treasury shares (2017: 360,590,019; 2016: 353,356,251). 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.
5 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.
6 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 France 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 France 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. The merger reserve includes a
deduction of $614m in respect of costs relating to the rights
issue, of which $149m was subsequently transferred to the income
statement. Of this $149m, $121m was a loss arising from accounting
for the agreement with the underwriters as a contingent forward
contract. The merger reserve excludes the loss of $344m on a
forward foreign exchange contract associated with hedging the
proceeds of the rights issue.
7 During 2018, an actuarial gain of $1,180m has arisen as a
result of the remeasurement of the defined benefit pension
obligation of the HSBC Bank (UK) Pension Scheme. During 2017, an
actuarial gain of $1,730m has arisen as a result of the
remeasurement of the defined benefit pension obligation of the HSBC
Bank (UK) Pension Scheme. Refer to Note 6 for further detail.
8 The $350m at 31 December 2017 represents the IAS 39
available-for-sale fair value reserve as at 31 December 2017.
9 Permitted transfers from the merger reserve to retained
earnings were made when the investment in HSBC Overseas Holdings
(UK) Limited was previously impaired. A part reversal of this
impairment results in a transfer from retained earnings back to the
merger reserve of $2,200m.
10 This includes a re-presentation of the cancellation of shares
to retained earnings and capital redemption reserve in respect of
the 2017 share buy-back, under which retained earnings have been
reduced by $3,000m, called up capital and share premium increased
by $2,731m and other reserves increased by $269m.
11 For further details refer to Note 32 .In May 2018, HSBC
announced a share buy-back of up to $2.0bn, which was completed in
August 2018.
219 HSBC Holdings plc Annual Report and Accounts 2018
HSBC Holdings income statement
for the year ended 31 December
2018 2017 2016
Notes $m $m $m
Net interest expense (1,112) (383) (424)
- interest income 2,193 2,185 1,380
- interest expense (3,305) (2,568) (1,804)
Fee (expense)/income - 2 (1)
Net income from financial instruments held for trading or
managed on a fair value basis 3 245 (181) 119
Changes in fair value of long-term debt and related derivatives
3 (77) 103 (49)
Changes in fair value of other financial instruments mandatorily
measured at fair value 3 43 - -
through profit or loss
Gains less losses from financial investments 4 154 -
Dividend income from subsidiaries(1) 55,304 10,039 10,436
Other operating income 960 769 696
Total operating income 55,367 10,503 10,777
Employee compensation and benefits 6 (37) (54) (570)
General and administrative expenses (4,507) (4,911) (4,014)
Reversal of impairment/(impairment) of subsidiaries(2) 2,064
(63) -
Total operating expenses (2,480) (5,028) (4,584)
Profit before tax 52,887 5,475 6,193
Tax (charge)/credit (62) 64 402
Profit for the year 52,825 5,539 6,595
1 2018 includes $44,893m (2017:nil) return on capital from HSBC
Finance (Netherlands) resulting from restructuring the Group's Asia
operation to meet resolution and recovery requirements. This amount
does not form part of distributable reserves.
2 2018 includes a $2,200m (2017:nil) part reversal of the
impairment previously recognised against HSBC Holdings investment
in HSBC Overseas Holdings (UK) Limited. This amount does not form
part of distributable reserves.
HSBC Holdings statement of comprehensive income
for the year ended 31 December
HSBC Holdings plc Annual Report and Accounts 2018 220
Financial statements
HSBC Holdings balance sheet
1 2018 includes a $56,587m (2017:nil) capital injection to HSBC Asia Holdings Overseas Limited.
2 Balances at 1 January 2018 have been prepared in accordance
with accounting policies referred to on page 224. 31 December 2017
balances have not been re-presented. Information regarding the
effects of adoption of IFRS 9 can be found in Note 37.
The accompanying notes on pages 224 to 309, and the audited
sections in: 'Global businesses and regions' on pages 47 to 64,
'Risk' on pages 69 to 147, 'Capital' on pages 148 to 151 and
'Directors' remuneration report' on pages 172 to 206 form an
integral part of these financial statements.
These financial statements were approved by the Board of
Directors on 19 February 2019 and signed on its behalf by:
Mark E Tucker Ewen Stevenson
Group Chairman Group Chief Financial Officer
221 HSBC Holdings plc Annual Report and Accounts 2018
HSBC Holdings statement of cash flows
for the year ended 31 December
2018 2017 2016
(Restated)(2)
$m $m $m
Profit before tax 52,887 5,475 6,193
Adjustments for non-cash items: (46,878) (17) 48
------------------------------------------------------ --------- ----------
- depreciation, amortisation and impairment/expected
credit losses 70 33 10
- (2) 34
(46,948) (48) 4
------------------------------------------------------ --------- ----- ---
- share-based payment expense
------------------------------------------------------ --------- ----- ---
- other non-cash items included in profit before
tax(1)
------------------------------------------------------ --------- ----- ---
Changes in operating assets and liabilities
------------------------------------------------------ --------- ----------
Interest received was $2,116m (2017: $2,103m; 2016: $1,329m)
Interest paid was $3,379m (2017: $2,443m; 2016: $1,791m) and
dividends received were $10,411m (2017: $10,039m; 2016:
$10,412m)
1 2018 includes $44,893m (2017:nil) return on capital from HSBC
Finance (Netherlands) resulting from restructuring the Group's Asia
operation to meet resolution and recovery requirements.
2 The 2016 comparative figure for cash and cash equivalents was
amended in 2017 to include loans and advances to HSBC undertakings
of one month or less duration.
HSBC Holdings plc Annual Report and Accounts 2018 222
Financial statements
HSBC Holdings statement of changes in equity
for the year ended 31 December
Other
reserves
--------------- ---------- -----------
Total
Called up Other Financial Other Merger share-
share Share equity Retained assets paid-in and other holders'
at
capital premium instruments earnings(1,3) capital(2) reserves(3) equity
FVOCI reserve
$m $m $m $m $m $m $m $m
Other comprehensive income
(net of tax) - - - 865 - - - 865
---------------------------------------------------------- ------------------------------------------------------------------------------
* changes in fair value of financial liabilities
designated at fair value upon initial recognition
arising from changes in own credit risk - - - 865 - - - 865
---------------------------------------------------------- ---- ------- ----------- ----- -------- ---------- ----------- --------
Total comprehensive income
for the year - - - 53,690 - - - 53,690
---------------------------------------------------------- ------------------------------------------------------------------------------
Profit for the year - - - 5,539 - - - 5,539
Other comprehensive income (net of tax) - - - (828) (53) - -
(881)
Total comprehensive income
for the year - - 0 4,711 (53) - - 4,658
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Shares issued under employee
share plans 38 584 - (52) - - - 570
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Shares issued in lieu of dividends
and amounts arising thereon 190 (190) - 3,205 - - - 3,205
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Cancellation of shares (164) (2,836) - - - - - (3,000)
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Capital securities issued - 5,103 - - - - 5,103
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Dividends to shareholders - - - (11,551) - - - (11,551)
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Cost of share-based payment
arrangements - - - (2) - - - (2)
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Other movements - (64) 10 (0)
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
At 31 Dec 2017 10,160 10,177 22,107 23,903 59 2,254 35,127 103,787
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
At 1 Jan 2016 9,842 12,421 15,020 32,224 183 2,597 35,127 107,414
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Profit for the year - - - 6,595 - - - 6,595
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Other comprehensive income
(net of tax) - - - (896) (72) - - (968)
Total comprehensive income
for the year - - - 5,699 (72) - - 5,627
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Shares issued under employee
share plans 35 417 - (51) - - - 401
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Shares issued in lieu of dividends
and amounts arising thereon 219 (219) - 3,040 - - - 3,040
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Net increase in treasury shares - - - (2,510) - - - (2,510)
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Capital securities issued - 1,984 - - - - 1,984
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Dividends to shareholders - - - (11,279) - - - (11,279)
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Cost of share-based payment
arrangements - - - 34 - - - 34
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Other movements - - - 499 1 (353) - 147
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
At 31
Dec
2016 10,096 12,619 17,004 27,656 112 2,244 35,127 104,858
-------------------------------------------------------- ------ ------- ------ -------- ----- ----- ------ --------
Dividends per ordinary share at 31 December 2018 were $0.51
(2017: $0.51; 2016: $0.51).
1 At 31 December 2018, retained earnings includes 326,503,319
($2,546m) of treasury shares (2017: 326,843,840 ($2,542m); 2016:
325,499,152 ($2,499m)). Treasury shares are held to fund employee
share plans.
2 Other paid-in capital arises from the exercise and lapse of
share options granted to employees of HSBC Holdings
subsidiaries.
3 HSBC Holdings distributable reserves at 31 December 2018 of
$30,705m (2017: $38,031m) represents realised profits included in
retained earnings of $14,974m (2017: $22,300m) and in merger
reserve of $15,731m (2017: $15,731m). The distributable reserves
are lower than retained earnings of $61,434m (2017: $23,903m). In
2018, income of $44,893m (2017:nil) generated from restructuring
the Group's Asia operation to meet resolution and recovery
requirements does not form part of distributable reserves.
4 This includes a re-presentation of the cancellation of shares
to retained earnings and capital redemption reserve in respect of
the 2017 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.
5 Permitted transfers from the merger reserve to retained
earnings were made when the investment in HSBC Overseas Holdings
(UK) Limited was previously impaired. A part reversal of this
impairment results in a transfer from retained earnings back to the
merger reserve of $2,200m.
223 HSBC Holdings plc Annual Report and Accounts 2018
Notes on the Financial Statements
Page Page
Basis of preparation and significant
1 accounting policies 224 21 Goodwill and intangible assets 272
-------------------------------------- ---- ------------------------------------- ----
Prepayments, accrued income
2 Net fee income 237 22 and other assets 274
-------------------------------------- ---- ------------------------------------- ----
Net income/(expense) from financial
instruments through profit
3 or loss 23 Trading liabilities 274
------------------------------------- ----
Financial liabilities designated
measured at fair value 238 24 at fair value 274
-------------------------------------- ---- ------------------------------------- ----
4 Insurance business 238 25 Debt securities in issue 275
-------------------------------------- ---- ------------------------------------- ----
Accruals, deferred income and
5 Operating profit 240 26 other liabilities 275
-------------------------------------- ---- ------------------------------------- ----
6 Employee compensation and benefits 240 27 Provisions 275
-------------------------------------- ---- ------------------------------------- ----
7 Auditors' remuneration 246 28 Subordinated liabilities 277
-------------------------------------- ---- ------------------------------------- ----
8 Tax 246 29
-------------------------------------- ---- ------------------------------------- ----
Maturity analysis of assets,
liabilities and off-balance
9 Dividends 249 sheet commitments 280
-------------------------------------- ---- ------------------------------------- ----
Offsetting of financial assets
10 Earnings per share 249 30 and financial liabilities 284
-------------------------------------- ---- ------------------------------------- ----
11 Trading assets 250 31 Non-controlling interests 285
-------------------------------------- ---- ------------------------------------- ----
Fair values of financial instruments Called up share capital and
12 carried at fair value 250 32 other equity instruments 286
-------------------------------------- ---- ------------------------------------- ----
Fair values of financial instruments Contingent liabilities, contractual
13 not carried at fair value 258 commitments
-------------------------------------- ----
Financial assets designated
and otherwise mandatorily measured
at fair 33 and guarantees 288
------------------------------------- ----
14 value 259 34 Lease commitments 288
-------------------------------------- ---- ------------------------------------- ----
Legal proceedings and regulatory
15 Derivatives 260 35 matters 289
-------------------------------------- ---- ------------------------------------- ----
16 Financial investments 263 36 Related party transactions 293
-------------------------------------- ---- ------------------------------------- ----
Assets pledged, collateral Effects of reclassification
17 received and assets transferred 264 37 upon adoption of IFRS 9 296
-------------------------------------- ---- ------------------------------------- ----
Interests in associates and Events after the balance sheet
18 joint ventures 265 38 date 301
-------------------------------------- ---- ------------------------------------- ----
HSBC Holdings' subsidiaries,
19 Investments in subsidiaries 269 39 joint ventures and associates 301
-------------------------------------- ---- ------------------------------------- ----
20 Structured entities 270
-------------------------------------- ----
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 have been 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, and as endorsed by the European Union
('EU'). At 31 December 2018, there were no unendorsed standards
effective for the year ended 31 December 2018 affecting these
consolidated and separate financial statements, and HSBC's
application of IFRSs results in no differences between IFRSs as
issued by the IASB and IFRSs as endorsed by the EU.
Standards adopted during the year ended 31 December 2018
HSBC has adopted the requirements of IFRS 9 'Financial
Instruments' from 1 January 2018, with the exception of the
provisions relating to the presentation of gains and losses on
financial liabilities designated at fair value, which were adopted
from 1 January 2017. This includes the adoption of 'Prepayment
Features with Negative Compensation (Amendments to IFRS 9)', which
is effective for annual periods beginning on or after 1 January
2019 with early adoption permitted. The effect of its adoption is
not significant. IFRS 9 includes an accounting policy choice to
remain with IAS 39 hedge accounting, which HSBC has exercised. The
classification and measurement, and impairment requirements, are
applied retrospectively by adjusting the opening balance sheet at
the date of initial application. As permitted by IFRS 9, HSBC has
not restated comparatives. Adoption reduced net assets at 1 January
2018 by $1,647m as set out in Note 37 of the Annual Report and
Accounts 2018.
In addition, HSBC has adopted the requirements of IFRS 15
'Revenue from contracts with customers' and a number of
interpretations and amendments to standards, which have had an
insignificant effect on the consolidated financial statements of
HSBC and the separate financial statements of HSBC Holdings.
IFRS 9 transitional requirements
The transitional requirements of IFRS 9 necessitated a review of
the designation of financial instruments at fair value. IFRS 9
requires that the designation is revoked where there is no longer
an accounting mismatch at 1 January 2018 and permits designations
to be revoked or additional designations created at 1 January 2018
if there are accounting mismatches at that date. As a result:
-- fair value designations for financial liabilities were
revoked where the accounting mismatch no longer exists, as required
by IFRS 9; and
-- fair value designations were revoked for certain long-dated
securities where accounting mismatches continue to exist, but where
HSBC has revoked the designation as permitted by IFRS 9 since it
will better mitigate the accounting mismatch by undertaking fair
value hedge accounting.
The results of these changes are included in the reconciliation
set out in Note 37.
Changes in accounting policy
While not necessarily required by the adoption of IFRS 9, the
following voluntary changes in accounting policy and presentation
were made as a result of reviews carried out in conjunction with
its adoption. The effect of presentational changes at 1 January
2018 is included in the reconciliation set out in Note 37, and
comparatives have not been restated.
HSBC Holdings plc Annual Report and Accounts 2018 224
Notes on the financial statements
-- We considered market practices for the presentation of
certain financial liabilities, which contain both deposit and
derivative components. We concluded that it would be appropriate to
change the accounting policy and presentation of 'trading customer
accounts and other debt securities in issue', to better align with
the presentation of similar financial instruments by peers. This
therefore provides more relevant information about the effect of
these financial liabilities on our financial position and
performance. As a result, rather than being classified as held for
trading, we designate these financial liabilities as at fair value
through profit or loss since they are managed and their performance
evaluated on a fair value basis. A further consequence of this
change in presentation is that the effects of changes in the
liabilities' credit risk are presented in 'Other comprehensive
income', with the remaining effect presented in profit or loss in
accordance with Group accounting policy adopted in 2017 (following
the adoption of the requirements in IFRS 9 relating to the
presentation of gains and losses on financial liabilities
designated at fair value).
-- Cash collateral, margin and settlement accounts have been
reclassified from 'Trading assets' and 'Loans and advances to banks
and customers' to 'Prepayments, accrued income and other assets'
and from 'Trading liabilities' and 'Deposits by banks' and
'Customer accounts' to 'Accruals, deferred income and other
liabilities'. The change in presentation for financial assets is in
accordance with IFRS 9 and the change in presentation for financial
liabilities is considered to provide more relevant information,
given the change in presentation for the financial assets. The
change in presentation for financial liabilities has had no effect
on the measurement of these items and therefore on retained
earnings or profit for any period.
-- Certain stock borrowing assets have been reclassified from
'Loans and advances to banks and customers' to 'Trading assets'.
The change in measurement is a result of the determination of the
global business model for this activity and will align the
presentation throughout the Group.
-- Prior to 2018, foreign exchange exposure on some financial
instruments designated at fair value was presented in the same line
in the income statement as the underlying fair value movement on
these instruments. In 2018, we have grouped the presentation of the
entire effect of foreign exchange exposure in profit or loss and
presented it within 'Net income from financial instruments held for
trading or managed on a fair value basis'. Comparative data has
been re-presented.
(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 published a number of minor amendments to IFRSs
that are effective from 1 January 2019, some of which have been
endorsed for use in the EU. 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.
Major new IFRSs
The IASB has published IFRS 16 'Leases' and IFRS 17 'Insurance
Contracts'. IFRS 16 has been endorsed for use in the EU and IFRS 17
has not yet been endorsed. In addition, an amendment to IAS 12
'Income Taxes' has not yet been endorsed.
IFRS 16 'Leases'
IFRS 16 'Leases' has an effective date for annual periods
beginning on or after 1 January 2019. IFRS 16 results in lessees
accounting for most leases within the scope of the standard in a
manner similar to the way in which finance leases are currently
accounted for under IAS 17 'Leases'. Lessees will recognise a right
of use ('ROU') asset and a corresponding financial liability on the
balance sheet. The asset will be amortised over the length of the
lease, and the financial liability measured at amortised cost.
Lessor accounting remains substantially the same as under IAS 17.
The Group expects to adopt the standard using a modified
retrospective approach where the cumulative effect of initially
applying it is recognised as an adjustment to the opening balance
of retained earnings and comparatives are not restated. The
implementation is expected to increase assets by approximately $5bn
and increase financial liabilities by the same amount with no
effect on net assets or retained earnings.
IFRS 17 'Insurance Contracts'
IFRS 17 'Insurance Contracts' was issued in May 2017, and sets
out the requirements that an entity should apply in accounting for
insurance contracts it issues and reinsurance contracts it holds.
IFRS 17 is currently effective from 1 January 2021. However, the
IASB is considering delaying the mandatory implementation date by
one year and may make additional changes to the standard. The Group
is in the process of implementing IFRS 17. Industry practice and
interpretation of the standard is still developing and there may be
changes to it, therefore the likely impact of its implementation
remains uncertain.
Amendment to IAS 12 'Income Taxes'
An amendment to IAS 12 was issued in December 2017 as part of
the annual improvement cycle. The amendment clarifies that an
entity should recognise the tax consequences of dividends where the
transactions or events that generated the distributable profits are
recognised. This amendment is effective for annual reporting
periods beginning on or after 1 January 2019 and is applied to the
income tax consequences of distributions recognised on or after the
beginning of the earliest comparative period. As a result of its
application, the income tax consequences of distributions on
certain capital securities classified as equity will be presented
in profit or loss rather than directly in equity. If the amendment
had been applied in 2018, the impact for the year ended 31 December
2018 would have been a $261m increase in profit after tax (2017:
$224m) with no effect on equity.
(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,
liabilities and results of foreign operations, whose functional
currency is not US dollars, are translated into the Group's
presentation currency at the reporting date. 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.
225 HSBC Holdings plc Annual Report and Accounts 2018
(e) Presentation of information
Certain disclosures required by IFRSs have been included in the
sections marked as ('Audited') in this Annual Report and Accounts
as follows:
-- segmental disclosures are included in the 'Report of the
Directors: Financial summary' on pages 34 to 68;
-- disclosures concerning the nature and extent of risks
relating to insurance contracts and financial instruments are
included in the 'Report of the Directors: Risk' on pages 69 to
147;
-- capital disclosures are included in the 'Report of the
Directors: Capital' on pages 148 to 151; and
-- disclosures relating to HSBC's securitisation activities and
structured products are included in the 'Report of the Directors:
Risk' on pages 69 to 147.
In accordance with the policy to provide disclosures that help
investors and other stakeholders understand the Group's
performance, financial position and changes to them, the
information provided in the 'Notes on the financial statements' and
the 'Report of the Directors' goes beyond the minimum levels
required by accounting standards, statutory and regulatory
requirements and listing rules. In addition, 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, 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 Management
Board ('GMB'), 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 GMB.
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 and capital resources.
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 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 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. They are
therefore subject to uncertainty and require the
exercise of significant judgement.
The accuracy of forecast cash flows is subject to a high degree of uncertainty
in volatile market conditions. In such circumstances, 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.
================================================================================
HSBC Holdings plc Annual Report and Accounts 2018 226
Notes on the financial statements
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
Impairment testing of investments in associates involves
significant judgement in determining the value in use, and in
particular estimating the present values of cash flows expected to
arise from continuing to hold the investment. The most significant
judgements relate to the impairment testing of our investment in
Bank of Communications Co. Limited ('BoCom'). Key assumptions used
in estimating BoCom's value in use, the sensitivity of the value in
use calculation 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
securities issued by HSBC that are designated under the fair value
option and on derivatives managed in conjunction with those debt
securities 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 we have 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,
together with the related interest income, expense and dividends.
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 long-term debt and related
derivatives': Interest paid on the external long-term debt and
interest cash flows on related derivatives is presented in interest
expense.
-- '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 ('SPPI') 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
227 HSBC Holdings plc Annual Report and Accounts 2018
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, 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).
(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'.
Under the above criterion, the main classes of financial
instruments designated by HSBC are:
-- Long-term debt issues: 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
HSBC Holdings plc Annual Report and Accounts 2018 228
Notes on the financial statements
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.
(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; 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; 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; 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.
Critical accounting estimates and judgements
As a result of the request received by the Financial Stability
Board from the G20, a fundamental review and reform of the major
interest rate benchmarks is under way across the world's largest
financial markets. The process of replacing existing benchmark
interbank offered rates ('I bors') with alternative risk-free rates
('RFRs') is at different stages, and is progressing at different
speeds, across several major jurisdictions. There is therefore
uncertainty as to the timing and the methods of transition for many
financial products affected by these changes, and whether some
existing benchmarks will continue to be supported in some way.
As a result of these developments, significant accounting
judgement is involved in determining whether certain hedge
accounting relationships that hedge the variability of cash flows
and interest rate risk due to changes in Ibors continue to qualify
for hedge accounting as at 31 December 2018. Management's judgement
is that those existing hedge accounting relationships continue to
be supported at the 2018 year-end. Even though there are plans to
replace those rates with economically similar rates based on new
RFRs over the next few years, there is widespread continued
reliance on Ibors in market pricing structures for long-term
products with maturities over the hedged horizons that extend
beyond the timescales for replacing Ibors. In addition there is a
current absence of term structures on the new RFRs. This judgement
will be kept under review in future as markets based on the new
RFRs develop, taking into consideration any specific accounting
guidance that may be developed to deal with these unusual
circumstances. The IASB has commenced the due process for providing
clarification on how the guidance for hedge accounting in IAS 39
'Financial Instruments: Recognition and Measurement' and IFRS 9:
'Financial Instruments' should be applied in these circumstances,
which were not contemplated when the standards were published.
(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
229 HSBC Holdings plc Annual Report and Accounts 2018
-- 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 that are not credit impaired
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.
HSBC Holdings plc Annual Report and Accounts 2018 230
Notes on the financial statements
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, 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
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:
Further information about the 23-grade scale used for CRR can be
found on page 80.
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
231 HSBC Holdings plc Annual Report and Accounts 2018
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:
-- Through the cycle (represents -- Point in time (based on current
long-run average PD throughout conditions, adjusted to take
a full economic cycle) into account estimates of future
conditions that will impact PD)
PD -- The definition of default includes -- Default backstop of 90+ days
a backstop of 90+ days past past due for all portfolios
due, although this has been
modified to 180+ days past due
for some portfolios, particularly
UK and US mortgages
----- --------- ------------------------------------ --- --------------------------------------------
EAD -- Cannot be lower than current -- Amortisation captured for term
balance products
----- --------- ------------------------------------ --- --------------------------------------------
-- Downturn LGD (consistent losses -- Expected LGD (based on estimate
expected to be suffered during of loss given default including
a severe but plausible economic the expected impact of future
downturn) economic conditions such as changes
in value of
-- Regulatory floors may apply collateral)
to mitigate risk of underestimating
downturn
LGD LGD due to lack of historical -- No floors
data
-- Discounted using cost of capital -- Discounted using the original
effective interest rate of the
loan
-- All collection costs included -- 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
three 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 will in general apply three forward-looking global economic
scenarios determined with reference to external forecast
distributions representative of our view of forecast economic
conditions, the consensus economic scenario approach. This approach
is considered sufficient to calculate unbiased expected loss in
most economic environments. They represent a most likely outcome
(the Central scenario) and two, less likely, outer scenarios
referred to as the Upside and Downside scenarios. The Central
scenario is the basis for the annual operating planning process
and, with regulatory modifications, will also be used in
enterprise-wide stress tests. The Upside and Downside scenarios are
constructed following a standard process supported by a scenario
narrative reflecting the Group's current top and emerging risks and
by consulting external and internal subject matter experts. The
relationship between the outer scenarios and Central scenario will
generally be fixed with the Central scenario being assigned a
weighting of 80% and the Upside and Downside scenarios 10% each,
with the difference between the Central and outer scenarios in
terms of economic severity being informed by the spread of external
forecast distributions among professional industry forecasts. The
outer scenarios are economically plausible, internally consistent
states of the world and will not necessarily be as severe as
scenarios used in stress testing. The period of forecasts is five
years for the Central scenario. Upside and Downside scenarios use
distributional forecasts for the first two years, after which they
converge to the Central forecasts. The spread between the Central
and outer scenarios is grounded on consensus distributions of
projected gross domestic product of the following economies: UK,
France, Hong Kong, mainland China, US and Canada. The economic
factors include, but are not limited to, gross domestic product,
unemployment, interest rates, inflation and commercial property
prices across all the countries and territories in which HSBC
operates.
In general, the consequences of the assessment of credit risk
and the resulting ECL outputs will be probability-weighted using
the standard probability weights. This probability weighting may be
applied directly or the effect of the probability weighting
determined on a periodic basis, at least annually, and then applied
as an adjustment to the outcomes resulting from the central
economic forecast. The central economic forecast is updated
quarterly.
HSBC recognises that the consensus economic scenario approach
using three scenarios will be insufficient in certain economic
environments. Additional analysis may be requested at management's
discretion, including the production of extra scenarios. If
conditions warrant, this could result in alternative scenarios and
probability weightings being applied in arriving at the ECL.
HSBC Holdings plc Annual Report and Accounts 2018 232
Notes on the financial statements
Critical accounting estimates and judgements
In determining ECL, management is required to exercise judgement in
defining what is considered to be a significant increase in credit risk
and in making assumptions and estimates to incorporate relevant information
about past events, current conditions and forecasts of economic conditions.
Judgement has been applied in determining the lifetime and point of
initial recognition of revolving facilities.
The PD, LGD and EAD models, which support these determinations are reviewed
regularly in light of differences between loss estimates and actual
loss experience, but given that IFRS 9 requirements have only just been
applied, there has been little time available to make these comparisons.
Therefore, the underlying models and their calibration, including how
they react to forward-looking economic conditions, remain subject to
review and refinement. This is particularly relevant for lifetime PDs,
which have not been previously used in regulatory modelling, and for
the incorporation of 'Upside scenarios', that have not generally been
subject to experience gained through stress testing.
The exercise of judgement in making estimations requires the use of
assumptions that are highly subjective and very sensitive to the risk
factors, in particular to changes in economic and credit conditions
across a large number of geographical areas. Many of the factors have
a high degree of interdependency and there is no single factor to which
loan impairment allowances as a whole are sensitive. The sections marked
as audited on pages 94 to 101, 'Measurement uncertainty and sensitivity
analysis of ECL estimates,' set out the assumptions underlying the Central
scenario and information about how scenarios are developed in relation
to the Group's top and emerging risks and its judgements, informed by
consensus forecasts of professional industry forecasters. The sensitivity
of ECL to different economic scenarios is illustrated by recalculating
the ECL for selected portfolios as if 100% weighting had been assigned
to each scenario.
=============================================================================
(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.
233 HSBC Holdings plc Annual Report and Accounts 2018
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, 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.
(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 a deferred tax asset relies on an assessment
of the probability and sufficiency of future taxable profits,
future reversals of existing taxable temporary differences and
ongoing tax planning strategies. In the absence of a history of
taxable profits, the most significant judgements relate to expected
future profitability and to the applicability of 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
Judgement is involved in determining whether a present
obligation exists and in estimating the probability, timing and
amount of any outflows. Professional expert advice is taken on the
assessment of litigation, property (including onerous contracts)
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 judgements and estimates as
appropriate. At more advanced stages, it is typically easier to
make judgements and estimates around a better defined set of
possible outcomes. However, the amount provisioned can remain very
sensitive to the assumptions used. There could be a wide 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 and judgement. The amounts
of provisions recognised depend on a number of different
assumptions, such as the volume of inbound complaints, the
projected period of inbound complaint volumes, the decay rate of
complaint volumes, the population identified as systemically
mis-sold and the number of policies per customer complaint.
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 as insurance contracts are recorded initially at their
fair value, which is generally the fee received or present value of
the fee receivable.
HSBC Holdings has issued financial guarantees and similar
contracts to other Group entities. HSBC elects to account for
certain guarantees as insurance contracts in HSBC Holdings'
financial statements, in which case they are measured and
recognised as insurance liabilities. This election is made on a
contract-by-contract basis, and is irrevocable.
( ) Accounting policies applied to financial instruments prior to 1 January 2018
Financial instruments measured at amortised cost
Loans and advances to banks and customers, held-to-maturity
investments and most financial liabilities are measured at
amortised cost. 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 (as described in sub-section
(c) above) through the recognition of interest income, unless the
loan becomes impaired.
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, a provision on the loan commitment is only
recorded where it is probable that HSBC will incur a loss.
Impairment of loans and advances
HSBC Holdings plc Annual Report and Accounts 2018 234
Notes on the financial statements
Losses for impaired loans are recognised when there is objective
evidence that impairment of a loan or portfolio of loans has
occurred. Losses that may arise from future events are not
recognised.
Individually assessed loans and advances
The factors considered in determining whether a loan is
individually significant for the purposes of assessing impairment
include the size of the loan, the number of loans in the portfolio,
the importance of the individual loan relationship and how this is
managed. Loans that are determined to be individually significant
will be individually assessed for impairment, except when volumes
of defaults and losses are sufficient to justify treatment under a
collective methodology.
Loans considered as individually significant are typically to
corporate and commercial customers, are for larger amounts and are
managed on an individual basis. For these loans, HSBC considers on
a case-by-case basis at each balance sheet date whether there is
any objective evidence that a loan is impaired.
The determination of the realisable value of security is based
on the most recently updated market value at the time the
impairment assessment is performed. The value is not adjusted for
expected future changes in market prices, although adjustments are
made to reflect local conditions such as forced sale discounts.
Impairment losses are calculated by discounting the expected
future cash flows of a loan, which include expected future receipts
of contractual interest, at the loan's original effective interest
rate or an approximation thereof, and comparing the resultant
present value with the loan's current carrying amount.
Collectively assessed loans and advances
Impairment is assessed collectively to cover losses that have
been incurred but have not yet been identified on loans subject to
individual assessment or for homogeneous groups of loans that are
not considered individually significant, which are generally retail
lending portfolios.
Incurred but not yet identified impairment
Individually assessed loans for which no evidence of impairment
has been specifically identified on an individual basis are grouped
together according to their credit risk characteristics for a
collective impairment assessment. This assessment captures
impairment losses that HSBC has incurred as a result of events
occurring before the balance sheet date that HSBC is not able to
identify on an individual loan basis, and that can be reliably
estimated. When information becomes available that identifies
losses on individual loans within a group, those loans are removed
from the group and assessed individually.
Homogeneous groups of loans and advances
Statistical methods are used to determine collective impairment
losses for homogeneous groups of loans not considered individually
significant. The methods used to calculate collective allowances
are set out below:
-- When appropriate empirical information is available, HSBC
utilises roll-rate methodology, which employs statistical analyses
of historical data and experience of delinquency and default to
reliably estimate the amount of the loans that will eventually be
written off as a result of events occurring before the balance
sheet date. Individual loans are grouped using ranges of past due
days, and statistical estimates are made of the likelihood that
loans in each range will progress through the various stages of
delinquency and become irrecoverable. Additionally, individual
loans are segmented based on their credit characteristics, such as
industry sector, loan grade or product. In applying this
methodology, adjustments are made to estimate the periods of time
between a loss event occurring, for example because of a missed
payment, and its confirmation through write-off (known as the loss
identification period). Current economic conditions are also
evaluated when calculating the appropriate level of allowance
required to cover inherent loss. In certain highly developed
markets, models also take into account behavioural and account
management trends as revealed in, for example bankruptcy and
rescheduling statistics.
-- When the portfolio size is small or when information is
insufficient or not reliable enough to adopt a roll-rate
methodology, HSBC adopts a basic formulaic approach based on
historical loss rate experience, or a discounted cash flow model.
Where a basic formulaic approach is undertaken, the period between
a loss event occurring and its identification is estimated by local
management, and is typically between six and 12 months.
Write-off of loans and advances
Loans and the related impairment allowance accounts 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.
Reversals of impairment
If the amount of an impairment loss decreases in a subsequent
period, and the decrease can be related objectively to an event
occurring after the impairment was recognised, the excess is
written back by reducing the loan impairment allowance account
accordingly. The write-back is recognised in the income
statement.
Assets acquired in exchange for loans
When non-financial assets acquired in exchange for loans as part
of an orderly realisation are held for sale, these assets are
recorded as 'Assets held for sale'.
Renegotiated loans
Loans subject to collective impairment assessment whose terms
have been renegotiated are no longer considered past due, but are
treated as up-to-date loans for measurement purposes once a minimum
number of required payments has been received. Where collectively
assessed loan portfolios include significant levels of renegotiated
loans, these loans are segregated from other parts of the loan
portfolio for the purposes of collective impairment assessment to
reflect their risk profile. Loans subject to individual impairment
assessment, whose terms have been renegotiated, are subject to
ongoing review to determine whether they remain impaired. The
carrying amounts of loans that have been classified as renegotiated
retain this classification until maturity or derecognition.
A loan that is renegotiated is derecognised if the existing
agreement is cancelled and a new agreement made on substantially
different terms or if the terms of an existing agreement are
modified such that the renegotiated loan is substantially a
different financial instrument. Any new loans that arise following
derecognition events will continue to be disclosed as renegotiated
loans and are assessed for impairment as above.
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.
235 HSBC Holdings plc Annual Report and Accounts 2018
Contracts that are economically equivalent to reverse repurchase
or repurchase 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 repurchase or repurchase agreements.
Financial instruments measured at fair value
Available-for-sale financial assets
Available-for-sale financial assets are recognised on the trade
date when HSBC enters into contractual arrangements to purchase
them, and are normally derecognised when they are either sold or
redeemed. They are subsequently remeasured at fair value, and
changes therein are recognised in other comprehensive income until
the assets are either sold or become impaired. Upon disposal, the
cumulative gains or losses in other comprehensive income are
recognised in the income statement as 'Gains less losses from
financial investments'.
Impairment of available-for-sale financial assets
Available-for-sale financial assets are assessed at each balance
sheet date for objective evidence of impairment. Impairment losses
are recognised in the income statement within 'Loan impairment
charges and other credit risk provisions' for debt instruments and
within 'Gains less losses from financial investments' for
equities.
Available-for-sale debt securities
In assessing objective evidence of impairment at the reporting
date, HSBC considers all available evidence, including observable
data or information about events specifically relating to the
securities which may result in a shortfall in the recovery of
future cash flows. A subsequent decline in the fair value of the
instrument is recognised in the income statement when there is
objective evidence of impairment as a result of decreases in the
estimated future cash flows. Where there is no further objective
evidence of impairment, the decline in the fair value of the
financial asset is recognised in other comprehensive income. If the
fair value of a debt security increases in a subsequent period, and
the increase can be objectively related to an event occurring after
the impairment loss was recognised in the income statement, or the
instrument is no longer impaired, the impairment loss is reversed
through the income statement.
HSBC Holdings plc Annual Report and Accounts 2018 236
Notes on the financial statements
Available-for-sale equity securities
A significant or prolonged decline in the fair value of the
equity below its cost is objective evidence of impairment. In
assessing whether it is significant, the decline in fair value is
evaluated against the original cost of the asset at initial
recognition. In assessing whether it is prolonged, the decline is
evaluated against the continuous period in which the fair value of
the asset has been below its original cost at initial
recognition.
All subsequent increases in the fair value of the instrument are
treated as a revaluation and are recognised in other comprehensive
income. Subsequent decreases in the fair value of the
available-for-sale equity security are recognised in the income
statement to the extent that further cumulative impairment losses
have been incurred. Impairment losses recognised on the equity
security are not reversed through the income statement.
Financial instruments designated at fair value
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;
-- when a group of financial assets, liabilities or both is
managed and its performance is evaluated on a fair value basis, in
accordance with a documented risk management or investment
strategy; and
-- where financial instruments contain 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/(expense)
from financial instruments designated at fair value'. Under this
criterion, the main classes of financial instruments designated by
HSBC are:
Long-term debt issues
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. See Note 1.2(j) for investment contracts with DPF and
contracts where HSBC accepts significant insurance risk. Customer
liabilities under linked and certain non-linked investment
contracts issued by insurance subsidiaries and the corresponding
financial assets are designated at fair value. Liabilities 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. Premiums receivable and amounts withdrawn are
accounted for as increases or decreases in the liability recorded
in respect of investment contracts. The incremental costs directly
related to the acquisition of new investment contracts or renewing
existing investment contracts are deferred and amortised over the
period during which the investment management services are
provided.
2 Net fee income
Net fee income by global business
2017 2016
Total Total
$m $m
Net Fee income includes $7,522m of fees earned on financial
assets that are not at fair value through profit or loss (other
than amounts included in determining the effective interest rate)
(2017: $7,577m; 2016: $7,732m), $1,682m of fees payable on
financial liabilities that are not at fair value through profit of
loss (other than amounts included in determining the effective
interest rate) (2017: $1,475m; 2016: $1,214m), $3,165m of fees
earned on trust and other fiduciary activities (2017: $3,088m;
2016: $2,926m), and $175m of fees payable relating to trust and
other fiduciary activities (2017: $134m; 2016: $129m). Comparatives
for fees earned on trust and other fiduciary activities have been
restated to align with current year treatment.
237 HSBC Holdings plc Annual Report and Accounts 2018
Notes on the financial statements
1 Discretionary participation features.
2 'Exchange differences and other movements' includes movements
in liabilities arising from net unrealised investment gains
recognised in other comprehensive income.
The key factors contributing to the movement in liabilities to
policyholders included movements in the market value of assets
supporting policyholder
liabilities, death claims, surrenders, lapses, liabilities to
policyholders created at the initial inception of the policies, the
declaration of bonuses and other amounts attributable to
policyholders.
239 HSBC Holdings plc Annual Report and Accounts 2018
5 Operating profit
Operating profit is stated after the following items:
External net operating income is attributed to countries and
territories on the basis of the location of the branch responsible
for reporting the results or advancing the funds:
2018 $m 2017
Footnotes $m
================================= ----------------
External net operating income by country/territory 2 53,780 51,445
--------------------------------------------------------------- ----------------
10,340 11,057
17,162 14,992
4,379 4,573
1,898 2,203
- UK 20,001 18,620
--------------------------------- ---------------------------- ----------------
- Hong Kong
--------------------------------- ---------------------------- ----------------
- US
---------------------------------
- France
---------------------------------
- other countries
--------------------------------- ---------------------------- ----------------
1 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.
2 Net operating income before change in expected credit losses
and other credit impairment charges/Loan impairment charges and
other credit risk provisions, also referred to as revenue.
6 Employee compensation and benefits
2018 2017 2016
$m $m $m
Wages and salaries
Social security costs
Post-employment benefits
Year ended 31 Dec
HSBC Holdings plc Annual Report and Accounts 2018 240
Notes on the financial statements
Average number of persons employed by HSBC during the year by
global business
2017 2016
------- -------
134,021 137,234
------- -------
46,716 45,912
------- -------
49,100 47,623
------- -------
7,817 8,322
------- -------
7,134 7,842
------- -------
244,788 246,933
------- -------
2017 2016
------- -------
70,301 71,196
------- -------
125,004 122,282
------- -------
10,408 12,021
------- -------
18,610 20,353
------- -------
20,465 21,081
------- -------
244,788 246,933
------- -------
Year in which income statement is expected to reflect deferred
bonuses
Charge recognised Expected charge
Share-based payments
'Wages and salaries' includes the effect of share-based settled (2017: $500m;
payments arrangements, of which $450m were equity 2016: $534m), as
follows:
-----------------------
2018 2017
$m $m
--------------------------------------------------------- ----------- ----------
Restricted share awards 499 520
--------------------------------------------------------- ----------- ----------
Savings-related and other share award option plans 23 26
--------------------------------------------------------- ----------- ----------
Year ended 31 Dec 522 546
--------------------------------------------------------- ----------- ----------
HSBC share awards
Deferred share
awards (including * An assessment of performance over the relevant period
annual incentive ending on 31 December is used to determine the amount
awards, LTI awards of the award to be granted.
delivered in shares)
and Group Performance
Share Plans ('GPSP') -- Deferred awards generally require employees to remain
in employment over the vesting period and are not subject
to performance conditions after the grant date.
-- Deferred share awards generally vest over a period
of three, five or seven years.
-- Vested shares may be subject to a retention requirement
post-vesting. GPSP awards are retained until cessation
of employment.
-- Awards granted from 2010 onwards are subject to a malus
provision prior to vesting.
-- Awards granted to Material Risk Takers from 2015 onwards
are subject to clawback post-vesting.
International -- The plan was first introduced in Hong Kong in 2013
Employee Share and now includes employees based in 27 jurisdictions.
Purchase Plan -- Shares are purchased in the market each quarter up
('ShareMatch') to a maximum value of GBP750, or the equivalent in local
currency.
-- Matching awards are added at a ratio of one free share
for every three purchased.
-- Matching awards vest subject to continued employment
and the retention of the purchased shares for a maximum
period of two years and nine months.
241 HSBC Holdings plc Annual Report and Accounts 2018
Movement on HSBC share awards
Restricted share awards outstanding at 1 Jan
Additions during the year
Released in the year
Forfeited in the year
Restricted share awards outstanding at 31 Dec
Weighted average fair value of awards granted ($)
HSBC share option plans
Savings-related share option plans
-- Two plans: the UK Plan and the International Plan. The last grant
of options under the International Plan was in 2012. ('Sharesave')
-- From 2014, eligible employees could save up to GBP500 per month with
the option to use the savings to acquire shares.
-- Exercisable within six months following either the third or fifth
anniversary of the commencement of a three-year or five-year contract,
respectively.
-- The exercise price is set at a 20% (2017: 20%) discount to the market
value immediately preceding the date of invitation.
-------------------------------------------------------------------------------------------------------------------
Calculation of fair values
The fair values of share options are calculated using a
Black-Scholes model. The fair value of a share award is based on
the share price at the date of the grant.
Movement on HSBC share option plans
Savings-related
share option plans
Post-employment benefit plans
The Group operates pension plans throughout the world for its
employees. 'Pension risk management' on page 87 contains details of
the policies and practices associated with these pension plans.
Some are defined benefit plans, of which the largest is the HSBC
Bank (UK) Pension Scheme ('the principal plan').
HSBC's balance sheet includes the net surplus or deficit, being
the difference between the fair value of plan assets and the
discounted value of scheme liabilities at the balance sheet date
for each plan. Surpluses are only recognised to the extent that
they are recoverable through reduced contributions in the future or
through potential future refunds from the schemes. In assessing
whether a surplus is recoverable, HSBC has considered its current
right to obtain a future refund or a reduction in future
contributions.
The principal plan
The principal plan has a defined benefit section and a defined
contribution section. The defined benefit section was closed to
future benefit accrual in 2015, with defined benefits earned by
employees at that date continuing to be linked to their salary
while they remain employed by HSBC. The plan is overseen by an
independent corporate trustee, who has a fiduciary responsibility
for the operation of the plan. Its assets are held separately from
the assets of the Group.
The investment strategy of the plan is to hold the majority of
assets in bonds, with the remainder in a diverse range of
investments. It also includes some interest rate swaps to reduce
interest rate risk and inflation swaps to reduce inflation
risk.
The latest funding valuation of the plan at 31 December 2016 was
carried out by Colin G Singer, of Willis Towers Watson Limited, who
is a Fellow of the UK Institute and Faculty of Actuaries, using the
projected unit credit method. At that date, the market value of the
plan's combined assets was GBP30.2bn ($37.2bn), and this exceeded
the value placed on its liabilities on an ongoing basis by GBP1.3bn
($1.6bn), giving a funding level of 104%. These figures include all
sections of the plan and defined contribution assets amounting to
GBP3.1bn ($3.8bn). The main differences between the assumptions
used for assessing the defined benefit liabilities for this funding
valuation and those used for IAS 19 are more prudent assumptions
for discount rate, inflation rate and life expectancy.
HSBC Holdings plc Annual Report and Accounts 2018 242
Notes on the financial statements
Although the plan was in surplus at the valuation date, HSBC
continues to make further contributions to the plan to support a
lower-risk investment strategy over the longer term. The remaining
contributions are GBP64m ($82m) in 2019, and GBP160m ($204m) in
each of 2020 and 2021.
To meet the requirements of the Banking Reform Act, the main
employer of the plan changed from HSBC Bank plc to HSBC UK Bank plc
with effect from 1 July 2018, with additional support from HSBC
Holdings plc. At the same time, non-ring-fenced entities including
HSBC Bank plc exited the section of the plan for ring-fenced
entities and joined a newly created section for the future defined
benefit and defined contribution pension benefits of their
employees. These changes have not materially affected the overall
funding position of
the plan.
The actuary also assessed the value of the liabilities if the
plan were to be stopped and an insurance company asked to secure
all future pension payments. This is generally larger than the
amount needed on the ongoing basis described above because an
insurance company would use more prudent assumptions and include an
explicit allowance for the future administrative expenses of the
plan. Under this approach, the amount of assets needed was
estimated to be GBP38bn ($47bn) at 31 December 2016.
Guaranteed minimum pension ('GMP') equalisation
On 26 October 2018, the High Court of Justice of England and
Wales issued a judgment in a claim between Lloyds Banking Group
Pension Trustees Limited as claimant and Lloyds Bank plc and others
as defendants regarding the rights of men and women to equal
treatment in relation to their benefits from certain pension
schemes.
The judgment concluded that the claimant is under a duty to
amend the schemes in order to equalise benefits for men and women
in relation to GMP benefits. The judgment also provided comments on
the method to be adopted in order to equalise benefits, on the
period during which a member can claim in respect of previously
underpaid benefits, and on what should be done in relation to
benefits that have been transferred into, and out of, the relevant
schemes.
The issues determined by the judgment arise in relation to many
other occupational pension schemes and consequently will result in
an increase in the principal plan's liabilities. We have estimated
the financial effect of equalising benefits in respect of GMPs, and
any potential conversion of GMPs into non-GMP benefits, to be an
approximate 0.8% increase in the plan's liabilities, or GBP177m
($226m) on the IAS19 basis as at 31 December 2018. This has been
recognised as a past service cost in profit and loss. The estimate
was performed based on Method C2, which compares the accumulated
benefits, with interest, payable to a member on their 'own sex' and
an 'opposite sex' basis and each year pays the amount necessary to
ensure the higher of the two accumulated amounts has been paid.
HSBC Holdings
Employee compensation and benefit expense in respect of HSBC
Holdings' employees in 2018 amounted to $37m (2017: $54m). The
average number of persons employed during 2018 was 43 (2017: 55).
Employees who are members of defined benefit pension plans are
principally members of either the HSBC Bank (UK) Pension Scheme or
the HSBC International Staff Retirement Benefits Scheme. HSBC
Holdings pays contributions to such plans for its own employees in
accordance with the schedules of contributions determined by the
trustees of the plans and recognises these contributions as an
expense as they fall due.
From 1 July 2016 employment costs of most employees are
recognised by the ServCo group and the ServCo group started
providing services to HSBC Holdings. HSBC Holdings recognised a
management charge of $2,428m (2017: $2,240m) for these services,
which is included under 'General and administrative expenses'.
243 HSBC Holdings plc Annual Report and Accounts 2018
Notes on the financial statements
Directors' emoluments
Details of Directors' emoluments, pensions and their interests
are disclosed in the Directors' remuneration report on page
172.
245 HSBC Holdings plc Annual Report and Accounts 2018
7 Auditors' remuneration
Footnotes
Audit fees payable to PwC 1
Other audit fees payable
Year ended 31 Dec
Fees payable by HSBC to PwC(6)
Footnotes
Fees for HSBC Holdings' statutory audit 2
Fees for other services provided to HSBC
Year ended 31 Dec 119.5 129.7 111.1
----------------- -----------
No fees were payable by HSBC to PwC as principal auditor for the
following types of services: internal audit services and services
related to litigation, recruitment and remuneration.
Fees payable by HSBC's associated pension schemes to PwC
2018 2017
$000 $000
-------------------------------------------- ---- ----
Audit of HSBC's associated pension schemes 172 260
-------------------------------------------- ---- ----
Audit-related assurance services - 4
-------------------------------------------- ---- ----
Year ended 31 Dec 172 264
-------------------------------------------- ---- ----
1 The 2016 audit fees payable amount includes $4.2m related to
the prior year audit in respect of overruns.
2 Fees payable to PwC for the statutory audit of the
consolidated financial statements of HSBC and the separate
financial statements of HSBC Holdings. They include amounts payable
for services relating to the consolidation returns of HSBC
Holdings' subsidiaries, which are clearly identifiable as being in
support of the Group audit opinion.
3 Fees payable for the statutory audit of the financial
statements of HSBC's subsidiaries, including the 2017 and 2016
changes in scope and additional procedures performed due to the
technology systems and data access controls matter as described on
page 207.
4 Including services for assurance and other services that
relate to statutory and regulatory filings, including comfort
letters and interim reviews and work performed related to the
implementation of IFRS 9.
5 Including other permitted services relating to advisory, corporate finance transactions, etc.
6 The 2017 and 2016 comparative data has been re-presented to
align to the current year presentation of fees payable. The totals
remain unchanged for both 2017 and 2016.
No fees were payable by HSBC's associated pension schemes to PwC
as principal auditor for the following types of services: internal
audit services, other assurance services, services related to
corporate finance transactions, valuation and actuarial services,
litigation, recruitment and remuneration, and information
technology.
In addition to the above, the estimated fees paid to PwC by
third parties associated with HSBC amount to $14.0m (2017: $3.5m;
2016: $4.3m). In these cases, HSBC is connected with the
contracting party and may therefore be involved in appointing PwC.
These fees arise from services such as auditing mutual funds
managed by HSBC and reviewing the financial position of corporate
concerns that borrow from HSBC.
Fees payable for non-audit services for HSBC Holdings are not
disclosed separately because such fees are disclosed on a
consolidated basis for the HSBC Group.
8 Tax
Tax expense
2018 $m 2017 2016
Footnotes $m $m
-------------------------------------------------------------------------------------------------------------- -------------------- -------------------------------------
Current tax 1 4,195 4,264 3,669
-------------------------------------------------------------------------------------------------------------- -------------------- -------------------------------------
- for this year 4,158 4,115 3,525
37 149 144
-------------------------------------------------------------------------------------------------------------- -------------------- ------------- ----------------------
- adjustments in respect of prior years
-------------------------------------------------------------------------------------------------------------- -------------------- ------------- ----------------------
Deferred tax 670 1,024 (3)
-------------------------------------------------------------------------------------------------------------- -------------------- -------------------------------------
- origination and reversal of temporary differences 656 (228) (111)
17 1,337 (4)
(3) (85) 112
-------------------------------------------------------------------------------------------------------------- -------------------- ------------- ----------------------
- effect of changes in tax rates
-------------------------------------------------------------------------------------------------------------- -------------------- ------------- ----------------------
- adjustments in respect of prior years
-------------------------------------------------------------------------------------------------------------- -------------------- ------------- ----------------------
Year ended 31 Dec 4,865 5,288 3,666
-------------------------------------------------------------------------------------------------------------- -------------------- -------------------------------------
1 Current tax included Hong Kong profits tax of $1,532m (2017:
$1,350m; 2016: $1,118m). The Hong Kong tax rate applying to the
profits of subsidiaries assessable in Hong Kong was 16.5% (2017:
16.5%; 2016: 16.5%).
HSBC Holdings plc Annual Report and Accounts 2018 246
Notes on the financial statements
Tax reconciliation
The tax charged to the income statement differs from the tax
charge that would apply if all profits had been taxed at the UK
corporation tax rate as follows:
The Group's profits are taxed at different rates depending on
the country or territory in which the profits arise. The key
applicable tax rates for 2018 include Hong Kong (16.5%), the US
(21%) and the UK (19%). If the Group's profits were taxed at the
statutory rates of the countries in which the profits arose, then
the tax rate for the year would have been 20.30% (2017: 21.15%).
The effective tax rate for the year was 24.5% (2017: 30.8%). The
effective tax rate for 2018 was significantly lower than for 2017
as 2017 included a charge of $1.3bn relating to the remeasurement
of US deferred tax balances to reflect the reduction in the US
federal tax rate to 21% from 2018.
Accounting for taxes involves some estimation because the tax
law is uncertain and its application requires a degree of
judgement, which authorities may dispute. Liabilities are
recognised based on best estimates of the probable outcome, taking
into account external advice where appropriate. We do not expect
significant liabilities to arise in excess of the amounts provided.
HSBC only recognises current and deferred tax assets where recovery
is probable.
247 HSBC Holdings plc Annual Report and Accounts 2018
Movement of deferred tax assets and liabilities
950 2,212 1,441 - 893 1,857 7,353
----- ----- ----- ------- ----- ------- -------
- - (274) (1,170) - (1,369) (2,813)
----- ----- ----- ------- ----- ------- -------
950 2,212 1,167 (1,170) 893 488 4,540
----- ----- ----- ------- ----- ------- -------
(235) (873) (397) 12 (269) 738 (1,024)
----- ----- ----- ------- ----- ------- -------
3 (6) 368 - - (1,255) (890)
----- ----- ----- ------- ----- ------- -------
- - - - - 29 29
----- ----- ----- ------- ----- ------- -------
(5) 40 51 (24) 19 (42) 39
----- ----- ----- ------- ----- ------- -------
713 1,373 1,189 (1,182) 643 (42) 2,694
----- ----- ----- ------- ----- ------- -------
2 713 1,373 1,282 - 643 2,313 6,324
----- ----- ----- ------- ----- ------- -------
2 - - (93) (1,182) - (2,355) (3,630)
----- ----- ----- ------- ----- ------- -------
1 Fair value of own debt.
2 After netting off balances within countries, the balances as
disclosed in the accounts are as follows: deferred tax assets
$4,450m (2017: $4,676m) and deferred tax liabilities $2,619m (2017:
$1,982m).
In applying judgement in recognising deferred tax assets,
management has critically assessed all available information,
including future business profit projections and the track record
of meeting forecasts.
The net deferred tax asset of $1.8bn (2017: $2.7bn) includes
$3.0bn (2017: $3.2bn) of deferred tax assets relating to the US, of
which $1bn relates to US tax losses that expire in 15-19 years.
Management expects the US deferred tax asset to be substantially
recovered in six to seven years, with the majority recovered in the
first five years. The most recent financial forecasts approved by
management covers a five-year period and the forecasts have been
extrapolated beyond five years by assuming that performance remains
constant after the fifth year.
US tax reform enacted in late 2017 and effective from 2018
included a reduction in the federal rate of tax from 35% to 21% and
the introduction of a base erosion anti-abuse tax. The US deferred
tax asset at 31 December 2017 was calculated using the rate of 21%.
The remeasurement of the deferred tax asset due to the reduction in
tax rate resulted in charges of $1.3bn to the income statement and
$0.3bn to other comprehensive income during 2017. The impact of the
base erosion anti-abuse tax is currently uncertain, and will depend
on the finalisation of regulatory guidance and the actions
management may take. It is not currently expected that the base
erosion anti-abuse tax will have a material impact on the Group's
future tax charges.
Unrecognised deferred tax
The amount of gross temporary differences, unused tax losses and
tax credits for which no deferred tax asset is recognised in the
balance sheet was $8.9bn (2017: $18.1bn). These amounts included
unused state losses arising in the Group's US operations of $0.8bn
(2017: $12.3bn). Of the total amounts unrecognised, $7.0bn (2017:
$4.8bn) had no expiry date, $1.3bn (2017: $0.8bn) was scheduled to
expire within 10 years and the remaining balance is expected to
expire after 10 years.
Deferred tax is not recognised in respect of the Group's
investments in subsidiaries and branches where HSBC is able to
control the timing of remittance or other realisation and where
remittance or realisation is not probable in the foreseeable
future. The aggregate temporary differences relating to
unrecognised deferred tax liabilities arising on investments in
subsidiaries and branches is $13.2bn (2017: $12.1bn) and the
corresponding unrecognised deferred tax liability is $0.9bn (2017:
$0.8bn).
HSBC Holdings plc Annual Report and Accounts 2018 248
Notes on the financial statements
9 Dividends
Dividends to shareholders of the parent company
2017 2016
------ ------ --------- ------ ------
Per Settled Per
share Total in scrip share Total
$ $m $m $ $m
------ ------ --------- ------ ------
0.21 4,169 1,945 0.21 4,137
------ ------ --------- ------ ------
0.10 2,005 826 0.10 1,981
------ ------ --------- ------ ------
0.10 2,014 193 0.10 1,991
------ ------ --------- ------ ------
0.10 2,005 242 0.10 1,990
------ ------ --------- ------ ------
0.51 10,193 3,206 0.51 10,099
------ ------ --------- ------ ------
62.00 90 62.00 90
------ ------ --------- ------ ------
1,268 1,090
------ ------ --------- ------ ------
11,551 11,279
------ ------ --------- ------ ------
Total coupons on capital securities classified as equity
Basic earnings per ordinary share is calculated by dividing the
profit attributable to ordinary shareholders of the parent company
by the weighted average number of ordinary shares outstanding,
excluding own shares held. Diluted earnings per ordinary share is
calculated by dividing the basic earnings, which require no
adjustment for the effects of dilutive potential ordinary shares,
by the weighted average number of ordinary shares outstanding,
excluding own shares held, plus the weighted average number of
ordinary shares that would be issued on conversion of dilutive
potential ordinary shares.
249 HSBC Holdings plc Annual Report and Accounts 2018
Profit attributable to the ordinary shareholders of the parent
company
Basic and diluted earnings per share
1 Weighted average number of ordinary shares outstanding (basic)
or assuming dilution (diluted).
The number of anti-dilutive employee share options excluded from
the weighted average number of dilutive potential ordinary shares
is nil (2017: nil; 2016: 10m).
11 Trading assets
1 Loans and advances to banks and customers include reverse
repos, stock borrowing and other accounts.
2 Settlement accounts, cash collateral and margin receivables
included within 'Loans and advances to banks' and 'Loans and
advances to customers' were reclassified from 'Trading assets' to
'Other assets' on 1 January 2018 and comparative data was not
restated. This reclassification was in accordance with IFRS 9.
3 Information regarding the effects of adoption of IFRS 9 can be found in Note 37.
Trading Securities(1)
1 Included within these figures are debt securities issued by
banks and other financial institutions of $18,918m (2017:
$18,585m), of which $2,367m (2017: $906m) are guaranteed by various
governments.
2 Includes securities that are supported by an explicit guarantee issued by the US Government.
3 Excludes asset-backed securities included under US Treasury and US Government agencies.
12 Fair values of financial instruments carried at fair value
Control framework
Fair values are subject to a control framework designed to
ensure that they are either determined or validated by a function
independent of the risk taker.
Where fair values are determined by reference to externally
quoted prices or observable pricing inputs to models, independent
price determination or validation is used. For inactive markets,
HSBC sources alternative market information, with greater weight
given to information that is considered to be more relevant and
reliable. Examples of the factors considered are price
observability, instrument comparability, consistency of data
sources, underlying data accuracy and timing of prices.
For fair values determined using valuation models, the control
framework includes development or validation by independent support
functions of the model logic, inputs, model outputs and
adjustments. Valuation models are subject to a process of due
diligence before becoming operational and are calibrated against
external market data on an ongoing basis.
Changes in fair value are generally subject to a profit and loss
analysis process and are disaggregated into high-level categories
including portfolio changes, market movements and other fair value
adjustments.
The majority of financial instruments measured at fair value are
in GB&M. GB&M's fair value governance structure comprises
its Finance function, Valuation Committees and a Valuation
Committee Review Group. Finance is responsible for establishing
procedures governing valuation and ensuring fair values are in
compliance with accounting standards. The fair values are reviewed
by the Valuation Committees, which consist of independent support
functions. These committees are overseen by the Valuation Committee
Review Group, which considers all material subjective
valuations.
HSBC Holdings plc Annual Report and Accounts 2018 250
Notes on the financial statements
Financial liabilities measured at fair value
In certain circumstances, HSBC records its own debt in issue at
fair value, based on quoted prices in an active market for the
specific instrument. When quoted market prices are unavailable, the
own debt in issue is valued using valuation techniques, the inputs
for which are either based on quoted prices in an inactive market
for the instrument or are estimated by comparison with quoted
prices in an active market for similar instruments. In both cases,
the fair value includes the effect of applying the credit spread
that is appropriate to HSBC's liabilities. The change in fair value
of issued debt securities attributable to the Group's own credit
spread is computed as follows: for each security at each reporting
date, an externally verifiable price is obtained or a price is
derived using credit spreads for similar securities for the same
issuer. Then, using discounted cash flow, each security is valued
using a Libor-based discount curve. The difference in the
valuations is attributable to the Group's own credit spread. This
methodology is applied consistently across all securities.
Structured notes issued and certain other hybrid instruments are
included within trading liabilities and are measured at fair value.
The credit spread applied to these instruments is derived from the
spreads at which HSBC issues structured notes.
Gains and losses arising from changes in the credit spread of
liabilities issued by HSBC recorded in other comprehensive income,
reverse over the contractual life of the debt, provided that the
debt is not repaid at a premium or a discount.
Fair value hierarchy
Fair values of financial assets and liabilities are determined
according to the following hierarchy:
-- Level 1 - valuation technique using quoted market price:
financial instruments with quoted prices for identical instruments
in active markets that HSBC can access at the measurement date.
-- Level 2 - valuation technique using observable inputs:
financial instruments with quoted prices for similar instruments in
active markets or quoted prices for identical or similar
instruments in inactive markets and financial instruments valued
using models where all significant inputs are observable.
-- Level 3 - valuation technique with significant unobservable
inputs: financial instruments valued using valuation techniques
where one or more significant inputs are unobservable.
Financial instruments carried at fair value and bases of
valuation
181,168 101,775 5,052 287,995
------- ------- ----- -------
N/A N/A N/A N/A
------- ------- ----- -------
1,017 216,357 2,444 219,818
------- ------- ----- -------
24,622 3,382 1,460 29,464
------- ------- ----- -------
227,943 104,692 3,432 336,067
------- ------- ----- -------
62,710 117,451 4,200 184,361
------- ------- ----- -------
4,164 90,265 - 94,429
------- ------- ----- -------
1,635 213,242 1,944 216,821
------- ------- ----- -------
The increase in Level 3 assets in 2018 was primarily due to new
private equity investments and new derivative transactions with
unobservable inputs.
251 HSBC Holdings plc Annual Report and Accounts 2018
Transfers between Level 1 and Level 2 fair values
Assets Liabilities
------------------ --------- ------------ ----------------------- ----------- -------------------- -----------
Designated
and otherwise
mandatorily Designated at
measured fair
Financial Trading at fair Trading liabilities
investments assets value Derivatives value Derivatives
$m $m $m $m $m $m $m
------------------ --------- ------------ ------- -------------- ----------- -------------------- -----------
At 31 Dec
2018
------------------ --------- ------------ ------- -------------- ----------- -------------------- -----------
Transfers from
Level 1 to Level
2 367 435 2 1 79 - -
------------------ --------- ------------ ------- -------------- ----------- -------------------- -----------
Transfers from
Level 2 to Level
1 17,861 4,959 85 128 1,821 - 138
------------------ --------- ------------ ------- -------------- ----------- -------------------- -----------
At 31 Dec 2017
------------------ ----------------------- ------- -------------- ----------- -------------------- -----------
Transfers from
Level 1 to Level
2 2,231 1,507 - - 35 - -
------------------ ----------------------- ------- -------------- ----------- -------------------- -----------
Transfers from
Level 2 to Level
1 11,173 1,384 - - 683 - -
Transfers between levels of the fair value hierarchy are deemed
to occur at the end of each quarterly reporting period. Transfers
into and out of levels of the fair value hierarchy are primarily
attributable to observability of valuation inputs and price
transparency.
Fair value adjustments
Fair value adjustments are adopted when HSBC determines there
are additional factors considered by market participants that are
not incorporated within the valuation model. Movements in the level
of fair value adjustments do not necessarily result in the
recognition of profits or losses within the income statement, such
as when models are enhanced and therefore fair value adjustments
may no longer be required.
Global Banking & Markets ('GB&M') and Corporate Centre
fair value adjustments
Type of adjustment
2018
Corporate
GB&M Centre
$m $m
Risk-related 1,042 138 1,078 79
--------------------------------------------- ------------------- -------------------
430 99
442 (198) 76 6 52
- bid-offer 256 13 - 4 - 413 5
91 420
(82) 233 8 59 -
3 7 -
--------------------------------------------- ---------- ------- ---------- -------
- uncertainty
--------------------------------------------- ---------- ------- ---------- -------
- credit valuation adjustment ('CVA')
---------------------------------------------
- debit valuation adjustment ('DVA')
---------------------------------------------
- funding fair value adjustment ('FFVA')
---------------------------------------------
- other
--------------------------------------------- ---------- ------- ---------- -------
Model-related 79 3 92 13
--------------------------------------------- ------------------- -------------------
- model limitation 79 3 92 6
- - - 7
--------------------------------------------- ---------- ------- ---------- -------
- other
--------------------------------------------- ---------- ------- ---------- -------
Inception profit (Day 1 P&L reserves) (Note
15) 85 - 106 -
--------------------------------------------- ------------------- -------------------
At 31 Dec 1,206 141 1,276 92
--------------------------------------------- -----------------------
Bid-offer
IFRS 13 'Fair value measurement' requires use of the price
within the bid-offer spread that is most representative of fair
value. Valuation models will typically generate mid-market values.
The bid-offer adjustment reflects the extent to which bid-offer
costs would be incurred if substantially all residual net portfolio
market risks were closed using available hedging instruments or by
disposing of or unwinding the position.
Uncertainty
Certain model inputs may be less readily determinable from
market data, and/or the choice of model itself may be more
subjective. In these circumstances, an adjustment may be necessary
to reflect the likelihood that market participants would adopt more
conservative values for uncertain parameters and/or model
assumptions than those used in HSBC's valuation model.
Credit and debit valuation adjustments
The CVA is an adjustment to the valuation of over-the-counter
('OTC') derivative contracts to reflect the possibility that the
counterparty may default and that HSBC may not receive the full
market value of the transactions.
The DVA is an adjustment to the valuation of OTC derivative
contracts to reflect the possibility that HSBC may default, and
that it may not pay the full market value of the transactions.
HSBC calculates a separate CVA and DVA for each legal entity,
and for each counterparty to which the entity has exposure. With
the exception of central
clearing parties, all third-party counterparties are included in
the CVA and DVA calculations, and these adjustments are not netted
across Group entities.
HSBC calculates the CVA by applying the probability of default
('PD') of the counterparty, conditional on the non-default of HSBC,
to HSBC's expected positive exposure to the counterparty and
multiplying the result by the loss expected in the event of
default. Conversely, HSBC calculates the DVA by applying the PD of
HSBC, conditional on the non-default of the counterparty, to the
expected positive exposure of the counterparty to HSBC and
multiplying the result by the loss expected in the event of
default. Both calculations are performed over the life of the
potential exposure.
For most products HSBC uses a simulation methodology, which
incorporates a range of potential exposures over the life of the
portfolio, to calculate the expected positive exposure to a
counterparty. The simulation methodology includes credit mitigants,
such as counterparty netting agreements and collateral agreements
with the counterparty.
The methodologies do not, in general, account for 'wrong-way
risk'. Wrong-way risk is an adverse correlation between the
counterparty's probability of default and the mark-to-market value
of the underlying transaction. The risk can either be general,
perhaps related to the currency of the issuer country, or specific
to the transaction concerned. When there is significant wrong-way
risk, a trade-specific approach is applied to reflect this risk in
the valuation.
HSBC Holdings plc Annual Report and Accounts 2018 252
Notes on the financial statements
Funding fair value adjustment
The FFVA is calculated by applying future market funding spreads
to the expected future funding exposure of any uncollateralised
component of the OTC derivative portfolio. The expected future
funding exposure is calculated by a simulation methodology, where
available, and is adjusted for events that may terminate the
exposure, such as the default of HSBC or the counterparty. The FFVA
and DVA are calculated independently.
Model limitation
Models used for portfolio valuation purposes may be based upon a
simplified set of assumptions that do not capture all current and
future material market characteristics. In these circumstances,
model limitation adjustments are adopted.
Inception profit (Day 1 P&L reserves)
Inception profit adjustments are adopted when the fair value
estimated by a valuation model is based on one or more significant
unobservable inputs. The accounting for inception profit
adjustments is discussed in Note 1.
Fair value valuation bases
Financial instruments measured at fair value using a valuation
technique with significant unobservable inputs - Level 3
Assets Liabilities
Assets Liabilities
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Available Designated Designated at
for Held for at fair Held for trading
sale trading value Derivatives Total fair value Derivatives Total
$m $m $m $m $m $m $m $m $m
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Private equity including
strategic
investments 2,012 38 1,458 - 3,508 20 - - 20
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Asset-backed securities 1,300 1,277 - - 2,577 - - - -
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Loans held for
securitisation - 24 - - 24 - - - -
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Structured notes - 3 - - 3 4,180 - - 4,180
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Derivatives with
monolines - - - 113 113 - - - -
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Other derivatives - - - 2,331 2,331 - - 1,944 1,944
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Other portfolios 120 3,710 2 - 3,832 - - - -
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
At 31 Dec 2017 3,432 5,052 1,460 2,444 12,388 4,200 - 1,944 6,144
------------------------- --------- -------- ---------- ----------- ------ ----------------- ----------- -----
Level 3 instruments are present in both ongoing and legacy
businesses. Loans held for securitisation, derivatives with
monolines, certain 'other derivatives' and predominantly all Level
3 ABSs are legacy positions. HSBC has the capability to hold these
positions.
Private equity including strategic investments
The fair value of a private equity investments (including
strategic investments) is estimated on the basis of an analysis of
the investee's financial position and results, risk profile,
prospects and other factors; by reference to market valuations for
similar entities quoted in an active market; or the price at which
similar companies have changed ownership.
Asset-backed securities
While quoted market prices are generally used to determine the
fair value of the asset-backed securities ('ABSs'), valuation
models are used to substantiate the reliability of the limited
market data available and to identify whether any adjustments to
quoted market prices are required. For certain ABSs, such as
residential mortgage-backed securities, the valuation uses an
industry standard model with assumptions relating to prepayment
speeds, default rates and loss severity based on collateral type,
and performance, as appropriate. The valuations output is
benchmarked for consistency against observable data for securities
of a similar nature.
Structured notes
The fair value of Level 3 structured notes is derived from the
fair value of the underlying debt security, and the fair value of
the embedded derivative is determined as described in the paragraph
below on derivatives. These structured notes comprise principally
equity-linked notes issued by HSBC, which provide the counterparty
with a return linked to the performance of equity securities and
other portfolios. Examples of the unobservable parameters include
long-dated equity volatilities and correlations between equity
prices, and interest and foreign exchange rates.
Derivatives
OTC derivative valuation models calculate the present value of
expected future cash flows, based upon 'no arbitrage' principles.
For many vanilla derivative products, the modelling approaches used
are standard across the industry. For more complex derivative
products, there may be some differences in market practice. Inputs
to valuation models are determined from observable market data
wherever possible, including prices available from exchanges,
dealers,
253 HSBC Holdings plc Annual Report and Accounts 2018
brokers or providers of consensus pricing. Certain inputs may
not be observable in the market directly, but can be determined
from observable prices via
model calibration procedures or estimated from historical data
or other sources.
Reconciliation of fair value measurements in Level 3 of the fair
value hierarchy
Movement in Level 3 financial instruments
Assets Liabilities
Designated
and otherwise
mandatorily
measured at
fair value
Financial Trading through profit Trading Designated at
investments assets or loss Derivatives liabilities fair value Derivatives
$m $m $m $m $m $m $m
1,767 5,080 3,958 2,444 93 4,107 1,949
Total gains/(losses) recognised
in profit or loss 251 284 608 597 (4) (637) 255
-----------------------------------------
- net income from financial instruments
held for trading or managed on
a fair value basis
----------------------------------------- ---- ------ ------ ------ ------ ------ -----
- net income from assets and liabilities
of insurance businesses, including
related derivatives, measured at
fair value through profit or loss
-----------------------------------------
- changes in fair value of other
financial instruments mandatorily
measured at fair value through
profit or loss
-----------------------------------------
- gains less losses from financial
investments at fair value through
other comprehensive income
-----------------------------------------
- 284 - 597 (4) - 255
- - - - - - -
- - 608 - - (637) -
- expected credit loss charges 251 - - - - - -
and other credit risk charges - - - - - - -
----------------------------------------- ---- ------ ------ ------ ------ ------ -----
- fair value gains transferred - - - - - - -
to the income statement on disposal
----------------------------------------- ---------------------------------------------------
Total gains/(losses) recognised in other comprehensive income ('OCI')
1 17 (274) (107) (113) (3) (144) (82)
----------------------------------------------------------------------------------------------
- financial investments: fair value 15 - - - - - 6 - - 6 - - - - - - - 2 -
gains/(losses) - 2 (274) (113) (119) - (3) (144) (84)
----------------------------------------- ---- ------ ------ ------ ------ ------ -----
- cash flow hedges: fair value
gains/(losses)
----------------------------------------- ---- ------ ------ ------ ------ ------ -----
- fair value gains transferred
to the income statement on disposal
-----------------------------------------
- exchange differences
----------------------------------------- ---- ------ ------ ------ ------ ------ -----
Purchases 275 4,377 2,172 - 3 76 -
----------------------------------------------------------------------------------------------
Unrealised gains/(losses) recognised in profit or loss relating to assets
and
liabilities held at 31 Dec 2018 - (5) 199 342 (5) 274 (351)
- net income from financial instruments - (5) - 342 (5) - (351)
held - - - - - - -
for trading or managed on a fair - - 199 - - 274 -
value basis - - - - - - -
----------------------------------------------- ---- ---- ----- --- --- ---- -----
- net income from assets and liabilities
of
insurance businesses, including
related derivatives
measured at fair value through
profit or loss
----------------------------------------------------- ---- ----- --- --- ---- -----
- changes in fair value of other
financial
instruments mandatorily measured
at fair
value through profit or loss
-----------------------------------------------------
- loan impairment recoveries and
other credit
risk provisions
----------------------------------------------------- ---- ----- --- --- ---- -----
Movement in Level 3 financial instruments (continued)
Assets Liabilities
Designated Designated
at fair value at fair value
Available Held for through profit Held for through profit
for sale trading or loss Derivatives trading or loss
Derivatives
Footnotes $m $m $m $m $m $m $m
At 1 Jan 2017 3,476 6,489 730 2,752 3,582 37 2,300
Total gains/(losses) recognised in profit or loss 351 (188)
(107) 152 154 (5) 400
- trading income/(expense) excluding
net interest income - (188) - 152 154 - 400
- - (107) - - (5) -
313 - - - - - -
38 - - - - - -
- net income from other financial
instruments designated at fair
value
-------------------------------------
- gains less losses from financial
investments
-------------------------------------
- loan impairment charges and other
credit risk provisions ('LICs')
-------------------------------------
Total gains/(losses) recognised in other comprehensive income
('OCI') 1 71 106 7 188 169 1 120
HSBC Holdings plc Annual Report and Accounts 2018 254
Notes on the financial statements
Purchases 200 1,503 1,127 2 5 - 23
------------------------------------- --------- ---------- ----- -------- ------- ---- ---------
New issuances - - - 1 1,915 - -
------------------------------------- --------- ---------- ----- -------- ------- ---- ---------
Sales (939) (3,221) (130) (8) (12) - (12)
------------------------------------- --------- ---------- ----- -------- ------- ---- ---------
Settlements (69) (331) (166) (60) (998) - (123)
------------------------------------- --------- ---------- ----- -------- ------- ---- ---------
Transfers out (565) (149) (3) (885) (678) (33) (1,030)
------------------------------------- --------- ---------- ----- -------- ------- ---- ---------
Transfers in 907 843 2 302 63 - 266
------------------------------------- --------- ---------- ----- -------- ------- ---- ---------
At 31 Dec 2017 3,432 5,052 1,460 2,444 4,200 - 1,944
------------------------------------- --------- ---------- ----- -------- ------- ---- ---------
Unrealised gains/(losses) recognised
in profit or loss relating to
assets and liabilities held at
31 Dec 2017 16 (110) (146) 218 (117) - (397)
- (110) - 218 (117) - (397)
- trading income/(expense) excluding - - (146) - - - -
net interest income 16 - - - - - -
-------------------------------------- ---- ---------- -------- ----- ------- ------- --------
- net income from other financial
instruments designated at fair
value
-------------------------------------- ---- ------ ---- ---- --- --- -------
- loan impairment charges and other
credit risk provisions
-------------------------------------- ---- ------ ---- ---- --- --- -------
1 Included in 'Available-for-sale investments: fair value
gains/(losses)' in prior years or 'Debt Instruments at fair value
through other comprehensive income' in 2018 and 'Exchange
differences'
in the consolidated statement of comprehensive income.
Transfers between levels of the fair value hierarchy are deemed
to occur at the end of each quarterly reporting period. Transfers
into and out of levels of the fair value hierarchy are primarily
attributable to observability of valuation inputs and price
transparency.
Effect of changes in significant unobservable assumptions to
reasonably possible alternatives
Sensitivity of Level 3 fair values to reasonably possible
alternative assumptions
2018 2017
---------------- --------------- ------- ---------- ----------- --------------- ------- ---------- -----------
Reflected Reflected Reflected Reflected in
in profit in OCI in profit OCI
or loss or loss
--------------- ------- ----------------------- --------------- ------- -----------------------
Un- Un- Un- Favourable Un-
Favourable favourable Favourable favourable Favourable favourable changes favourable
changes changes changes changes changes changes $m changes
Footnotes $m $m $m $m $m $m $m
---------------- ------------------------ ---------- ----------- ------------------------ ---------- -----------
Derivatives,
trading
assets and
trading
liabilities 1 269 (257) - - 372 (253) - -
---------------- --------------- ------- ---------- ----------- --------------- ------- ---------- -----------
Designated and
otherwise
mandatorily
measured
at fair value
through
profit or loss 394 (310) - - 89 (74) - -
---------------- --------------- ------- ---------- ----------- --------------- ------- ---------- -----------
Financial
investments 34 (36) 23 (22) 53 (30) 128 (149)
---------------- --------------- ------- ---------- ----------- --------------- ------- ---------- -----------
At 31 Dec 697 (603) 23 (22) 514 (357) 128 (149)
---------------- ---------------
1 Derivatives, trading assets and trading liabilities are
presented as one category to reflect the manner in which these
instruments are risk managed.
Sensitivity of Level 3 fair values to reasonably possible
alternative assumptions by instrument type
2018
Reflected in profit or loss Reflected in OCI
Un- Un-
Favourable favourable Favourable favourable
changes changes changes changes
$m $m $m $m
142 (105) 117 (102)
66 (39) 3 (39)
1 (1) - -
12 (9) - -
- - - -
249 (150) - -
44 (53) 8 (8)
514 (357) 128 (149)
The sensitivity analysis aims to measure a range of fair values
consistent with the application of a 95% confidence interval.
Methodologies take account of the nature of the valuation technique
employed, as well as the availability and reliability of observable
proxy and historical data.
When the fair value of a financial instrument is affected by
more than one unobservable assumption, the above table reflects the
most favourable or the most unfavourable change from varying the
assumptions individually.
Key unobservable inputs to Level 3 financial instruments
255 HSBC Holdings plc Annual Report and Accounts 2018
The following table lists key unobservable inputs to Level 3
financial instruments, and provides the range of those inputs at 31
December 2018. The core range of inputs is the estimated range
within which 90% of the inputs fall.
Quantitative information about significant unobservable inputs
in Level 3 valuations
Fair value 2018 2017
Footnotes $m $m Lower Higher Lower Higher Lower Higher Lower
Higher
Other derivatives 2,358 1,755
- Interest rate
derivatives:
Model -
securitisation Discounted Prepayment
swaps cash flow rate 6% 7% 6% 7% 20% 90% 20% 90%
Model -
Option
long-dated swaptions model IR volatility 13% 39% 14% 36% 8% 41% 15% 31%
other
- FX derivatives:
Model -
Option
FX options model FX volatility 1% 27% 7% 12% 0.7% 50% 5% 11%
other
- Equity derivatives:
Model -
long-dated single Option Equity
stock options model volatility 5% 83% 5% 81% 7% 84% 15% 44%
other
- Credit derivatives:
other 233 700
1,019 27
250 148
186 244
113 77
215 267
310 216
32 76
Other portfolios 6,443 1
Model -
Discounted
- structured cash Credit
certificates flow volatility 2% 4% 2% 4% 2% 4% 2% 4%
- other 33,013 -
3,430 1
At 31 Dec 2018 16,674 7,142
1 The core range of inputs is the estimated range within which 90% of the inputs fall.
2 Collateralised loan obligation/collateralised debt obligation.
3 'Other' includes a range of smaller asset holdings.
Private equity including strategic investments
Given the bespoke nature of the analysis in respect of each
private equity holding, it is not practical to quote a range of key
unobservable inputs.
Prepayment rates
Prepayment rates are a measure of the anticipated future speed
at which a loan portfolio will be repaid in advance of the due
date. They vary according to the nature of the loan portfolio and
expectations of future market conditions, and may be estimated
using a variety of evidence, such as prepayment rates implied from
proxy observable security prices, current or historical prepayment
rates and macroeconomic modelling.
Market proxy
Market proxy pricing may be used for an instrument when specific
market pricing is not available but there is evidence from
instruments with common characteristics. In some cases it might be
possible to identify a specific proxy, but more generally evidence
across a wider range of instruments will be used to understand the
factors that influence current market pricing and the manner of
that influence.
Volatility
HSBC Holdings plc Annual Report and Accounts 2018 256
Notes on the financial statements
Volatility is a measure of the anticipated future variability of
a market price. It varies by underlying reference market price, and
by strike and maturity of the option.
Certain volatilities, typically those of a longer-dated nature,
are unobservable and are estimated from observable data. The range
of unobservable volatilities reflects the wide variation in
volatility inputs by reference market price. The core range is
significantly narrower than the full range because these examples
with extreme volatilities occur relatively rarely within the HSBC
portfolio.
Correlation
Correlation is a measure of the inter-relationship between two
market prices and is expressed as a number between minus one and
one. It is used to value more complex instruments where the payout
is dependent upon more than one market price. There is a wide range
of instruments for which correlation is an input, and consequently
a wide range of both same-asset correlations and cross-asset
correlations is used. In general, the range of same-asset
correlations will be narrower than the range of cross-asset
correlations.
Unobservable correlations may be estimated based upon a range of
evidence, including consensus pricing services, HSBC trade prices,
proxy correlations and examination of historical price
relationships. The range of unobservable correlations quoted in the
table reflects the wide variation in correlation inputs by market
price pair.
Credit spread
Credit spread is the premium over a benchmark interest rate
required by the market to accept lower credit quality. In a
discounted cash flow model, the credit spread increases the
discount factors applied to future cash flows, thereby reducing the
value of an asset. Credit spreads may be implied from market prices
and may not be observable in more illiquid markets.
Inter-relationships between key unobservable inputs
Key unobservable inputs to Level 3 financial instruments may not
be independent of each other. As described above, market variables
may be correlated. This correlation typically reflects the manner
in which different markets tend to react to macroeconomic or other
events. Furthermore, the effect of changing market variables on the
HSBC portfolio will depend on HSBC's net risk position in respect
of each variable.
HSBC Holdings
257 HSBC Holdings plc Annual Report and Accounts 2018
Notes on the financial statements
Financial investments
The fair values of listed financial investments are determined
using bid market prices. The fair values of unlisted financial
investments are determined using valuation techniques that
incorporate the prices and future earnings streams of equivalent
quoted securities.
Deposits by banks and customer accounts
The fair values of on-demand deposits are approximated by their
carrying value. For deposits with longer-term maturities, fair
values are estimated using discounted cash flows, applying current
rates offered for deposits of similar remaining maturities.
Debt securities in issue and subordinated liabilities
Fair values in debt securities is issue and subordinated
liabilities are determined using quoted market prices at the
balance sheet date where available, or by reference to quoted
market prices for similar instruments.
Repurchase and reverse repurchase agreements - non-trading
Fair values of repurchase and reverse repurchase agreements that
are held on a non-trading basis provide approximate carrying
amounts. This is due to the fact that balances are generally short
dated.
HSBC Holdings
The methods used by HSBC Holdings to determine fair values of
financial instruments for the purposes of measurement and
disclosure are described above. Fair values of HSBC Holdings'
financial instruments not carried at fair value on the balance
sheet
15 Derivatives
Notional contract amounts and fair values of derivatives by
product contract type held by HSBC
Notional contract amount Fair value - Assets Fair value -
Liabilities
Trading Hedging Trading Hedging Total Trading Hedging
Total
$m $m $m $m $m $m $m $m
6,215,518 28,768 78,089 428 78,517 74,915 853 75,768
19,751,577 178,289 235,430 1,365 236,795 229,989 3,042 233,031
-----
590,156 - 9,353 - 9,353 11,845 - 11,845
-----
391,798 - 4,692 - 4,692 5,369 - 5,369
-----
59,716 - 886 - 886 1,233 - 1,233
-----
27,008,765 207,057 328,450 1,793 330,243 323,351 3,895 327,246
-----
(110,425) (110,425)
-----
27,008,765 207,057 328,450 1,793 219,818 323,351 3,895 216,821
The notional contract amounts of derivatives held for trading
purposes and derivatives designated in hedge accounting
relationships indicate the nominal value of transactions
outstanding at the balance sheet date; they do not represent
amounts at risk.
Derivative assets and liabilities decreased during 2018, driven
by the adoption of Settled to Market accounting for cleared
derivatives, yield curve movements and changes in foreign exchange
rates.
Notional contract amounts and fair values of derivatives by
product contract type held by HSBC Holdings with subsidiaries
Notional contract Assets Liabilities
amount
Trading Hedging Trading Hedging Total Trading Hedging Total
$m $m $m $m $m $m $m $m
Foreign exchange 16,623 1,120 207 - 207 628 155 783
Interest rate 44,059 38,148 283 217 500 538 838 1,376
-----
At 31 Dec
2018 60,682 39,268 490 217 707 1,166 993 2,159
Foreign exchange 20,484 1,120 588 - 588 1,330 110 1,440
-----
Interest rate 41,061 25,294 1,364 436 1,800 678 964 1,642
At 31 Dec 2017 61,545 26,414 1,952 436 2,388 2,008 1,074 3,082
Use of derivatives
For details regarding use of derivatives, see page 138 under
'Market Risk'.
Trading derivatives
Most of HSBC's derivative transactions relate to sales and
trading activities. Sales activities include the structuring and
marketing of derivative products to customers to enable them to
take, transfer, modify or reduce current or expected risks. Trading
activities include market-making and risk management. Market-making
entails quoting bid and offer prices to other market participants
for the purpose of generating revenue based on spread and volume.
Risk management activity is undertaken to manage the risk arising
from client transactions, with the principal purpose of retaining
client margin. Other derivatives classified as held for trading
include non-qualifying hedging derivatives.
Substantially all of HSBC Holdings' derivatives entered into
with subsidiaries are managed in conjunction with financial
liabilities designated at fair value. Derivatives valued using
models with unobservable inputs
The difference between the fair value at initial recognition
(the transaction price) and the value that would have been derived
had valuation techniques used for subsequent measurement been
applied at initial recognition, less subsequent releases, is as
shown in the following table:
Unamortised balance of derivatives valued using models with
significant unobservable inputs
Footnotes 2018 $m 2017 $m
Unamortised balance at 1 Jan 106 99
Deferral on new transactions 161 191
Recognised in the income statement during
the year: (158) (187)
- amortisation (96) (85)
(2) (2)
(60) (100)
- subsequent to unobservable inputs becoming
observable
- maturity, termination or offsetting
derivative
Exchange differences (4) 10
Other (19) (7)
Unamortised balance at 31 Dec 1 86 106
1 This amount is yet to be recognised
in the consolidated income statement.
Hedge accounting derivatives
HSBC Holdings plc Annual Report and Accounts 2018 260
Notes on the financial statements
HSBC applies hedge accounting to manage the following risks:
interest rate, foreign exchange and net investment in foreign
operations. Further details on how these risks arise and how they
are managed by the Group can be found in the Report of the
Directors.
Fair value hedges
HSBC enters into fixed-for-floating-interest-rate swaps to
manage the exposure to changes in fair value caused by movements in
market interest rates on certain fixed-rate financial instruments
that are not measured at fair value through profit or loss,
including debt securities held and issued.
HSBC hedging instrument by hedged risk
Hedging instrument
Carrying amount
Notional amount(1) Assets Liabilities Balance sheet Change in
fair value(2)
Hedged risk $m $m $m presentation $m
Interest 123,551 915 2,123 Derivatives 283
rate(3)
At 31 Dec
2018 123,551 915 2,123 283
1 The notional contract amounts of derivatives designated in
qualifying hedge accounting relationships indicate the nominal
value of transactions outstanding at the balance sheet date; they
do not represent amounts at risk.
2 Used in effectiveness testing; comprising the full fair value
change of the hedging instrument not excluding any component.
3 The hedged risk 'interest rate' includes inflation risk.
HSBC hedged item by hedged risk
Hedged item Ineffectiveness
At 31 Dec
2018 94,924 18,951 225 (110) (320) (37)
1 Used in effectiveness assessment; comprising amount
attributable to the designated hedged risk that can be a risk
component.
2 The accumulated amount of fair value adjustments remaining in
the statement of financial position for hedged items that have
ceased to be adjusted for hedging gains and losses were assets of
$93m for FVOCI and assets of $19m for debt issued.
3 The hedged risk 'interest rate' includes inflation risk.
HSBC Holdings hedging instrument by hedged risk
Hedging instrument
Carrying amount
1 The notional contract amounts of derivatives designated in
qualifying hedge accounting relationships indicate the nominal
value of transactions outstanding at the balance sheet date; they
do not represent amounts at risk.
2 Used in effectiveness testing; comprising the full fair value
change of the hedging instrument not excluding any component.
3 The hedged risk 'interest rate' includes foreign exchange risk.
4 The notional amount of non-dynamic fair value hedges is equal
to $39,538m, of which the weighted-average maturity date is
December 2026 and the weighted-average swap rate is 1.34%. The
majority of these hedges are internal to HSBC Group.
HSBC Holdings hedged item by hedged risk
Hedged item Ineffectiveness
At 31 Dec
2018 4,620 33,874 29 (763) 229 (2)
1 Used in effectiveness assessment; comprising amount
attributable to the designated hedged risk that can be a risk
component.
2 The accumulated amount of fair value adjustments remaining in
the statement of financial position for hedged items that have
ceased to be adjusted for hedging gains and losses were liabilities
of $80m for debt issued.
3 The hedged risk 'interest rate' includes foreign exchange risk.
261 HSBC Holdings plc Annual Report and Accounts 2018
Sources of hedge ineffectiveness may arise from basis risk,
including but not limited to the discount rates used for
calculating the fair value of derivatives, hedges using instruments
with a non-zero fair value, and notional and timing differences
between the hedged items and hedging instruments.
For some debt securities held, HSBC manages interest rate risk
in a dynamic risk management strategy. The assets in scope of this
strategy are high-quality fixed-rate debt securities, which may be
sold to meet liquidity and funding requirements.
The interest rate risk of the HSBC fixed-rate debt securities
issued is managed in a non-dynamic risk management strategy. Cash
flow hedges
HSBC's cash flow hedging instruments consist principally of
interest rate swaps and cross-currency swaps that are used to
manage the variability in future interest cash flows of non-trading
financial assets and liabilities, arising due to changes in market
interest rates and foreign-currency basis.
HSBC applies macro cash flow hedging for interest rate risk
exposures on portfolios of replenishing current and forecasted
issuances of non-trading assets and liabilities that bear interest
at variable rates, including rolling such instruments. The amounts
and timing of future cash flows, representing both principal and
interest flows, are projected for each portfolio of financial
assets and liabilities on the basis of their contractual terms and
other relevant factors, including estimates of prepayments and
defaults. The aggregate cash flows representing both principal
balances and interest cash flows across all portfolios are used to
determine the effectiveness and ineffectiveness. Macro cash flow
hedges are considered to be dynamic hedges.
HSBC also hedges the variability in future cash flows on
foreign-denominated financial assets and liabilities arising due to
changes in foreign exchange market rates with cross-currency swaps,
which are considered dynamic hedges.
Hedging instrument by hedged risk
Hedging instrument Hedged item Ineffectiveness
At 31 Dec
2018 64,674 460 791 (275) (267) (8)
1 The notional contract amounts of derivatives designated in
qualifying hedge accounting relationships indicate the nominal
value of transactions outstanding at the balance sheet date; they
do not represent amounts at risk.
2 Used in effectiveness testing; comprising the full fair value
change of the hedging instrument not excluding any component.
3 Used in effectiveness assessment; comprising amount
attributable to the designated hedged risk that can be a risk
component.
Sources of hedge ineffectiveness may arise from basis risk,
including but not limited to timing differences between the hedged
items and hedging instruments and hedges using instruments with a
non-zero fair value.
Reconciliation of equity and analysis of other comprehensive
income by risk type
HSBC Holdings plc Annual Report and Accounts 2018 262
This information is provided by RNS, the news service of the
London Stock Exchange. RNS is approved by the Financial Conduct
Authority to act as a Primary Information Provider in the United
Kingdom. Terms and conditions relating to the use and distribution
of this information may apply. For further information, please
contact rns@lseg.com or visit www.rns.com.
END
ACSJFMRTMBIMBTL
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