The Hongkong and Shanghai
Banking Corporation Limited
Annual Report and Accounts 2019

Contents

Certain defined terms
Page

Certain defined terms

1

Cautionary statement regarding forward-looking statements

1

Chinese translation

1

Financial Highlights

2

Report of the Directors

3

Financial Review

8

Risk

12

Capital51

Statement of Directors’ Responsibilities

54

Independent Auditor’s Report

55

Consolidated Financial Statements
Consolidated income statement

60

Consolidated statement of comprehensive income

61

Consolidated balance sheet

62

Consolidated statement of cash flows

63

Consolidated statement of changes in equity

64

Notes on the Consolidated Financial
Statements
1

Basis of preparation and significant accounting policies

66

2

Operating profit

76

3

Insurance business

78

4

Employee compensation and benefits

79

5

Tax

83

6

Dividends

84

7

Trading assets

85

8

Derivatives

85

9

87

10

Financial assets designated and otherwise mandatorily
measured at fair value through profit or loss
Loans and advances to customers

11

Financial investments

88

12

Assets pledged, assets transferred and collateral received

89

13

Investments in subsidiaries

90

14Interests in associates and joint ventures

90

15

Goodwill and intangible assets

93

16

Property, plant and equipment

95

17

Prepayments, accrued income and other assets

96

18

Customer accounts

96

19

Trading liabilities

96

20

Financial liabilities designated at fair value

96

21

Debt securities in issue

97

22

Accruals and deferred income, other liabilities and provisions

97

23

Subordinated liabilities

98

24

Preference shares

98

25

Share capital

98

26

Other equity instruments

99

27

Maturity analysis of assets and liabilities

99

28

102

29

Analysis of cash flows payable under financial liabilities byremaining contractual maturities
Contingent liabilities, contractual commitments and guarantees

30

Other commitments

103

31

Offsetting of financial assets and financial liabilities

103

32

Segmental analysis

104

33

Related party transactions

106

34

Fair values of financial instruments carried at fair value

108

35

Fair values of financial instruments not carried at fair value

111

36

Structured entities

112

37

Bank balance sheet and statement of changes in equity

114

38

Legal proceedings and regulatory matters

116

39

Ultimate holding company

117

40

Events after the balance sheet date

117

41

Approval of financial statements

117

87

This document comprises the Annual Report and Accounts 2019
for The Hongkong and Shanghai Banking Corporation Limited (‘theBank’) and its subsidiaries (together ‘the group’). References to‘HSBC’, ‘the Group’ or ‘the HSBC Group’ within this document
mean HSBC Holdings plc together with its subsidiaries. Within thisdocument the Hong Kong Special Administrative Region of thePeople’s Republic of China is referred to as ‘Hong Kong’. The
abbreviations ‘HK$m’ and ‘HK$bn’ represent millions and billions(thousands of millions) of Hong Kong dollars respectively.

Cautionary statement regarding forwardlooking statements
This Annual Report and Accounts contains certain forward-looking
statements with respect to the financial condition, results ofoperations and business of the group.
Statements that are not historical facts, including statements
about the Bank’s beliefs and expectations, are forward-looking
statements. Words such as ‘expects’, ‘anticipates’, ‘intends’,‘plans’, ‘believes’, ‘seeks’, ‘estimates’, ‘potential’ and ‘reasonably
possible’, variations of these words and similar expressions areintended to identify forward-looking statements. These statements
are based on current plans, estimates and projections, andtherefore undue reliance should not be placed on them. Forwardlooking statements speak only as of the date they are made, and it
should not be assumed that they have been revised or updated in
the light of new information or future events.
Forward-looking statements involve inherent risks anduncertainties. Readers are cautioned that a number of factors
could cause actual results to differ, in some instances materially,
from those anticipated or implied in any forward-looking
statement.

Chinese translation
A Chinese translation of the Annual Report and Accounts isavailable upon request from: Communications (Asia), Level 32,
HSBC Main Building, 1 Queen’s Road Central, Hong Kong. The
report is also available, in English and Chinese, on the Bank’s
website at www.hsbc.com.hk.

103

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20191

Financial Highlights | Report of the Directors

Financial Highlights
2019

2018

HK$m

HK$m

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

219,381

210,469

Profit before tax

136,433

134,583

Profit attributable to shareholders

105,722103,013

Total shareholders’ equity

814,678752,758

Total equity

879,281812,920

Total capital1

598,934

557,180

Customer accounts

5,432,424

5,207,666

Total assets

8,661,714

8,263,454

For the year

At the year-end

RatiosReturn on average ordinary shareholders’ equity

%

%

13.9

14.8

Post-tax return on average total assets

1.3

1.4

Cost efficiency ratio

42.6

41.5

Net interest margin

2.02

2.06

Advances-to-deposits ratio

68.5

67.8

Common equity tier 1 capital

17.2

16.5

Tier 1 capital

18.8

17.8

Total capital

21.0

19.8

Capital ratios

1

Capital is calculated in accordance with the Banking (Capital) Rules issued by the Hong Kong Monetary Authority (“HKMA”) under section 97C(1)of the Banking Ordinance.

Established in Hong Kong and Shanghai in 1865, The Hongkong and Shanghai Banking Corporation Limited is the founding member ofthe HSBC Group – one of the world’s largest banking and financial services organisations. It is the largest bank incorporated in Hong
Kong and one of Hong Kong’s three note-issuing banks. It is a wholly-owned subsidiary of HSBC Holdings plc, the holding company of
the HSBC Group, which has an international network organised into five geographical regions: Europe, Asia, Middle East and North
Africa, North America and Latin America.

The Hongkong and Shanghai Banking Corporation Limited
Incorporated in the Hong Kong SAR with limited liability
Registered Office and Head Office: HSBC Main Building, 1 Queen’s Road Central, Hong Kong
Telephone: (852) 2822 1111 Facsimile: (852) 2810 1112 Web: www.hsbc.com.hk.
2

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Report of the Directors
Principal Activities
The group provides a comprehensive range of domestic andinternational banking and related financial services, principally in
the Asia–Pacific region.

Asia Strategy
HSBC’s Asian franchise remains integral to the Group’s focus on
growth and value creation for our stakeholders. Leveraging the
HSBC Group’s signature balance sheet strength, privileged accessto high growth Asian markets, and unique history and positioning
as the world’s Leading International Bank, we have made good
progress in executing our key strategic priorities in Asia. We
continue to fortify our leading position in the Greater Bay Area
(including in Hong Kong SAR and the Pearl River Delta), to invest
in growing our business in Southeast Asia, and to enhance ourability to serve more of the region’s growing wealth, insurance,
and asset management needs. We continue to support clients andeconomies participating in the China-led Belt and Road Initiative,
and we re-affirm our commitment as an industry leader insustainable finance to support the world’s ongoing transition to a
low-carbon economy.

Consolidated Financial Statements
The state of affairs of the Bank and the group, and theconsolidated profit of the group, are shown on pages 60 to 117.

Subordinated liabilities, Preference Shares andShare Capital
Details on subordinated liabilities issued by the group are set out
in notes 23 and 33. Details on preference shares and share capitalof the Bank are set out in notes 24, 25 and 26 on the Consolidated
Financial Statements.

Dividends
The interim dividends paid in respect of 2019 are set out in note 6
on the Consolidated Financial Statements.

Directors
The Directors at the date of this report are set out below:

Laura May Lung Cha*, GBM
Chairman
She is an independent non-executive Director of HSBC Holdings plc. She
is also Chairman and an independent non-executive Director of Hong
Kong Exchanges and Clearing Limited; an independent non-executive
Director of Unilever PLC and Unilever N.V.; and a non-executive Director of
The London Metal Exchange. She holds a Bachelor of Arts from Universityof Wisconsin-Madison and a Juris Doctor from University of Santa Clara
Law School. She is also admitted to practice in the State of California andin Federal Courts.

Peter Tung Shun Wong
Deputy Chairman & Chief Executive
He is a Group Managing Director and a member of the GroupManagement Board of HSBC Holdings plc and a non-executive Director ofHang Seng Bank Limited. He is also Chairman and a non-executive
Director of HSBC Bank (China) Company Limited. He holds a Bachelor ofArts, a Master of Business Administration and a Master of Science from
Indiana University.

Zia Mody*
Deputy Chairman
She is a partner of AZB & Partners; an independent non-executive Directorof CLP Holdings Limited; and an independent Director of Ascendas
Property Fund Trustee Pte. Ltd. She holds a Bachelor of Arts (Law) from
Cambridge University and a Master of Laws from Harvard University.

Graham John Bradley*
He is non-executive Chairman and a Director of HSBC Bank Australia
Limited. He is also Chairman and a non-executive Director of Graincorp
Limited; Chairman and a Director of EnergyAustralia Holdings Limited,
Infrastructure New South Wales and Virgin Australia International
Holdings Limited. He holds a Bachelor of Arts and a Bachelor of Laws
(Hons I) from Sydney University and a Master of Laws from Harvard
University.

Louisa Wai Wan Cheang
She is Vice-Chairman and Chief Executive of Hang Seng Bank Limited.
She is also a Group General Manager of HSBC Holdings plc; an
independent non-executive Director of Treasury Wine Estates Limited; andan International Advisor of China Union Pay. She holds a Bachelor ofSocial Sciences from The University of Hong Kong. She is also an
Honorary Certified Financial Management Planner of The Hong Kong
Institute of Bankers.

Dr Christopher Wai Chee Cheng*, GBS, OBE
He is Chairman of Wing Tai Properties Limited; an independent nonexecutive Director of NWS Holdings Ltd.; and an independent nonexecutive Director of Eagle Asset Management (CP) Limited. He holds a
Bachelor of Business Administration from University of Notre Dame; aMaster of Business Administration from Columbia University; a Doctorate
in Social Sciences honoris causa from The University of Hong Kong and an
Honorary Degree of Doctor of Business Administration from The Hong
Kong Polytechnic University.

Dr Raymond Kuo Fung Ch'ien*, GBS, CBE
He is independent non-executive Chairman of Hang Seng Bank Limited.
He is also an independent non-executive Director of China Resources
Power Holdings Company Limited, Swiss Re Limited and Swiss Re Asia
Pte. Ltd. He holds a Bachelor of Arts from Rockford College and a Masterof Arts and Doctor of Philosophy (Economics) from University ofPennsylvania.

Yiu Kwan Choi*
He is an independent non-executive Director of HSBC Bank (China)
Company Limited. He holds a higher certificate in Accountancy from The
Hong Kong Polytechnic University and is a fellow member of The Hong
Kong Institute of Bankers.
He was Deputy Chief Executive of the Hong Kong Monetary Authority(‘HKMA’) in charge of Banking Supervision when he retired in January
2010. Before this, he was Deputy Chief Executive of the HKMA in chargeof Monetary Policy and Reserves Management from June 2005 to August
2007 and held various senior positions in the HKMA including Executive
Director (Banking Supervision), Head of Administration, and Head of
Banking Policy from 1993 to 2005.

Irene Yun-lien Lee*
She is an independent non-executive Director of HSBC Holdings plc andHang Seng Bank Limited. She is also executive Chairman of Hysan
Development Company Limited. She holds a Bachelor of Arts (Distinction)
in History of Art from Smith College, Northampton, Massachusetts, USA.
She is also a member of the Honourable Society of Gray’s Inn, UK and a
Barrister-at-Law in England and Wales.

Jennifer Xinzhe Li*
She is General Managing Partner of Changcheng Investment Partners,
having previously been Chief Executive Officer and General Partner of
Baidu Capital and Chief Financial Officer of Baidu, Inc. She is also an
independent non-executive Director of Philip Morris International Inc, anda non-executive Director of Flex Ltd. and ABB Ltd. She holds a Bachelor ofArts from Tsinghua University and a Master of Business Administrationfrom University of British Columbia.

Victor Tzar Kuoi Li#
He is Chairman and Managing Director of CK Asset Holdings Limited;
Chairman and a Group Co-Managing Director of CK Hutchison Holdings
Limited; Chairman of CK Infrastructure Holdings Limited and CK Life
Sciences Int’l., (Holdings) Inc.; a non-executive Director of Power Assets
Holdings Limited and HK Electric Investments Manager Limited; a nonexecutive Director and Deputy Chairman of HK Electric Investments
Limited; and Co-Chairman of Husky Energy Inc. He is also Deputy
Chairman of Li Ka Shing Foundation Limited, Li Ka Shing (Overseas)
Foundation and Li Ka Shing (Canada) Foundation. He holds a Bachelor of
Science degree in Civil Engineering, a Master of Science degree in Civil
Engineering, both received from Stanford University; and an honorary
degree, Doctor of Laws, honoris causa (LL.D.) from The University ofWestern Ontario.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20193

Report of the Directors

Bin Hwee Quek (née Chua)*, PBM, BBM, JP
She is an independent non-executive Director of CapitaLand Commercial
Trust Management Limited and Mapletree Oakwood Holdings Pte. Ltd.; aDirector of Certis Cisco Security Pte. Ltd.; and Senior Adviser to theEnvision group of companies. She is also a Director of several
government or government-funded organisations in Singapore, including
Duke-NUS Graduate Medical School, Health Promotion Board, Maritime
and Port Authority of Singapore, and National Heritage Board.
She was an audit partner of PricewaterhouseCoopers (PwC) Singapore
until June 2017 and held leadership positions including Vice Chairman of
PwC Singapore and Deputy Markets Leader of PwC Asia-Pacific andAmericas. She holds a Bachelor of Accountancy (Hons) from The
University of Singapore and is a Chartered Accountant with the Instituteof Singapore Chartered Accountants.

Kevin Anthony Westley*, BBS
He is an independent non-executive Director of Fu Tak Iam Foundation
Limited and a member of the investment committee of the West Kowloon
Cultural Development Authority. He holds a Bachelor of Arts (Hons) fromthe University of London (LSE) and is a Fellow of the Institute of Chartered
Accountants in England and Wales.
He was Chairman (from 1996) and Chief Executive (from 1992) of HSBC
Investment Bank Asia Limited (formerly named as Wardley Limited) until
his retirement in 2000 and subsequently acted as an advisor to the Bankand the Group in Hong Kong.

Tan Sri (Sir) Francis Sock Ping Yeoh*, KBE, CBE
He is executive Chairman of YTL Corporation Berhad, YTL Land &Development Berhad, YTL Power International Berhad, YTL Cement
Berhad, Malayan Cement Berhad and executive Chairman and aManaging Director of YTL E-Solutions Berhad. He holds a Bachelor of
Science (Hons) in Civil Engineering and an Honorary Doctorate ofEngineering from the University of Kingston.
* Independent non-executive Director# Non-executive Director

During the year, Marjorie Yang retired as a Director on 4 April 2019
and John Flint stepped down as Chairman and a Director witheffect from 5 August 2019. Laura Cha, an independent nonexecutive Director and a former Deputy Chairman, was appointed
as Chairman with effect from 6 December 2019. Save for theabove, all the Directors served throughout the year.
A list of the directors of the Bank’s subsidiary undertakings(consolidated in the financial statements) during the period from
1 January 2019 to the date of this report will be available on the
Bank’s website https://www.hsbc.com.hk/legal/regulatorydisclosures/.

Secretary
Paul Stafford was appointed as the Corporation Secretary witheffect from 13 January 2020. Neil Olofsson was Corporation
Secretary until 13 December 2019, when Philip Miller assumed the
responsibilities on an interim basis until Paul Stafford's
appointment.

Permitted Indemnity Provision
The Bank’s Articles of Association provide that the Directors andother officers for the time being of the Bank shall be indemnified
out of the Bank’s assets against any liability incurred by them or
any of them as the holder of any such office or appointment to aperson other than the Bank or an associated company of the Bankin connection with any negligence, default, breach of duty or
breach of trust in relation to the Bank or associated company (asthe case may be). In addition, the Bank’s ultimate holding
company, HSBC Holdings plc, has maintained directors’ andofficers’ liability insurance providing appropriate cover for the
directors and officers within the Group, including the Directors of
the Bank and its subsidiaries.

Directors’ Interests in Transactions, Arrangements
or Contracts
Save as disclosed in note 33 on the Consolidated Financial
Statements, no transactions, arrangements or contracts that weresignificant in relation to the Bank’s business and in which a
Director or his or her connected entities had, directly or indirectly,
a material interest were entered into by or subsisted with the
4Bank, its holding companies, its subsidiaries or subsidiaries of its
holding companies during the year.

Directors’ Rights to Acquire Shares or Debentures
To help align the interests of employees with shareholders,
executive Directors of the Bank and those executive Directors of
HSBC Holdings plc are eligible to be granted conditional awards
over ordinary shares in HSBC Holdings plc by that company (being
the ultimate holding company) under the HSBC Share Plan 2011
and the HSBC International Employee Share Purchase Plan.
Executive Directors of the Bank and those executive Directors of
HSBC Holdings plc are eligible to receive an annual incentive
award based on the outcome of the performance measures(financial and non financial) set out in their annual performance
scorecard. Annual incentive awards are normally delivered in cash
and/or shares, and these generally have a deferral rate of 60% or
40% if the annual incentive award is GBP500,000 or below. The
period over which annual incentive awards would be deferred isdetermined in accordance with the requirements of the Prudential
Regulation Authority (‘PRA’) Remuneration Rules, i.e. seven years
for Senior Managers (individuals in PRA and Financial Conduct
Authority (‘FCA’) designation Senior Management Functions), five
years for Risk Managers, and three years for other Material Risk
Takers (‘MRTs’). From January 2017 onwards, all share awards
granted to MRTs are subject to a minimum retention period of one
year as opposed to six months previously. However, for certain
individuals whose variable pay awards will be deferred for at least
five years and who are not considered to be members of senior
management, their retention period may be kept at six months.
All unvested deferred awards made under the HSBC Share Plan
2011 are subject to the application of malus, i.e. the cancellation
and reduction of unvested deferred awards. All paid or vested
variable pay awards made to Identified Staff and MRTs will be
subject to clawback for a period of seven years from the date ofaward. For Senior Managers, this may be extended to 10 years in
the event of an ongoing internal or regulatory investigation at theend of the seven-year period.
Executive Directors and other senior executives of HSBC Holdings
plc are subject to Group minimum shareholding requirements.
Individuals are given five years from 2014 or (if later) their
appointment to build up the recommended levels of shareholding.
HSBC operates an anti-hedging policy for Group, sectorial andlocal MRTs including executive Directors in accordance with the
PRA Rules, who are required to certify each year via the Bank's
Global Personal Account Dealing system that they have notentered into any personal hedging strategies in relation to theirholdings of HSBC shares.
The HSBC International Employee Share Purchase Plan is an
employee share purchase plan offered to employees in Hong Kong
since 2013 and has been extended to further countries in the
HSBC Group from 2014. For every three shares in HSBC Holdings
plc purchased by an employee (‘Investment Shares’), a conditional
award to acquire one share is granted (‘Matching Shares’). The
employee becomes entitled to the Matching Shares subject tocontinued employment with HSBC and retention of the Investment
Shares until the third anniversary of the start of the relevant plan
year. HSBC Holdings Savings-Related Share Option Plan (UK) is an
all employee share plan under which eligible employees may be
granted options to acquire HSBC Holdings ordinary shares.
Employees may make monthly contributions, up to a maximum
defined limit, over a period of three or five years and shares are
exercisable within six months following either the third or fifth
anniversary of the commencement. The exercise price is set at a
20% discount to the market value immediately preceding the dateof invitation.
During the year, John Flint, Peter Wong and Louisa Cheangacquired or were awarded shares of HSBC Holdings plc under theterms of the HSBC Share Plan 2011. John Flint also exercised
options over ordinary shares in HSBC Holdings plc under the
HSBC Holdings Savings-Related Share Option Plan (UK).
Apart from these arrangements, at no time during the year was
the Bank, its holding companies, its subsidiaries or any fellow

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019subsidiaries a party to any arrangements to enable the Directors toacquire benefits by means of the acquisition of shares in ordebentures of the Bank or any other body corporate.

Donations

implementation of the strategy and policy as established by the
Board and the day-to-day running of operations. The Chief
Executive is Chairman of the Executive Committee. Each AsiaPacific Global Business and Global Function head reports to theChief Executive.

Donations made by the Bank and its subsidiaries during the year
amounted to HK$339m (2018: HK$302m).

Board Committees

Compliance with the Banking (Disclosure) Rules
The Directors are of the view that the Annual Report and Accounts
2019 and Banking Disclosure Statements 2019, fully comply with
the Banking (Disclosure) Rules made under section 60A of the
Banking Ordinance.

Auditor
The Annual Report and Accounts have been audited byPricewaterhouseCoopers (‘PwC’). A resolution to reappoint PwC
as auditor of the Bank will be proposed at the forthcoming AGM.

Corporate Governance
The Bank is committed to high standards of corporate governance.
As an Authorised Institution, the Bank is subject to and complies
with the Hong Kong Monetary Authority (‘HKMA’) Supervisory
Policy Manual CG-1 ‘Corporate Governance of Locally
Incorporated Authorised Institutions’.

Board of Directors
The Board, led by the Chairman, provides entrepreneurial
leadership of the Bank within a framework of prudent andeffective controls which enables risks to be assessed andmanaged. The Board is collectively responsible for the long-term
success of the Bank and delivery of sustainable value toshareholders. The Board sets the strategy and risk appetite for thegroup and approves capital and operating plans presented bymanagement for the achievement of the strategic objectives it has
set.

Directors
The Bank has a unitary Board. The authority of each Director is
exercised in Board meetings where the Board acts collectively. As
at the date of this report, the Board comprised: the independent
non-executive Chairman; the Deputy Chairman and Chief
Executive; one Deputy Chairman who is an independent nonexecutive Director; one Director with executive responsibilities fora subsidiary’s operations; one non-executive Director; and anothernine independent non-executive Directors.

Independent non-executive Directors
Independent non-executive Directors do not participate in the daily
business management of the Bank. They bring an external
perspective, constructively challenge and help develop proposals
on strategy, scrutinise the performance of management in meeting
agreed goals and objectives, and monitor the risk profile andreporting of performance of the Bank. The independent nonexecutive Directors bring experience from a number of industries
and business sectors, including the leadership of large complex
multinational enterprises. The Board has determined that there are
11 independent non-executive Directors. In making thisdetermination, it was agreed that there are no relationships orcircumstances likely to affect the judgement of the independent
non-executive Directors, with any relationships or circumstancesthat could appear to do so not considered to be material.

Chairman and Chief Executive
The roles of Chairman and Chief Executive are separate and held
respectively by an experienced independent non-executive
Director and a full-time employee of the HSBC Group. There is aclear division of responsibilities between leading the Board andthe executive responsibility for running the Bank’s business.
The Chairman provides leadership to the Board and is responsible
for the overall effective functioning of the Board. The Chairman
shall lead the Board in the development of strategy in Asia-Pacificand the oversight of implementation of Board approved strategies
and direction. The Chief Executive is responsible for ensuring

The Board has established various committees consisting of
Directors and senior management. The committees include the
Executive Committee, Audit Committee, Risk Committee,
Nomination Committee, Remuneration Committee and Chairman's
Committee. The Chairmen of the Executive Committee and of each
Board committee that includes independent non-executive
Directors report to each subsequent Board meeting on the relevant
committee’s proceedings.
The Board has also established an Asset, Liability and CapitalManagement Committee (formerly known as Asset and Liability
Management Committee), a Risk Management Meeting and a
Financial Crime Risk Management Committee. The Executive
Committee has the delegated authority to approve any changes in
the membership and terms of reference of the Asset, Liability andCapital Management Committee, the Risk Management Meetingand the Financial Crime Risk Management Committee.
The Board and each Board committee have terms of reference todocument their responsibilities and governance procedures. The
key roles of the committees are described in the paragraphs
below.

Executive Committee
The Executive Committee is responsible for the exercise of all of
the powers, authorities and discretions of the Board in so far as
they concern the management, operations and day-to-day runningof the group, in accordance with such policies and directions as
the Board may from time to time determine, with power to subdelegate. A schedule of items that require the approval of theBoard is maintained.
The Bank’s Deputy Chairman and Chief Executive, Peter Wong, is
Chairman of the Committee. The current members of theCommittee are: Diana Cesar (Chief Executive Officer Hong Kong),
Pui Mun Chan (Head of Regulatory Compliance Asia-Pacific),David Grimme (Chief Operating Officer Asia-Pacific), Gordon
French (Head of Global Banking and Markets Asia-Pacific), Ming
Lau (Chief Financial Officer Asia-Pacific), Tony Cripps (Chief
Executive Officer Singapore), Mukhtar Hussain (Head of Belt andRoad Initiative Asia-Pacific), Darren Furnarello (Head of Financial
Crime Compliance Asia-Pacific), David Liao (Chief Executive
Officer China), Kevin Martin (Head of Retail Banking and WealthManagement Asia-Pacific), Edward Jenkins (Chief Risk Officer
Asia-Pacific), Stuart Milne (Chief Executive Officer Malaysia),
Surendranath Rosha (Chief Executive Officer India), Siew Meng
Tan (Head of Global Private Banking Asia-Pacific), Matthew Lobner(Head of Strategy and Planning Asia-Pacific and Head ofInternational Asia-Pacific), Susan Sayers (General Counsel AsiaPacific), Stuart Tait (Head of Commercial Banking Asia-Pacific) andDavid Thomas (Head of Human Resources, Asia-Pacific). Paul
Stafford (Corporation Secretary) is the Committee Secretary. In
attendance are: Kaber Mclean (Head of Remediation Management
Office Asia-Pacific), Patrick Humphris (Head of Communications
Asia-Pacific), Astor Law (Head of Global Internal Audit Asia-Pacific)
Noel McNamara (Acting Chief Executive Officer Australia) andPhilip Miller (Deputy Corporation Secretary). The Committee met
12 times in 2019.

Asset, Liability and Capital Management
Committee
The Asset, Liability and Capital Management Committee (‘ALCO’)is chaired by the Chief Financial Officer and is an advisorycommittee to provide recommendations and advice to support theChief Financial Officer's individual accountability for the efficientmanagement of the Bank’s balance sheet within the constraints ofliquidity, funding and capital, and other key balance sheet risks
such as interest rate risk, market risk and equity risk.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20195

Report of the Directors

The Committee consists of Ming Lau (Chief Financial Officer AsiaPacific), Peter Wong (the Bank's Deputy Chairman and Chief
Executive), the Head of Asset, Liability and Capital Management
Asia-Pacific, the Head of Balance Sheet Management Asia-Pacificand other senior executives of the Bank most of whom aremembers of the Executive Committee. The Committee met 12
times in 2019.

Risk Management Meeting
The Risk Management Meeting is chaired by the Chief Risk Officer
and is a formal governance committee established to provide
recommendations and advice to the Chief Risk Officer onenterprise-wide management of all risks, including key policies
and frameworks for the management of risk within the Bank. The
Risk Management Meeting consists of Edward Jenkins (Chief Risk
Officer Asia-Pacific), Peter Wong (the Bank’s Deputy Chairman
and Chief Executive), the Head of Global Internal Audit Asia-Pacificand other senior executives of the Bank most of whom aremembers of the Executive Committee. The Risk Management
Meeting met 10 times in 2019.

Financial Crime Risk Management Committee
The Financial Crime Risk Management Committee is chaired by
the Bank’s Deputy Chairman and Chief Executive and is a formal
governance committee established to ensure effective enterprisewide management of financial crime risk within the Asia–PacificRegion and to support the Chief Executive in discharging his
financial crime risk responsibilities. The Committee consists ofPeter Wong (the Bank's Deputy Chairman and Chief Executive),
the Head of Financial Crime Compliance Asia–Pacific, the Head ofOperational Risk Asia-Pacific, the Head of Remediation Office
Asia-Pacific, and other senior executives of the Bank most ofwhom are members of the Executive Committee. The Committee
met 10 times in 2019.

Audit Committee
The Audit Committee has non-executive responsibility foroversight of and advice to the Board on matters relating tofinancial reporting and internal financial controls. The current
members of the Committee, all being independent non-executive
Directors, are Kevin Westley (Chairman of the Committee),
Graham Bradley, Yiu Kwan Choi, Irene Lee and Jennifer Li. The
Committee met four times in 2019.
The Audit Committee monitors the integrity of the Consolidated
Financial Statements and disclosures relating to financial
performance, the effectiveness of the internal audit function andthe external audit process, and the effectiveness of internalfinancial control systems. The Committee reviews the adequacy of
resources and expertise as well as succession planning for thefinance function. It reviews, and considers changes to, the Bank’s
accounting policies. The Committee advises the Board on theappointment, re-appointment, or removal of the external auditor
and reviews and monitors the external auditor’s independence andobjectivity. The Committee reviews matters escalated for its
attention by subsidiaries’ audit committees and reviews minutesof meetings of the Asset, Liability and Capital Management
Committee.

Risk Committee
The Risk Committee has non-executive responsibility for oversightof and advice to the Board on risk-related matters impacting the
Bank and its subsidiaries, including risk governance and internal
control systems (other than internal controls over financial
reporting). The current members of the Committee, all being
independent non-executive Directors, are Graham Bradley(Chairman of the Committee), Christopher Cheng, Yiu Kwan Choi,
Irene Lee, Zia Mody and Kevin Westley. The Committee met fivetimes in 2019.
All of the Bank’s activities involve, to varying degrees, theidentification, assessment, monitoring and management of risk or
combinations of risks. The Board, advised by the Risk Committee,
requires and encourages a strong risk culture which shapes the
Bank’s attitude to risk. The Bank’s risk governance is supported by
the Group’s enterprise risk management framework which
6

provides a clear policy of risk ownership and accountability of all
staff for identifying, assessing and managing risks within thescope of their assigned responsibilities. This personalaccountability, reinforced by clear and consistent employee
communication on risk that sets the tone from senior leadership,
the governance structure, mandatory learning and remuneration
policy, helps to foster a disciplined and constructive culture of risk
management and control throughout the group.
The Board and the Risk Committee oversee the maintenance anddevelopment of a strong risk management framework bycontinually monitoring the risk environment, top and emerging
risks facing the group and mitigating actions planned and taken.
The Risk Committee reviews any revisions to the group’s risk
appetite statement at least annually and recommends any
proposed changes to the Board for approval. The Committee
reviews management’s assessment of risk against the risk
appetite statement and provides scrutiny of management’s
proposed mitigating actions. The Committee monitors the risk
profiles for all of the risk categories within the group’s business.
The Committee also monitors the effectiveness of the Bank’s risk
management and internal controls other than those over financial
reporting. Regular reports from the Risk Management Meeting,which is the executive body supporting the executive
accountability of the group Chief Risk Officer for the ongoing
monitoring, assessment and management of the risk environment
and the effectiveness of the risk management framework, are alsopresented at each Risk Committee meeting to report on these
items. The Committee reviews matters escalated for its attention
by subsidiaries’ risk committees and reviews minutes of meetingsof the Risk Management Meeting.

Nomination Committee
The Nomination Committee is responsible for leading the process
for Board and senior management appointments and for
identifying and nominating, for the approval of the Board,candidates for appointment to the Board and certain senior
management roles. Appointments to the Board and certain senior
management roles are subject to the approval of the HKMA. The
Committee considers plans for orderly succession to the Boardand the appropriate balance of skills, knowledge and experienceon the Board.
The current members of the Committee, all being independent
non-executive Directors, are Christopher Cheng (Chairman of theCommittee), Laura Cha (Chairman of the Board) and Zia Mody. The
Deputy Chairman and Chief Executive attends each meeting of theCommittee. The Committee met once in 2019. The Committee also
approved a number of matters during the year by written
resolutions of all members.
A rigorous selection process, overseen by the Nomination
Committee and based upon agreed requirements using an external
search consultancy, is followed in relation to the appointment of
non-executive Directors. Before recommending an appointment ofa Director to the Board, the Committee evaluates the Board
composition including balance of skills, knowledge andexperience, as well as diversity and the role and capabilities
required. In identifying suitable Board candidates, the Committee
considers candidates’ backgrounds, knowledge and experience(including international experience) to promote diversity of views,
and takes into account the required time commitment and any
potential conflicts of interest.

Chairman’s Committee
The Chairman’s Committee acts on behalf of the Board either inaccordance with authority delegated by the Board from time totime, or as specifically set out within its terms of reference. The
Committee meets with such frequency and at such times as it may
determine and can implement previously agreed strategic
decisions by the full Board, approve specified matters subject totheir prior review by the full Board, and act exceptionally on urgent
matters within its terms of reference.
The current members of the Committee comprise the Chairman of
the Board, the Deputy Chairman and Chief Executive, the non-

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

executive Deputy Chairman and the Chairmen of the Audit andRisk Committees. The Committee met twice in 2019.

Remuneration Committee
The Group Remuneration Committee is responsible for setting theoverarching principles, parameters and governance for the Group‘sremuneration framework applicable to all Group employees.
Following revisions to the HKMA’s Supervisory Policy Manual
CG-1 ‘Corporate Governance of Locally Incorporated Authorised
Institutions’, the Board established a Remuneration Committeewith effect from 1 January 2018 which annually reviews theeffectiveness and compliance of the Group's reward strategy as
adopted by the Bank. The current members of the Committee, allbeing independent non-executive Directors, are Irene Lee(Chairman of the Committee), Christopher Cheng, Jennifer Li and
Bin Hwee Quek. The Committee met four times in 2019. The
following is a summary of the Committee's key activities during
2019:

Details of the Committee’s key activities
Senior Management*

All employees• Reviewed and approved senior management population's remuneration
matters and pay proposals• Reviewed and approved the scorecards for the Chief Executive andExecutive Committee members of the group• Approved Remuneration Committee section in the Report of the Directors• Approved 2018/2019 performance year pay review matters• Reviewed remuneration framework effectiveness• Received updates on notable events and regulatory and corporate
governance matters• Reviewed and approved 2019 Material Risk Taker (‘MRT’) identification
approaches and outcomes of MRT review under the Group definition andas defined by some of its principal subsidiaries, as applicable• Reviewed attrition data and plans to address area of concerns• Approved 2019 regulatory submissions* Senior Management includes the Chief Executive of the group, Chief Executive of Hang Seng Bank Limited, Executive Committee members,
Alternate Chief Executives, Managers as registered with the Hong Kong Monetary Authority (HKMA).

Remuneration Strategy
Our remuneration strategy is designed to reward competitively theachievement of long-term sustainable performance, and attract
and motivate the very best people, regardless of gender, ethnicity,age, disability or any other factor unrelated to performance orexperience with the Group. We believe that remuneration is an
important tool for instilling the right behaviours, and driving andencouraging actions that are aligned to organisational values andthe long-term interests of our stakeholders. Our remuneration
strategy, as approved by the Group Remuneration Committee andadopted subject to annual review by the Bank's Remuneration
Committee, is based on the following principles:• An alignment to performance at all levels (individual, businessand Group) taking into account both ‘what’ has been achievedand ‘how’ it has been achieved. The ‘how’ helps ensure that
performance is sustainable in the longer term, consistent with
HSBC’s values and risk and compliance standards.
• Being informed, but not driven by, market position andpractice. Market benchmarks are sourced through independent
specialists and provide an indication of the range of pay levels
and employee benefits provided by our competitors.
• Considering the full-market range when making pay decisions
for employees, taking into account the individual’s and theGroup’s performance in any given year. An individual’s pay willvary depending upon their performance.
• Compliance with relevant regulation across all of our countries
and territories.
More details of the Bank’s remuneration strategy are contained
within the Annual Report and Accounts 2019 of HSBC Holdingsplc.
The Bank as an authorised institution under the Banking
Ordinance is required by HKMA Supervisory Policy Manual CG-5
'Guideline on a Sound Remuneration System' (the Guideline) toassess whether their existing remuneration systems and policy arein line with the principles in the Guideline, independently of
management and at least annually. The annual review for 2019was commissioned externally to Deloitte LLP, and the results
confirm that the Bank’s remuneration framework as adopted fromthe Group is consistent with the principles set out in the Guideline.

Banking structural reform and recovery andresolution planning
The Financial Institutions (Resolution) (Loss-absorbing Capacity
Requirements–Banking Sector) Rules (‘LAC Rules’) came into
operation in Hong Kong in December 2018, under the powers set
out in the Financial Institutions (Resolution) Ordinance (‘FIRO’)
which came into effect in 2017. Within the LAC Rules, the groupneeds to have sufficient loss-absorbing capacity (‘LAC’) which canbe written down or converted into equity at an intermediateholding company in Hong Kong to recapitalise the group as awhole in the event of failure.
HSBC Asia Holdings Limited, a wholly-owned subsidiary of HSBC
Holdings plc and the intermediate holding company of the groupsince November 2018, is designated as the resolution entity for thegroup, where adequate LAC has to be available in a form that will
be bailed-in at the point of resolution. The group completed therestructuring of its internal regulatory capital and LAC-eligible debt
and equity instruments such that they are all held by HSBC Asia
Holdings Limited, in compliance with LAC requirements as at
1 July 2019.
During 2019, the group also made progress in mitigating
operational dependencies, where one group entity provides criticalservices to another, to facilitate operational continuity inresolution. In particular, a substantial number of employees
performing critical shared services in Hong Kong have beentransferred from the group into a separate service company inHong Kong, HSBC Global Services (Hong Kong) Limited (the‘ServCo’), which is outside the group but is wholly-owned by
HSBC Holdings plc. There were no changes to employment terms
and conditions or pension benefits as a result of these transfers.

Business review
The Bank is exempt from the requirement to prepare a business
review under section 388(3) of the Companies Ordinance Cap. 622
since it is a wholly-owned subsidiary of HSBC Holdings plc.

On behalf of the Board

Laura Cha, Chairman
18 February 2020

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20197

Financial Review

Financial Review
Results for 2019
Profit before tax for 2019 reported by The Hongkong and Shanghai Banking Corporation Limited (‘the Bank’) and its subsidiaries (together‘the group’) increased by HK$1,850m, or 1%, to HK$136,433m.
Consolidated income statement and balance sheet data by global business(Audited)
Retail Banking
and WealthManagement

Commercial
BankingGlobal Banking
and Markets

Global Private
Banking

Corporate
Centre1

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Net interest income

68,37442,80725,1402,956(8,374)130,903

Net fee income

18,647

9,960

9,977

2,839

82

41,505

Net income from financial instruments measured at fairvalue

16,0382,699

17,4091,095

13,21750,458

20

—

—

—

618

638

56,222

4,380

—

—

(327)

60,275

Year ended 31 Dec 2019

Gains less losses from financial investments
Net insurance premium income/(expense)
Other operating income

13,793

434

828

119

584

15,758

Total operating income

173,094

60,28053,354

7,009

5,800

299,537

Net insurance claims and benefits paid and movement inliabilities to policyholders(75,628)(4,528)———(80,156)

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

97,46655,75253,354

7,009

5,800

219,381of which: – external

62,22653,20871,511

5,442

26,994

219,381

35,2402,544(18,157)

1,567(21,194)—– inter-segment
Change in expected credit losses and other credit
impairment charges(2,078)(3,029)

(549)

1

(17)

(5,672)

Net operating income

95,38852,72352,805

7,010

5,783

213,709

Operating expenses(41,756)(19,212)(23,319)(4,013)(5,194)(93,494)

Operating profit

53,63233,511

29,486

2,997

589

120,215

Share of profit in associates and joint ventures

346

—

—

—

15,872

16,21853,97833,511

29,486

2,997

16,461

136,433

Loans and advances to customers (net)1,244,236

1,244,007

1,066,235

164,895

1,502

3,720,875

Customer accounts

2,903,203

1,344,590

983,682

197,654

3,295

5,432,424

Net interest income

62,82939,004

22,590

2,683

(643)

126,463

Net fee income

21,087

10,598

9,794

2,650

102

44,231

Net income/(expense) from financial instruments
measured at fair value(3,731)

2,694

18,283800

7,919

25,965

109

(34)

104

—

322

501

57,301

3,441

—

—

(64)

60,678

Profit before tax
Balance sheet data at 31 Dec 2019Year ended 31 Dec 2018

Gains less losses from financial investments
Net insurance premium income/(expense)
Other operating income

5,851

508

737

110

3,264

10,470Total operating income

143,446

56,21151,5086,243

10,900268,308

Net insurance claims and benefits paid and movement inliabilities to policyholders(54,539)(3,300)———(57,839)

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

88,90752,91151,5086,243

10,900210,469of which: – external

62,27750,05964,626

4,422

29,085

210,469

26,6302,852(13,118)

1,821(18,185)—– inter-segment
Change in expected credit losses and other credit
impairment charges(2,019)(2,315)

(394)

(13)

21

(4,720)Net operating income

86,88850,596

51,114

6,230

10,921

205,749

Operating expenses(38,946)(17,878)(21,807)(3,479)(5,314)(87,424)

Operating profit

47,942

32,71829,307

2,751

5,607

118,325

Share of profit in associates and joint ventures

247

—

—

—

16,011

16,25848,18932,71829,3072,751

21,618

134,583

Loans and advances to customers (net)1,146,689

1,223,999

1,035,629

120,985

1,400

3,528,702

Customer accounts

2,750,104

1,306,775

949,812

196,413

4,562

5,207,666

Profit before tax
Balance sheet data at 31 Dec 2018

1 Includes inter-segment elimination.

8

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Financial Review(Unaudited)

The commentary that follows compares the group's financial
performance for the years ended 2019 with 2018.

Results Commentary
The group reported profit before tax of HK$136,433m, an increaseof HK$1,850m, or 1%, driven by higher net insurance income,higher net interest income and higher income from financial
instruments held for trading or managed on a fair value basis,
partly offset by higher operating expenses.
Net interest income increased by HK$4,440m, or 4%, withincreases across all global businesses and mainly in Hong Kong,
primarily from growth in loans and advances to customers,
coupled with improved customer deposit spreads. Net interest
income in India and Singapore also increased, driven by growth inloans and advances to customers. These were partly offset bydecreases in mainland China, Australia and Taiwan due to higher
funding costs to support business activities.
Net fee income decreased by HK$2,726m, or 6%, primarily in
Retail Banking and Wealth Management (‘RBWM’). The decrease
was driven by Hong Kong from lower securities brokerage due tolower equity market turnover in 2019, lower income from funds
under management and unit trusts, coupled with lower net fee
income from credit cards due to higher rewards and bonus points
expenses. To a lesser extent, net fee income also decreased inCommercial Banking ('CMB'), mainly in trade-related andremittance fees.
Net income from financial instruments measured at fairvalue through profit or loss increased by HK$24,493m, or 94%.
Net income from financial instruments held for trading or
managed on a fair value basis increased by HK$4,318m, or 13%,driven by Hong Kong, mainly from Rates and Credit trading, andmainland China from lower cost on structured deposits, coupledwith higher Rates trading income.
Net income from assets and liabilities of insurance business,
including related derivatives, measured at fair value through profit
or loss increased by HK$19,818m, mainly in Hong Kong driven byrevaluation gains on the equity portfolio held to back insurance
and investment contracts from the favourable equity market
movements in 2019, as compared to revaluation losses in 2018. To
the extent that these gains are attributable to policyholders, thegains are offset by a corresponding movement in ‘Net insurance
claims and benefits paid and movement in liabilities topolicyholders’.

Other operating income increased by HK$5,288m, or 51%,
driven by the favourable movement in the present value of in-force
long-term insurance business ('PVIF'), primarily in Hong Kong. To
the extent that these gains are attributable to policyholders, thegains are offset by a corresponding movement in ‘Net insurance
claims and benefits paid and movement in liabilities topolicyholders’. The impact from the favourable change in PVIF waspartly offset by lower recoveries from fellow group companies due
to a change in the cost recharge mechanism following the transferof shared services and operations to the HSBC Global Service(Hong Kong) Limited ('ServCo') in 2019, with a corresponding
decrease in 'operating expenses'.
Net insurance claims and benefits paid and movement inliabilities to policyholders increased by HK$22,317m, or 39%,
reflecting higher investment returns to policyholders due to thefavourable equity market performance in 2019, coupled withhigher premium income and the favourable movement in PVIF,
partly offset by the major reinsurance arrangement in 2019.
Change in expected credit losses and other credit
impairment charges increased by HK$952m, or 20%, driven by
CMB mainly in Hong Kong due to increased provisions to reflect
the deterioration in the Hong Kong and global economic outlook,partly offset by lower specific charges.
Total operating expenses increased by HK$6,070m, or 7%, withincreases across all global businesses. The increase was driven byhigher IT and staff costs to support growth initiatives, wage
inflation and higher management charges from ServCo following
the transfer of over 8,500 employees to ServCo during the year.
Depreciation charges also increased due to a change in valuationbase of certain properties from cost to fair value following theimplementation of HKFRS 16. These increases were partly offset
by the release of a customer remediation provision in Hong Kong,
release of a provision in relation to a tax matter in Indonesia, andfrom a change in cost recharge mechanism from fellow groupcompanies as mentioned above.
Share of profit in associates and joint ventures decreased by
HK$40m, driven by an unfavourable effect of foreign exchangetranslation. Excluding this impact, share of profit in associates andjoint ventures increased by HK$667m, mainly from Bank ofCommunications Co., Limited.

Net insurance premium income decreased slightly by
HK$403m, or 1%, driven by higher reinsurance ceded in 2019 inHong Kong. Gross insurance premium income (excluding theimpact from reinsurance arrangements) increased by 10%, mainlyin Hong Kong from higher renewal premiums and new businesssales. These were largely offset by a corresponding movement in‘Net insurance claims and benefits paid and movement in liabilities
to policyholders’.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20199

Financial Review

Net interest income(Unaudited)

Net interest income
Average interest-earning assets

2019

2018

HK$m

HK$m

130,903

126,4636,464,424

6,151,920%%

Net interest spread

1.87

1.93

Contribution from net free funds

0.15

0.13

Net interest margin

2.02

2.06

Net interest income (‘NII’) increased by HK$4,440m, or 4%,
with increases across all global businesses and mainly in Hong
Kong, primarily from growth in loans and advances to customers,
coupled with improved customer deposit spreads. NII in India andSingapore also increased, driven by growth in loans and advances
to customers. These were partly offset by decreases in mainland
China, Australia and Taiwan due to higher funding costs to support
business activities.
Average interest-earning assets increased by HK$313bn, or
5%, driven by Hong Kong primarily due to an increase in loans andadvances to customers, notably in corporate term lending andmortgages. To a lesser extent, increases were also noted in
Singapore, Australia and India, mainly from growth in loans andadvances to customers.
Net interest margin decreased by four basis points, driven bymainland China, Australia and Taiwan, partly offset by an increasein Hong Kong.
At the Bank’s operations in Hong Kong, the net interest marginincreased by one basis point, mainly from improved customer
deposit spreads and higher reinvestment yields on financial

investments which benefited from higher market interest rates
compared to the prior year, coupled with the change in asset
portfolio mix due to growth in customer lending. These increases
were partly offset by compressed lending spreads in mortgages
and corporate lending.
At Hang Seng Bank, the net interest margin decreased by threebasis points, mainly from compressed lending spreads and fromfinancial liabilities raised to meet the ‘Total Loss Absorbing
Capacity’ regulatory requirement. These were partly offset by
improved customer deposit spreads, higher reinvestment yields on
financial investments, coupled with higher contribution from net
free funds as market interest rates increased.
In mainland China, the decrease in net interest margin was driven
by higher cost of funds from increased funding to support
business growth, coupled with lower reinvestment yields fromfinancial investments due to ample liquidity in the market.
In Australia and Taiwan, net interest margin decreased mainly due
to higher cost of funds following increases in market interest rates
in the prior year.

Insurance business(Unaudited)

The following table shows the results of our insurance manufacturing operations by income statement line item, and separately the
insurance distribution income earned by the group's bank channels.
Results of insurance manufacturing operations and insurance distribution income earned by the group's bank channels
2019

2018

HK$m

HK$m

Net interest income

14,634

13,650Net fee expense(4,424)(3,162)

Net income/(expense) from financial instruments measured at fair value

13,633(6,279)Net insurance premium income

60,57760,713

Change in present value of in-force long-term insurance business

12,546

4,629

Insurance manufacturing operations1

Other operating income

267

529

Total operating income

97,23370,080Net insurance claims and benefits paid and movement in liabilities to policyholders(80,156)(57,839)

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

17,077

12,241

Change in expected credit losses and other credit impairment charges
Net operating income

(113)

1

16,964

12,242

Total operating expenses(2,095)(2,217)

Operating profit

14,86910,025

Share of profit in associates and joint ventures

346

246

Profit before tax

15,215

10,271

Annualised new business premiums of insurance manufacturing operations

22,39521,804

Distribution income earned by the group's bank channels

5,800

5,726

1

The results presented for insurance manufacturing operations are shown before elimination of intercompany transactions with the group's noninsurance operations.

10

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Insurance manufacturing
Profit before tax from the insurance manufacturing operations
increased by HK$4,944m, or 48%, driven by the favourable equity
market performance in 2019 (compared with adverse equity
markets in 2018), together with growth in the value of new
business.
Net interest income increased by 7% from growth in invested
funds, reflecting net new business and renewal premium inflows
on life insurance contracts.
Net income from financial instruments measured at fair value
increased significantly, driven by revaluation gains on the equity
portfolio held to support insurance and investment contracts, ascompared to revaluation losses in 2018.
Net insurance premium income decreased slightly, driven byhigher reinsurance ceded in 2019 in Hong Kong. Gross insurance
premium income (excluding the impact from reinsurance
arrangements) increased by 10%, mainly in Hong Kong fromhigher renewal premiums and new business sales.
The higher movement in the present value of in-force long-term
insurance business was driven by Hong Kong, mainly from theoffsetting of the effect of interest rate changes on the valuation of
the liabilities under insurance contracts, actuarial assumption andmethodology updates, and from higher value of new businesswritten in 2019. For further details, please see note 15 on theConsolidated Financial Statements.
To the extent that the above gains or losses are attributable topolicyholders, there is an offsetting movement reported under ‘Net
insurance claims and benefits paid and movement in liabilities topolicyholders'.
Annualised new business premiums (‘ANP’) is a measure of new
insurance premium generation by the business. It is calculated as
the sum of 100% of annualised first year regular premiums and
10% of single premiums, before reinsurance ceded. Growth in
ANP during the year reflected new business growth in all
insurance manufacturing markets, principally in Hong Kong.

Balance sheet commentary compared with
1 January 2019
(Unaudited)

The consolidated balance sheet at 31 December 2019 is set out in
the Consolidated Financial Statements.
The effect of transitioning to HKFRS 16 'Leases' on 1 January
2019 was an increase in total assets by HK$25bn, increase in total
liabilities by HK$12bn, and an increase in shareholders’ equity by
by HK$13bn. The commentary that follows compares our balance
sheet at 31 December 2019 with that at 1 January 2019.
Gross loans and advances to customers increased by
HK$193bn, or 5%, including unfavourable foreign currencytranslation effects of HK$5bn. Excluding this impact, theunderlying increase of HK$198bn was driven by an increase inresidential mortgages of HK$91bn, mainly in Hong Kong andAustralia, coupled with an increase in other personal lending of
HK$44bn, mainly in Hong Kong and Singapore. Non-bank financial
institution lending also increased by HK$38bn, mainly in Hong
Kong.
Overall credit quality remained strong, with total gross impairedloans and advances as a percentage of gross loans and advances
standing at 0.56% at the end of 2019. Change in expected credit
losses in 2019 in relation to average gross customer advances
remained low at 0.15% (2018: 0.13%).

Interest in associates and joint ventures
At 31 December 2019, an impairment review on the group’s
investment in Bank of Communications Co., Ltd (‘BoCom’) was
carried out and it was concluded that the investment was not
impaired based on our value in use calculation (see note 14 on theConsolidated Financial Statements for further details). As
discussed in that note, in future periods the value in use may
increase or decrease depending on the effect of changes to model
inputs. It is expected that the carrying amount will increase due toretained profits earned by BoCom. At the point where the carrying
amount exceeds the value in use, impairment would berecognised. The group would continue to recognise its share of
BoCom’s profit or loss, but the carrying amount would be reduced
to equal the value in use, with a corresponding reduction inincome. An impairment review would continue to be performed ateach subsequent reporting period, with the carrying amount andincome adjusted accordingly.
Customer deposits rose by HK$225bn, or 4%, to HK$5,432bn.
The advances-to-deposits ratio was 68.5% at the end of the year(2018: 67.8%).
Shareholders’ equity grew by HK$48bn to HK$815bn at
31 December 2019, mainly reflecting current year’s profit, net of
dividend payment, coupled with additional tier 1 capital
instruments issued.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

11

Risk

• communication with risk stewards on the developing risklandscape;Risk• strength of our capital, liquidity and balance sheet;

Our approach to risk
(Unaudited)

Our conservative risk appetite
We have maintained a conservative risk profile throughout ourhistory. This is central to our business and strategy. We recognise
the importance of a strong risk culture, which refers to our shared
attitudes, values and norms that shape behaviours related to risk
awareness, risk taking and risk management. All employees are
responsible for the management of risk, with the ultimate
accountability residing with the Board.
We seek to build our business for the long term by balancing
social, environmental and economic considerations in thedecisions we make. Our strategic priorities are underpinned by ourendeavour to operate in a sustainable way. This helps us to carryout our social responsibility and manage the risk profile of thebusiness. We are committed to managing and mitigating climaterelated risks, both physical and transition, and will continue toincorporate this into how we manage and oversee risks internallyand with our customers.
The following principles guide the group’s overarching appetite forrisk and determine how our businesses and risks are managed.

Financial position• We aim to maintain a strong capital position, defined byregulatory and internal capital ratios.
• We carry out liquidity and funding management for each
operating entity, on a stand-alone basis.

• compliance with applicable laws and regulations;• effectiveness of the applicable control environment to mitigate
risk, informed by risk ratings from risk control assessments;• functionality, capacity and resilience of available systems to
manage risk; and• the level of available staff with the required competencies tomanage risks.
We formally articulate our risk appetite through our risk appetitestatement (‘RAS’), which is approved by the Board. Setting out ourrisk appetite ensures that planned business activities provide anappropriate balance of return for the risk we are taking, and that
we agree a suitable level of risk for our strategy. In this way, risk
appetite informs our financial planning process and helps senior
management to allocate capital to business activities, services andproducts.
The RAS consists of qualitative statements and quantitative
metrics, covering financial and non-financial risks. It isfundamental to the development of business line strategies,
strategic and business planning, and senior managementbalanced scorecards.
At a group level, performance against the RAS is reported to thegroup Risk Management Meeting (‘RMM’) on a monthly basis sothat any actual performance that falls outside the approved risk
appetite is discussed and appropriate mitigating actions are
determined. This reporting allows risks to be promptly identified
and mitigated, and informs risk-adjusted remuneration to drive astrong risk culture.

• We seek to generate returns in line with a conservative risk
appetite and strong risk management capability.

Global businesses, regions and strategically important countries
are required to have their own RASs, which are monitored toensure they remain aligned with the group’s. All RASs andbusiness activities are guided and underpinned by qualitative
principles and or quantitative metrics.

• We aim to deliver sustainable earnings and consistent returns
for shareholders.

Risk Management

Operating modelBusiness practice• We have zero tolerance for any of our people to knowingly
engage in any business, activity or association where
foreseeable reputational risk or damage has not been
considered and/or mitigated.
• We have no appetite for deliberately or knowingly causing
detriment to consumers, or incurring a breach of the letter or
spirit of regulatory requirements.
• We have no appetite for inappropriate market conduct by amember of staff or by any group business.

Enterprise-wide application
Our risk appetite encapsulates consideration of financial and nonfinancial risks. We define financial risk as the risk of a financial
loss as a result of business activities. We actively take andprudently manage these types of risks to maximise shareholder
value and profits. Non-financial risk is defined as the risk toachieving our strategy or objectives as a result of inadequate or
failed internal processes, people and systems or from external
events.
Our risk appetite is expressed in both quantitative and qualitative
terms and applied at the global business level, at the regional level
and to material operating entities.

We recognise that the primary role of risk management is toprotect our business, customers, colleagues, shareholders and thecommunities that we serve, while ensuring we are able to support
our strategy and provide sustainable growth. As we move into
revised business focus, active risk management will be critical inensuring we manage the associated change and execution risks
arising from a major change programme. In addition we will
perform periodic risk assessments, including strategies to ensure
retention of key personnel to ensure our continued safe operation.
We use a comprehensive risk management framework across theorganisation and across all risk types, underpinned by the group's
culture and values. This outlines the key principles that we employ
in managing material risks, both financial and non-financial.
The framework fosters continual monitoring, promotes risk
awareness and encourages sound operational and strategic
decision making. It also ensures a consistent approach toidentifying, assessing, managing and reporting the risks we accept
and incur in our activities.

Our risk management framework
The following diagram and descriptions summarise key aspects of
the risk management framework, including governance andstructure, our risk management tools and our risk culture, which
together help align employee behaviour with our risk appetite.

The Board reviews and approves the group’s risk appetite to makesure it remains fit for purpose. The group’s risk appetite isconsidered, developed and enhanced through:• an alignment with our strategy, purpose, values and customer
needs;• trends highlighted in other group risk reports, such as the ‘Risk
map’ and ‘Top and emerging risks’;12

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Key components of our risk management framework
HSBC Values and risk culture

Non-executive risk governance

The Board approves the group's risk appetite, plans and performancetargets. It sets the ‘tone from the top’ and is advised by the group's Risk
Committee.

Executive risk governanceOur executive risk governance structure is responsible for the enterprisewide management of all risks, including key policies and frameworks forthe management of risk within the group.

Three lines of defence model

Our ‘three lines of defence’ model defines roles and responsibilities forrisk management. An independent Risk function helps ensure thenecessary balance in risk/return decisions.

Risk governance

Roles and
responsibilities

Risk appetite

Processes and tools

Enterprise-wide risk management tools

The group has several processes to identify/assess, monitor, manage
and report risks to ensure we remain within our risk appetite.

Active risk management:
identification/assessment,
monitoring, management and reporting
Policies and procedures

Policies and procedures define the minimum requirements for thecontrols required to manage our risks.

Control activities

The operational risk management framework defines minimum
standards and processes for managing operational risks and internal
controls.

Internal controls

Systems and infrastructure

Risk governance
The Board has ultimate responsibility for the effective
management of risk. It is advised on risk-related matters by the
Risk Committee ('RC').
The group's Chief Risk Officer, supported by the RMM, holds
executive accountability for the ongoing monitoring, assessmentand management of the risk environment and the effectiveness of
the risk management framework.

The group has systems and/or processes that support the identification,
capture and exchange of information to support risk management
activities.

Day-to-day responsibility for risk management is delegated tosenior managers with individual accountability for decision
making. All our people have a role to play in risk management.
These roles are defined using the three lines of defence model,
which takes into account the group’s business and functional
structures.
We use a defined executive risk governance structure to help
ensure there is appropriate oversight and accountability of risk,
which facilitates reporting and escalation to the RMM.

The management of financial crime risk resides with the group's
Chief Executive Officer. He is supported by the Financial Crime
Risk Management Committee.
Governance structure for the management of risk
Authority

MembershipResponsibilities include:

Risk Management
Meeting of the group

group Chief Risk Officergroup General Counsel
group Chief Executive
group Chief Financial Officergroup heads of global business and global
functions• Supporting the group Chief Risk Officer in exercising Board-delegatedrisk management authority• Overseeing the implementation of risk appetite and the enterprise risk
management framework• Forward-looking assessment of the risk environment, analysing possible
risk impacts and taking appropriate action• Monitoring all categories of risk and determining appropriate mitigating
action• Promoting a supportive group culture in relation to risk management
and conduct

Global business/Site risk
management meetings

Global business/Site Chief Risk Officer
Global business/Site Chief Executive
Global business/Site Chief Financial Officer
Global business/Site heads of global functions• Supporting the Chief Risk Officer in exercising Board-delegated risk
management authority• Forward-looking assessment of the risk environment, analysing thepossible risk impact and taking appropriate action• Implementation of risk appetite and the enterprise risk management
framework• Monitoring all categories of risk and determining appropriate mitigating
actions• Embedding a supportive culture in relation to risk management andcontrols

The Board committees with responsibility for oversight of risk-related matters are set out on page 6.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

13

Risk

Our responsibilities

Stress testing

All our people are responsible for identifying and managing risk
within the scope of their role as part of the three lines of defence
model.

The group operates a wide-ranging stress testing programme thatis a key part of our risk management and capital planning. Stresstesting provides management with key insights into the impact ofseverely adverse events on the group, and provides confidence toregulators on the group’s financial stability.

Three lines of defence
To create a robust control environment to manage risks, we use an
activity-based three lines of defence model. This model delineates
management accountabilities and responsibilities for risk
management and the control environment.
The model underpins our approach to risk management byclarifying responsibility and encouraging collaboration, as well as
enabling efficient coordination of risk and control activities.
The three lines of defence are summarised below:• The first line of defence owns the risks and is responsible for
identifying, recording, reporting and managing them in linewith risk appetite, and ensuring that the right controls andassessments are in place to mitigate them.
• The second line of defence sets the policy and control
standards for managing specific risk areas, provides advice andguidance in relation to the risk, and challenges the first line ofdefence on effective risk management.
• The third line of defence is our Internal Audit function, which
provides independent assurance that our risk management
approach and processes are designed and operating effectively.

Risk function
The group’s Risk function, headed by the group’s Chief Risk
Officer, is responsible for the group’s risk management
framework. This responsibility includes establishing andmonitoring of risk profiles, and forward-looking risk identificationand management. The group’s Risk function is made up of subfunctions covering all risks to our business and forms part of thesecond line of defence. It is independent from the global
businesses, including sales and trading functions, to provide
challenge, appropriate oversight and balance in risk/return
decisions.
Responsibility for minimising both financial and non-financial risklies with our people. They are required to manage the risks of thebusiness and operational activities for which they are responsible.
We maintain adequate oversight of our risks through our various
specialist risk stewards as well as the collective accountability heldby our Chief Risk Officers.
Non-financial risk includes some of the most material risks thegroup faces, such as cyber-attacks, the loss of data and poor
conduct outcomes. Actively managing non-financial risk is crucial
to serving our customers effectively and having a positive impact
on society. During 2019 we continued to strengthen the control
environment and our approach to the management of nonfinancial risk, as set out in our Operational Risk Management
Framework. The approach outlines non-financial risk governanceand risk appetite, and provides a single view of the non-financial
risks that matter the most, and associated controls. It incorporates
a risk management system designed to enable the active
management of non-financial risk. Our ongoing focus is on
simplifying our approach to non-financial risk management, whiledriving more effective oversight and better end-to-end
identification and management of non-financial risks. This isoverseen by the Operational Risk function, headed by the group
Head of Operational Risk.

14

Our stress testing programme assesses our capital strength
through a rigorous examination of our resilience to external
shocks. As well as undertaking regulatory-driven stress tests, we
conduct our own internal stress tests, in order to understand thenature and level of all material risks, quantify the impact of suchrisks and develop plausible business as usual mitigating actions.
Many of our regulators – including the Hong Kong Monetary
Authority (‘HKMA’) – use stress testing as a prudential regulatory
tool, and the group has focused significant governance andresources to meet their requirements.

Internal stress tests
Our internal capital assessment uses a range of stress scenariosthat explore risks identified by management. They include
potential adverse macroeconomic, geopolitical and operationalrisk events, as well as other potential events that are specific to
the group.
The selection of scenarios is based upon the output of our top andemerging risks identified and our risk appetite. Stress testing
analysis helps management understand the nature and extent ofvulnerabilities to which the group is exposed. Using thisinformation, management decides whether risks can or should be
mitigated through management actions or, if they were to
crystallise, should be absorbed through capital. This in turninforms decisions about preferred capital levels.
In addition to the group-wide stress testing scenarios, each major
HBAP entity performs regular macroeconomic and event-driven
scenario analyses specific to the region. They also participate, as
required, in the regulatory stress testing programmes of thejurisdictions in which they operate, and the stress tests of theHKMA. Global functions and businesses also perform bespoke
stress testing to inform their assessment of risks in potential
scenarios.
The group stress testing programme is overseen by the RC andresults are reported, where appropriate, to the RMM and RC.
We also conduct reverse stress tests each year at a group level
and, where required, at subsidiary entity level to understandpotential extreme conditions that would make our business model
non-viable. Reverse stress testing identifies potential stresses andvulnerabilities we might face, and helps inform early warning
triggers, management actions and contingency plans designed tomitigate risks.

Recovery and resolution plans
Recovery and resolution plans form an integral framework in thesafeguarding of the group’s financial stability. Together with stresstesting, it helps us understand the outcomes of adverse businessor economic conditions and the identification of mitigating
actions.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Key developments in 2019
In 2019, it was announced that Mark McKeown was stepping
down from his role of the group's Chief Risk Officer. Edward
Jenkins, who was previously the Global Head of Wholesale Credit
and Market Risk, has been appointed as the group's Chief Risk
Officer with effect from 1 September 2019.
During the year, we also undertook a number of initiatives toenhance our approach to the management of risk. We continued
efforts to simplify and enhance how we manage risk. We
simplified the Group risk taxonomy through consolidating certain
existing risks into broader categories. These changes streamlined
risk reporting and promoted common language in our risk
management approach. Further simplification will continue during
2020, including the combining of our two key risk management
frameworks. These changes include:• We formed a Resilience Risk sub-function to reflect thegrowing regulatory importance of being able to ensure ouroperations continue to function when an operational
disturbance occurs. Resilience Risk was formed to simplify theway we interact with our stakeholders and to deliver clear,consistent and credible responses globally. The leadership of
the Resilience Risk function is the responsibility of the group
Head of Resilience Risk. For further details on resilience risk,
see page 44.
• We have placed greater focus on our model risk activities
during 2019. To reflect this, Group has created the role of Chief
Model Risk Officer, which for the group is undertaken by the
Head of Model Risk Management.

Top and emerging risks(Unaudited)

We use a top and emerging risks process to provide a forwardlooking view of issues with the potential to threaten the executionof our strategy or operations over the medium to long term.
We proactively assess the internal and external risk environment,
as well as review the themes identified across our regions andglobal businesses, for any risks that may require global escalation,
updating our top and emerging risks as necessary.
We define a ‘top risk’ as a thematic issue that may form andcrystallise within one year, and which has the potential tomaterially affect the group’s financial results, reputation orbusiness model. It may arise across any combination of risk types,
countries or global businesses. The impact may be wellunderstood by senior management and some mitigating actions
may already be in place. Stress tests of varying granularity may
also have been carried out to assess the impact.
An ‘emerging risk’ is a thematic issue with large unknown
components that may form and crystallise beyond a one year time
horizon. If it were to materialise, it could have a material effect on
the group’s long-term strategy, profitability and/or reputation.
Existing mitigation action plans are likely to be minimal, reflecting
the uncertain nature of these risks at this stage. Some high-level
analysis and/or stress testing may have been carried out to assess
the potential impact.
Our current top and emerging risks are as follows:

Externally driven
Economic outlook and capital flows
Global manufacturing was in recession in 2019 as the Chinese
economy slowed, trade and geopolitical tensions continued, andkey sectors like automotive and information technology sufferedfrom idiosyncratic issues. This had an impact on trade-reliant
regions including the European Union, while the US benefited
from a resilient consumer. Early in 2019, global central banks
abandoned their previous intentions to tighten monetary policy
gradually in order to underpin economic activity. These and otherfactors contributed to an increase in market optimism towards theend of 2019 that global economic activity may be bottoming out.

However, a significant degree of caution is warranted. US–China
relations are likely to remain tense as negotiations move to asecond phase, covering aspects like intellectual property.
Changing global consumption patterns and the introduction ofstricter environmental standards may continue to hamper the
automotive and other traditional industries. The net impact on
trade flows could be negative, and may damage the group’s
traditional lines of business.
The coronavirus outbreak is a new emerging risk. In a baseline
scenario, the outbreak should be contained and may lead to a
slowdown in China’s economic activity during the first quarter of
2020, followed by a rebound in the remainder of the year, helpedby an increased policy stimulus in response to the outbreak.
However, there is a risk that containment proves morechallenging, and the resulting socio-economic disruption more
extensive and prolonged, spilling beyond China. Since thebeginning of January 2020, the coronavirus outbreak has caused
disruption to our staff, suppliers and customers particularly inmainland China and Hong Kong. It remains unclear how this will
evolve through 2020 and we continue to monitor the situation
closely. The group has invoked its business continuity plans toensure the safety and well-being of our staff, whilst ensuring ourcapability to support our customers and maintain our business
operations is upheld.
Subject to the extent of the effects and duration of the outbreakreferred to above, it is anticipated that oil prices are likely toremain range-bound in 2020, with occasional spikes in volatility.
The run-up to the US presidential election in November may be a
key factor in causing market volatility. Persistent social tensions inHong Kong may disrupt the local economy and businesssentiment further. We believe our businesses are well placed toweather risks, but would nevertheless be affected by severe
shocks.
Mitigating actions• We actively assess the impact of economic developments in
key markets on specific customer segments and portfolios andtake appropriate mitigating actions. These actions include
revising risk appetite and/or limits as circumstances evolve.
• We use internal stress testing and scenario analysis, as well as
regulatory stress test programmes, to evaluate the potential
impact of macroeconomic shocks on our businesses andportfolios. Our approach to stress testing is described on
page 14.

Geopolitical risk
The group's operations and portfolios are exposed to risks
associated with political instability, civil unrest and conflict, which
could lead to disruption to our operations, physical risk to our staff
and/or physical damage to our assets.
Multinational businesses are increasingly caught between
governments, heightening the risk of business decisions being
perceived as political statements. Global tensions over trade,technology and ideology can manifest in divergent regulatory,
standards and compliance regimes, presenting long-term strategic
challenges.
In 2019, societies in nearly all our markets were affected by aseries of common issues with global reach in 2020. Migration,
income inequality, corruption, climate change, and terrorism haveappeared as common threads of discontent across markets. Thisdissatisfaction is manifesting through increased protest activity
and at the ballot box, challenging traditional political structures.
This level of geopolitical risk is expected to remain heightened
throughout 2020.
In 2019, Hong Kong experienced heightened levels of domesticsocial unrest and if prolonged, there could be broader economic
ramifications, affecting several of the group's portfolios.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

15

Risk

Intensified US–China competition is expected to featureprominently in 2020 – despite the Phase 1 trade deal, as
negotiations move to phase 2, which covers aspects such as
intellectual property. New regulations from both the US and China
will increase scrutiny of companies involved in cross-border datatransfers and limit the use of foreign technology in private, as wellas national infrastructure. Combined, these regulations could drive
the bifurcation of US and Chinese technology sectors, standards
and supply chain ecosystems, which may limit innovation anddrive up production and compliance costs for firms operating inboth markets.

Mitigating actions• We continually monitor the geopolitical outlook, in particular incountries where we have material exposures and/or a physicalpresence. We have also established dedicated forums tomonitor geopolitical developments.
• We use internal stress tests and scenario analysis as well as
regulatory stress test programmes, to adjust limits andexposures to reflect our risk appetite and mitigate risks as
appropriate. Our internal credit risk ratings of sovereigncounterparties take into account geopolitical developments that
could potentially disrupt our portfolios and businesses.
• We have taken steps to enhance physical security in thosegeographical areas deemed to be at high risk from terrorism
and military conflicts.

The credit cycle
Dovish global monetary policies remained accommodative
through much of 2019, and share indices hit record highs. The US
Federal Reserve System ('FRB'), European Central Bank ('ECB')
and the Bank of Japan ('BoJ') are expected to keep global liquidity
abundant in 2020. However, there are signs of stress in parts ofthe credit market, as shown by the FRB’s interventions in the repo
market. There has been a surge in borrowing by entities in thelowest investment grade segment ('BBB'), which now makes up
55% of the total universe of rated corporate bonds. Profit margins
at US non-financial corporations are falling, as are job openings,
both of which could foreshadow a turn in the credit cycle.
Corporate credit quality in Europe is also deteriorating. Chinese
authorities are warier than in the past about leverage, but will still
enact limited stimulus measures, which could act to limit
downside risks to a degree.

Mitigating actions• We closely monitor economic developments in key markets andsectors and undertake scenario analysis. This helps enable us
to take portfolio actions where necessary, including enhanced
monitoring, amending our risk appetite and/or reducing limits
and exposures.
• We stress test portfolios of particular concern to identify
sensitivity to loss under a range of scenarios, withmanagement actions being taken to rebalance exposures andmanage risk appetite where necessary.
• We undertake regular reviews of key portfolios to help ensurethat individual customer or portfolio risks are understood andour ability to manage the level of facilities offered through any
downturn is appropriate.

16

Cyber threat and unauthorised access to systems
The group and other organisations continue to operate in an
increasingly hostile cyber threat environment, which requires
ongoing investment in business and technical controls to defend
against these threats.
Key threats include unauthorised access to online customer
accounts, advanced malware attacks and distributed denial ofservice (‘DDOS’) attacks.

Mitigating actions• We continually evaluate threat levels for the most prevalentattack types and their potential outcomes. To further protect
the group and our customers, we strengthen our controls to
reduce the likelihood and impact of advanced malware, dataleakage, infiltration of payment systems and denial of service
attacks. We continued to enhance our cybersecurity
capabilities, including threat detection, access control as wellas back-up and recovery. An important part of our defence
strategy is ensuring our people remain aware of cybersecurity
issues and know how to report incidents.
• Cyber risk is a priority area for the Board, we report and review
cyber risk and control effectiveness quarterly at executive andnon-executive Board level. We also report it across the global
businesses, functions and regions to help ensure appropriate
visibility and governance of the risk and mitigating actions.

Regulatory developments including conduct, withadverse impact on business model and profitability
Financial service providers continue to face stringent regulatory
and supervisory requirements, particularly in the areas of capitaland liquidity management, conduct of business, financial crime,
internal control frameworks, the use of models and the integrity offinancial services delivery. The competitive landscape in which thegroup operates may be significantly altered by future regulatorychanges and government intervention. Regulatory changes may
affect the activities of the group as a whole, or of some or all of its
principal subsidiaries.
As described in note 38 on the Consolidated Financial Statements,
we continue to be subject to a number of material legal
proceedings, regulatory actions and investigations, including ourJanuary 2018 deferred prosecution agreement with the US
Department of Justice arising from its investigation into HSBC’s
historical foreign exchange activities (the ‘FX DPA’).

Mitigating actions• We are fully engaged, wherever possible with governments andregulators in the countries in which we operate, to help ensurethat new requirements are considered properly by regulatory
authorities and the financial sector and can be implemented
effectively.
• We have invested significant resources and have taken, and willcontinue to take, a number of steps to improve our compliancesystems and controls relating to our activities in global markets.
These included enhancements to pricing and disclosure, ordermanagement and trade execution; trade, voice and audio
surveillance; front office supervision; and improvements to our
enforcement and discipline framework for employee
misconduct.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Financial crime risk environment
Throughout 2019, we continued to implement the final elementsof our Global Standards programme to integrate our anti-money
laundering and sanctions capabilities into our day-to-day
operations. We continue to enhance our financial crime risk
management capabilities and the effectiveness of our financial
crime controls, and we are maintaining our investment in the next
generation of tools to fight financial crime through the applicationof advanced analytics and artificial intelligence.
Financial institutions remain under considerable regulatory
scrutiny regarding their ability to prevent and detect financial
crime. There is an increased regulatory focus on fraud and antibribery and corruption controls, with expectations that banks
should do more to protect customers from fraud and identify andmanage bribery and corruption risks within our businesses.
Financial crime threats continue to evolve, often in tandem withgeopolitical developments. The highly speculative, volatile andopaque nature of virtual currencies, including the pace ofdevelopment in this area, create challenges in effectively
managing financial crime risks. The evolving regulatoryenvironment continues to present execution challenge. We
continue to see increasing challenges presented by national data
privacy requirements in a global organisation, which may affectour ability to effectively manage financial crime risks.
In December 2012, among other agreements, HSBC Holdings plc(‘HSBC Holdings’) agreed to an undertaking with the UK Financial
Services Authority, which was replaced by a Direction issued by
the UK Financial Conduct Authority ('FCA') in 2013, and consented
to a cease-and-desist order with the US Federal Reserve Board(‘FRB’), both of which contained certain forward-looking antimoney laundering (‘AML’) and sanctions-related obligations. HSBC
also agreed to retain an independent compliance monitor (who is,
for FCA purposes, a ‘Skilled Person’ under section 166 of the
Financial Services and Markets Act and, for FRB purposes, an‘Independent Consultant’) to produce periodic assessments of theGroup’s AML and sanctions compliance programme (the ‘Skilled
Person/Independent Consultant’). In December 2012, HSBC
Holdings also entered into an agreement with the Office of Foreign
Assets Control (‘OFAC’) regarding historical transactions involving
parties subject to OFAC sanctions. Reflective of HSBC’s significant
progress in strengthening its financial crime risk management
capabilities, HSBC’s engagement with the current Skilled Person
will be terminated and a new Skilled Person with a narrower
mandate will be appointed to assess the remaining areas that
require further work in order for HSBC to transition fully tobusiness-as-usual financial crime risk management. The
Independent Consultant will continue to carry out an annual OFAC
compliance review at the FRB’s discretion. The role of the Skilled
Person/Independent Consultant is discussed on page 45.

Mitigating actions• We continue to enhance our financial crime risk management
capabilities. We are investing in next generation capabilities tofight financial crime through the application of advanced
analytics and artificial intelligence.

• We continue to take steps designed to ensure that the reforms
we have put in place are both effective and sustainable over thelong term.

IBOR transition
Interbank offered rates ('IBORs') are used to set interest rates onhundreds of trillions of US dollars’ worth of different types offinancial transactions and are used extensively for valuation
purposes, risk measurement and performance benchmarking.
Following the announcement by the UK’s Financial Conduct
Authority in July 2017 that it will no longer oblige or require banks
to submit rates for Libor after 2021, the national working groups(‘NWG’) for the affected currencies were tasked with facilitating anorderly transition of the relevant Libors to their chosen
replacement rates. The euro national working group is also
responsible for facilitating an orderly transition of the EuroOvernight Index Average (‘Eonia’) to the euro short-term rate(‘€STER’). In addition, there are four benchmark interest rates(Singapore Dollar Swap Offer Rate (‘SOR’), Thai Baht Interest Rate
Fixing (‘THBFIX’), Mumbai Interbank Forward Offer Rate (‘MIFOR’)and Philippine Interbank Reference Rate (‘PHPREF’)) in the AsiaPacific region which are impacted through their calculation
currently including US Dollar Libor (’Dependent Rates’). Working
groups for these Dependent Rates have been established toaddress relevant requirements.
The process of developing products that reference thereplacement rates and transitioning legacy IBOR contracts
exposes the group to material execution, conduct and financial
risks.

Mitigating actions• We have a global programme to facilitate an orderly transition
from Libor, Eonia and Dependent Rates for our business andour clients. This programme, led by the Group Chief Risk
Officer, oversees the transitions made by each of the global
businesses.
• Our programme is focused on developing alternative rate
products that reference the working group-selected
replacement rates and making them available to customers. It
is also focusing on the supporting processes and systems todeveloping these products. At the same time, we aredeveloping the capability to transition, through repapering,
outstanding Libor, Eonia and Dependent Rates contracts.
• We have identified a number of execution, conduct andfinancial risks and are in the process of addressing these.
• We will continue to engage with industry participants and theofficial sector to support an orderly transition.

Climate-related risks
Climate change can impact across HSBC’s risk taxonomy throughboth transition and physical channels:• Transition Risk, arising from the move to a low-carbon
economy, such as through policy, regulatory and technologicalchanges.

• We are strengthening and investing in our Fraud controls, tointroduce next generation anti-fraud capabilities to protect bothcustomers and the bank.

• Physical Risk, through increasing severity and/or frequency ofsevere weather events or other climatic events (e.g. sea levelrise, flooding).

• We continue to embed our improved Anti-Bribery andCorruption policies and controls, focusing on conduct.

These have potential to cause both idiosyncratic and systemicrisks, resulting in potential financial impacts for the group. Impacts
could materialise through higher risk-weighted assets (‘RWAs‘)
over the longer term, greater transactional losses and/or increased
capital requirements.

• We continue to educate our staff on emerging digitallandscapes and associated risks.
• We have developed procedures and controls to manage therisks associated with direct and indirect exposure to virtual
currencies, and we continue to monitor external developments.
• We continue to work with jurisdictions and relevantinternational bodies to address data privacy challenges throughinternational standards, guidance, and legislation to enableeffective management of financial crime risk.

The awareness of climate risk, regulatory expectations andreputational risk have all heightened through 2019. The exposure
we have to the risk and materialisation of the risk have notmaterially heightened.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

17

Risk

Mitigating actions

Mitigating actions

We continue to enhance our approach to managing climaterelated risks, and develop and embed the measurement,
monitoring and management.

• We are improving data quality across a large number ofsystems globally. Our data management, aggregation andoversight continue to strengthen and enhance the effectivenessof internal systems and processes. We are implementing data
controls for critical processes in the front-office systems to
improve our data capture at the point of entry. We achieved a’largely compliant’ rating in support of the Basel Committee for
Banking Supervision (BCBS 239) principles and have embedded
them across the key markets.

An internal Climate Risk Working Group provides oversight byseeking to develop policy and limit frameworks in order to achieve
desired portfolios over time, and protect the group from climaterelated risks that are outside of risk appetite.
We have commenced sector specific scenario analysis andcontinue our current work to source data and develop scenarios.
For wholesale credit risk work is focused on questionnaires toassess transition risk across six sectors and 11 countries. Longer
term, a modelled framework is envisaged.
For retail credit risk, mortgage exposures are being reviewed on ageographical basis in respect of natural hazard risk and mitigants.
For operational risk, we are working with our property insurers tounderstand geographical exposure of the property portfolio andassess effectiveness of controls for design resilience, operations
and business continuity.
We have public and internal policies for certain sectors that posesustainability risk to the group. These include policies on energy,
agricultural commodities, chemicals, forestry, mining and metals,
and UNESCO World Heritage Sites and Ramsar-designatedwetlands.
We are working through the Climate Financial Risk Forum toensure we remain aware of and drive emerging best practice.

Internally driven
Risks arising from the receipt of services from third
parties
We use third parties for the provision of a range of services, incommon with other financial service providers. Risks arising fromthe use of third-party service providers may be less transparent
and therefore more challenging to manage or influence. It is
critical that we ensure that we have appropriate risk management
policies, processes and practices. These should include adequate
control over the selection, governance and oversight of third
parties, particularly for key processes and controls that could
affect operational resilience. Any deficiency in our management ofrisks arising from the use of third parties could affect our ability tomeet strategic, regulatory or client expectations.

Mitigating actions• We continued to embed our delivery model in the first line ofdefence through a dedicated team. We have deployedprocesses, controls and technology to assess third party
service providers against key criteria and associated control
monitoring, testing and assurance.
• A dedicated oversight forum in the second line of defence
monitors the embedding of policy requirements andperformance against risk appetite.

Data management
The group uses a large number of systems and applications to
support key business processes and operations. As a result, we
often need to reconcile multiple data sources, including customer
data sources, to reduce the risk of error. Along with otherorganisations, the group also needs to meet external/regulatory
obligations such as the General Data Protection Regulation('GDPR'), the Basel Committee for Banking Supervision (BCBS239) principles and Basel III.

18

• We are expanding and enhancing our global data governanceprocesses to monitor proactively the quality of criticalcustomer, product, reference and transaction data andresolving associated data issues in a timely manner. We have
implemented data controls to improve the reliability of data
used by our customers and staff.
• We are also modernising our data and analytics infrastructure
through investments in advanced capabilities in cloud,visualisation, machine learning and artificial intelligenceplatforms.
• We have implemented a global data privacy framework that
establishes data privacy practices, design principles andguidelines that demonstrate compliance with data privacy laws
and regulations in the jurisdictions in which we operate.
• We continue to hold annual data symposiums and data privacy
awareness training to help our employees keep abreast of data
management and data privacy laws and regulations. These
highlight our commitment to protect personal data for ourcustomers, employees and stakeholders.

Areas of special interest
During 2019, a number of areas were identified and considered aspart of our top and emerging risks because of the effect they may
have on the group. In this section, we have placed particular focus
on IBOR transition and the risks to our operations and portfolios in
Asia-Pacific.

IBOR transition
The Financial Stability Board has observed that the decline ininterbank short-term unsecured funding poses structural risks forinterest rate benchmarks that reference these markets. In
response, regulators and central banks in various jurisdictions
have convened national working groups to identify replacement
rates for these interbank offer rates (‘IBORs’) and, whereappropriate, to facilitate an orderly transition to these rates.
Following the announcement by the UK’s Financial Conduct
Authority in July 2017 that it will no longer oblige or require banks
to submit rates for Libor after 2021, the national working groups
for the affected currencies were tasked with facilitating an orderlytransition of the relevant Libors to their chosen replacement rates.
The euro working group is also responsible for facilitating anorderly transition of the Euro Overnight Index Average (‘Eonia’) tothe euro short-term rate (‘€STER’). In addition, there are fourbenchmark interest rates (Singapore Dollar Swap Offer Rate(‘SOR’), Thai Baht Interest Rate Fixing (‘THBFIX’), Mumbai
Interbank Forward Offer Rate (‘MIFOR’) and Philippine Interbank
Reference Rate (‘PHPREF’)) in the Asia–Pacific region which are
impacted through their calculation currently including US Dollar
Libor ('Dependent Rates’). Working groups for these Dependent
Rates have been established to address relevant requirements.
Although national working groups in other jurisdictions haveidentified replacements for their respective IBORs, there is nointention for these benchmark rates to be discontinued.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Given the current lack of alternatives, the group has an increasing
portfolio of contracts referencing Libor, Eonia and Dependent
Rates with maturities beyond 2021. The Group established the
IBOR transition programme with the objective of facilitating anorderly transition from Libor, Eonia and Dependent Rates for HSBC
and its clients. This global programme oversees the transition
effected by each of the global businesses and is led by the Group
Chief Risk Officer.
The programme is currently focused on developing alternative rate
products, and the supporting processes and systems, thatreference the national working group-selected replacement rates
and making them available to customers. Depending on the takeup of these products by customers, this should reduce the current
growth in Libor, Eonia and Dependent Rates contracts beingtransacted with maturities beyond end 2021, while the new
product capabilities will also enable the transition of outstanding
Libor, Eonia and Dependent Rates products onto the replacement
rates. A structured development plan is required given thewidespread use of Libor, Eonia and Dependent Rates in a wide
range of products, systems and processes across each of the fourglobal businesses and all of the jurisdictions in which the group
operates. The resulting execution risk is closely monitored by the
programme.
The programme is concurrently developing the capability totransition, through repapering, outstanding Libor, Eonia and
Dependent Rates contracts. We expect that the International
Swaps and Derivatives Association's ('ISDA') efforts in guiding thetransition of derivatives contracts should reduce the risk of a nonorderly transition of derivatives with an estimated notional market
size in excess of US$200tn. The process of implementing ISDA’s
proposed protocol and transitioning outstanding contracts is
nonetheless a material undertaking for the industry as a whole andmay expose the group to the risk of financial losses.
We intend to actively engage in the process to achieve an orderlytransition of the group’s Libor, Eonia and Dependent Rates bondissuance, the group’s holdings of Libor/Eonia/Dependent Rates
bonds and of those bonds where the group is the payment agent.
At this stage we are confident that we will be able to transition thebulk of these exposures and we are actively engaged in industry
working groups.
Although we have plans to transition multi-billion dollar
contractually IBOR-referenced commercial loans onto replacement
rates, our ability to transition this portfolio by the end of 2021 ismaterially dependent on the availability of products that reference
the replacement rates and on our customers being ready and able
to adapt their own processes and systems to accommodate thereplacement products. This may give rise to an elevated level of
conduct-related risk. The group is engaging with impacted clientsto ensure that customers are aware of the risks associated withthe ongoing purchase of Libor-, Eonia- and Dependent Ratesreferencing contracts as well as the need to transition legacy
contracts prior to the end of 2021.
In addition to the execution and conduct risk previously
highlighted, the process of adopting new reference rates may
expose the group to an increased level of operational and financial
risks, such as potential earnings volatility resulting from contract
modifications, changes in hedge accounting and a large volume of
product and associated process changes. Furthermore, thetransition to alternative reference rates could have a range ofadverse impacts on our business, including legal proceedings orother actions regarding the interpretation and enforceability ofprovisions in IBOR-based contracts, and regulatory investigations
or reviews in respect of our preparation and readiness for the
replacement of IBOR with alternative reference rates. We continue
to engage with industry participants, the official sector and ourclients to support an orderly transition and the mitigation of therisks resulting from the transition.

Risks to our operations and portfolios in AsiaPacific
In 2019, the mainland Chinese economy grew at the slowest pacein nearly three decades in the context of rising domestic leverage.
The authorities are expected to enact only modest stimulus
measures to boost growth. Along with the ’phase one’ US-China
trade deal and plentiful global liquidity, these measures should
help emerging-market growth to make a partial recovery.
Nevertheless, downside idiosyncratic risks will abound.
Intensified US-China competition continued to feature prominently
in 2019. The two countries now compete across multiple
dimensions: economic power, diplomatic influence, innovation andadvanced technology leadership.
In 2019, we saw heightened levels of risk in Hong Kong. The
downside risk is further increased given the coronavirus outbreak,which could further impact the local economy and dampen
investor and business sentiment in many sectors where the Group
has a material presence. The increasing headwinds will bechallenging and we will continue to monitor our portfolios tomanage risk exposures. We have carefully reviewed our exposures
to help ensure that we continue to support our customers and theHong Kong economy. We have reviewed and enhanced ourbusiness continuity plans to ensure we minimise disruption to ourclients and continued safe operations of our branches andemployees. The new coronavirus outbreak is being actively
monitored. It will have an immediate impact on the economic
scenarios used for expected credit losses (‘ECL’), as key inputs forcalculating ECL such as GDP for Hong Kong and mainland China
are deteriorating, and the probability of particularly adverse
economic scenarios for the short term is higher. The economic
scenarios for Hong Kong used for ECL at 31 December 2019 are
set out on pages 27-30. In addition, should the virus continue tocause disruption to economic activity in Hong Kong and mainland
China through 2020, there could be adverse impacts on income
due to lower lending and transaction volumes, and insurance
manufacturing revenue. Further ECL could arise from other partsof our business impacted by the disruption to supply chains.
We have invoked our business continuity plans to help ensure thesafety and well-being of our staff while maintaining our ability tosupport our customers and maintain our business operations.
We regularly conduct stress tests to assess the resilience of ourbalance sheet and our capital adequacy. We conduct this acrossthe group and in key sites such as Hong Kong. The stress tests areused to consider our risk appetite and provide insights into ourfinancial stability. In the case of Hong Kong, our balance sheet andcapital adequacy remain resilient based on regulatory and internal
stress test outcomes.
Our central scenario for Hong Kong, used as a key input forcalculating ECL in Hong Kong, has kept pace with expectations of
economic growth. The economy entered a technical recession in
the second-half of 2019 and is expected to record negative annual
GDP growth for the first time since 2009. This is a result of bothtensions over trade and tariffs between the US and China anddomestic social unrest. The economy is expected to gradually
recover in 2020. We have also developed a number of additional
scenarios to capture more extreme downside risks, and have used
these in impairment testing and measuring, and to assess ourcapital resilience. While our economic scenarios used to calculatecredit loss capture a range of outcomes, the potential economic
impact of the coronavirus was not explicitly considered at the year
end due to the limited information and the emergent nature of theoutbreak in 2019.
For further details of all scenarios used in impairment
measurements see 'Measurement uncertainty and sensitivity
analysis of ECL estimates' on pages 27-30.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

19

Risk

Our material banking and insurance risks
The material risk types associated with our banking and insurance manufacturing operations are described in the following tables:

Banking operations
Description of risks – banking operations(Audited)
Risks

Credit risk
Credit risk is the risk of financial loss if
a customer or counterparty fails tomeet an obligation under a contract.

Liquidity and funding risk
Liquidity risk is the risk that we do nothave sufficient financial resources tomeet our obligations as they fall due orthat we can only do so at an excessive
cost. Funding risk is the risk thatfunding considered to be sustainable,
and therefore used to fund assets, isnot sustainable over time.

Pension risk
Pension risk is the risk of increased
costs to the group from offering postemployment benefit plans to its
employees.

Market risk
Market risk is the risk that movements
in market factors, such as foreignexchange rates, interest rates, credit
spreads, equity prices and commodity
prices, will reduce our income or thevalue of our portfolios.

Arising from

Measurement, monitoring and management of risk

Credit risk arises principally from direct
lending, trade finance and leasing
business, but also from certain otherproducts such as guarantees andderivatives.

Credit risk is:• measured as the amount that could be lost if a customer or counterparty
fails to make repayments;• monitored using various internal risk management measures andwithin limits approved by individuals within a framework of delegatedauthorities; and• managed through a robust risk control framework which outlines clear
and consistent policies, principles and guidance for risk managers.

• Liquidity risk arises from mismatches
in the timing of cash flows.
• Funding risk arises when illiquid
asset positions cannot be funded at
the expected terms and whenrequired.

Liquidity and funding risk is:• measured using a range of metrics including liquidity coverage ratio
and net stable funding ratio;• assessed through the internal liquidity adequacy assessment process;• monitored against the group’s liquidity and funding risk framework;and• managed on a stand-alone basis with no reliance on any Group entity(unless pre-committed) or central bank unless this represents routine
established business-as-usual market practice.

Pension risk arises from investments
delivering an inadequate return,adverse changes in interest rates or
inflation, or members living longer than
expected. Pension risk includes
operational and reputational risks ofsponsoring pension plans.

Pension risk is:• measured in terms of the schemes’ ability to generate sufficient
funds to meet the cost of their accrued benefits;• monitored through a specific risk appetite; and• managed through the appropriate pension risk governance structure
and ultimately the RMM.

Exposure to market risk is separated
into two portfolios: trading and nontrading. Market risk exposures arisingfrom our insurance operations are
discussed on the following page.

Market risk is:• measured using sensitivities, value at risk (‘VaR’) and stress testing,giving a detailed picture of potential gains and losses for a range ofmarket movements and scenarios, as well as tail risks over specified
time horizons;• monitored using VaR, stress testing and other measures including
the sensitivity of net interest income and the sensitivity of structuralforeign exchange; and• managed using risk limits approved by the RMM for the group andthe various global businesses.

Resilience risk arises from failures orinadequacies in processes, people,
systems or external events. These may
be driven by rapid technologicalinnovation, changing behaviours of ourconsumers, cyber-threats and attacks,
cross-border dependencies, and thirdparty relationships.

Resilience risk is:• measured through a range of metrics with defined maximum
acceptable impact tolerances, and against our agreed risk appetite;• monitored through oversight of enterprise processes, risks, controls
and strategic change programmes; and• managed by continual monitoring and thematic reviews.

Resilience risk
Resilience risk is the risk that we areunable to provide critical services toour customers, affiliates, andcounterparties as a result of sustained
and significant operational disruption.

Regulatory compliance risk
Regulatory compliance risk is the riskthat we fail to observe the letter andspirit of all relevant laws, codes, rules,
regulations and standards of goodmarket practice, which as aconsequence incur fines and penalties
and suffer damage to our business.

20

Regulatory compliance risk arises from Regulatory compliance risk is:
the risks associated with breaching our • measured by reference to identified metrics, incident assessments,
duty to our customers and otherregulatory feedback and the judgement and assessment of ourcounterparties, inappropriate market
regulatory compliance teams;
conduct and breaching other regulatory• monitored against the first line of defence risk and control
requirements.
assessments, the results of the monitoring and control assurance
activities of the second line of defence functions, and the results ofinternal and external audits and regulatory inspections; and• managed by establishing and communicating appropriate policies
and procedures, training employees in them, and monitoring activity
to help ensure their observance. Proactive risk control and/or
remediation work is undertaken where required.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Description of risks – banking operations (continued)(Audited)
Risks

Arising from

Measurement, monitoring and management of risk

Financial crime and fraud risk
Financial crime and fraud risk is the risk Financial crime and fraud risk arisesthat we knowingly or unknowingly help from day-to-day banking operations.
parties to commit or to further
potentially illegal activity through
HSBC.

Financial crime and fraud risk is:• measured by reference to identified metrics, incident assessments,
regulatory feedback and the judgement and assessment of our
financial crime risk teams;• monitored against our financial crime risk appetite statements andmetrics, the results of the monitoring and control activities of thesecond line of defence functions, and the results of internal andexternal audits and regulatory inspections; and• managed by establishing and communicating appropriate policies
and procedures, training employees in them, and monitoring activity
to help ensure their observance. Proactive risk control and/or
remediation work is undertaken where required.

Model risk
Model risk is the potential for adverse
consequences from business decisions
informed by models, which can beexacerbated by errors in methodology,
design or the way they are used.

Model risk arises in both financial andnon-financial contexts wheneverbusiness decision making includes
reliance on models.

Insurance manufacturing operations
Our insurance manufacturing subsidiaries are separately regulated
from our banking operations. Risks in the insurance entities aremanaged using methodologies and processes that are subject toModel risk is:• measured by reference to model performance tracking and theoutput of detailed technical reviews, with key metrics including
model review statuses and findings;• monitored against model risk appetite statements, insight from theindependent review function, feedback from internal and external
audits, and regulatory reviews; and• managed by creating and communicating appropriate policies,
procedures and guidance, training colleagues in their application,and supervising their adoption to ensure operational effectiveness.

oversight at group level. Our insurance operations are also subject
to some of the same risks as our banking operations, which arecovered by the group’s respective risk management processes.

Description of risks – insurance manufacturing operations(Audited)
Risks

Arising from

Measurement, monitoring and management of risk

Exposure to financial risks arises from:• market risk affecting the fair valuesof financial assets or their future
cash flows;• credit risk; and• liquidity risk of entities being
unable to make payments topolicyholders as they fall due.

Financial risk is:• measured separately for each type of risk:– market risk is measured in terms of economic capital, internal
metrics and fluctuations in key financial variables;– credit risk is measured in terms of economic capital and theamount that could be lost if a counterparty fails to makerepayments; and– liquidity risk is measured in terms of internal metrics including
stressed operational cash flow projections;• monitored through a framework of approved limits and delegatedauthorities; and• managed through a robust risk control framework, which outlines
clear and consistent policies, principles and guidance. This includes
using product design, asset liability matching and bonus rates.

• The cost of claims and benefits canbe influenced by many factors,
including mortality and morbidity
experience, as well as lapse andsurrender rates.

Insurance risk is:• measured in terms of life insurance liabilities and economic capital
allocated to insurance underwriting risk;• monitored through a framework of approved limits and delegatedauthorities; and• managed through a robust risk control framework which outlines
clear and consistent policies, principles and guidance. This includes
using product design, underwriting, reinsurance and claimshandling procedures.

Financial risk
Our ability to effectively match theliabilities arising under insurance
contracts with the asset portfolios thatback them is contingent on the
management of financial risks and theextent to which these risks are borneby the policyholders.

Insurance risk
Insurance risk is the risk that, overtime, the cost of insurance policies
written, including claims and benefits,
may exceed the total amount ofpremiums and investment income
received.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

21

Risk

Credit risk
Overview
Credit risk is the risk of financial loss if a customer or counterparty
fails to meet an obligation under a contract. Credit risk arises
principally from direct lending, trade finance and leasing business,but also from other products, such as guarantees and credit
derivatives.

Credit risk management(Audited)

Key developments 2019
There were no material changes to the policies and practices
for the management of credit risk in 2019. We continued to apply
the requirements of HKFRS 9 ‘Financial Instruments’ within Credit
Risk.

Governance and structure

validation checks and enhancements, from a variety of client,finance and risk systems. Where possible, these checks andprocesses are performed in a globally consistent and centralisedmanner.
GovernanceRegional management review forums are established in key sites
and regions in order to review and approve the impairment results.
Regional management review forums have representatives from
Credit Risk and Finance. The key site and regional approvals arereported up to the global business impairment committee for final
approval of the Group’s ECL for the period. Required members of
the committee are the global heads of Wholesale Credit, Market
Risk, and Retail Banking and Wealth Management ('RBWM') Risk,
as well as the global business Chief Financial Officers and theGroup Chief Accounting Officer.

Concentration of exposure(Audited)

We have established credit risk management and related HKFRS 9
processes throughout the group. We continue to actively assess
the impact of economic developments in key markets on specificcustomers, customer segments or portfolios. As credit conditions
change, we take mitigating action, including the revision of risk
appetites or limits and tenors, as appropriate. In addition, we
continue to evaluate the terms under which we provide credit
facilities within the context of individual customer requirements,
the quality of the relationship, local regulatory requirements,
market practices and our local market position.

Concentrations of credit risk arise when a number ofcounterparties or exposures have comparable economic
characteristics, or such counterparties are engaged in similar
activities or operate in the same geographical areas or industry
sectors so that their collective ability to meet contractual
obligations is uniformly affected by changes in economic, politicalor other conditions. We use a number of controls and measures tominimise undue concentration of exposure in our portfolios acrossindustries, countries and global businesses. These include portfolio
and counterparty limits, approval and review controls, and stresstesting.

Credit risk sub-function

Credit quality of financial instruments(Audited)(Audited)

Credit approval authorities are delegated by the Board to the group
Chief Executive together with the authority to sub-delegate them.
The Credit Risk sub-function in Global Risk is responsible for the
key policies and processes for managing credit risk, which include
formulating group credit policies and risk rating frameworks,
guiding the group’s appetite for credit risk exposures, undertaking
independent reviews and objective assessment of credit risk, andmonitoring performance and management of portfolios.

Our risk rating system facilitates the internal ratings-based
approach under the Basel framework adopted by the Group to
support the calculation of our minimum credit regulatory capitalrequirement.

The principal objectives of our credit risk management are:• to maintain across the group a strong culture of responsible
lending, and robust risk policies and control frameworks;• to both partner and challenge our businesses in defining,
implementing and continually re-evaluating our risk appetite
under actual and scenario conditions; and• to ensure there is independent, expert scrutiny of credit risks,
their costs and their mitigation.

Key risk management processes(Unaudited)HKFRS 9 ‘Financial Instruments’ process
The HKFRS 9 process comprises three main areas: modelling anddata; implementation; and governance.
Modelling and data
We have established HKFRS 9 modelling and data processes invarious geographies, which are subject to internal model risk
governance including independent review of significant model
developments.
Implementation

The five credit quality classifications each encompass a range of
granular internal credit rating grades assigned to wholesale andretail lending businesses, and the external ratings attributed byexternal agencies to debt securities.
For debt securities and certain other financial instruments,
external ratings have been aligned to the five quality classifications
based upon the mapping of related customer risk rating (‘CRR’) to
external credit rating.

Wholesale lending(Unaudited)

The CRR 10-grade scale summarises a more granular underlying
23-grade scale of obligor probability of default (‘PD’). All corporate
customers are rated using the 10- or 23-grade scale, depending on
the degree of sophistication of the Basel approach adopted for the
exposure.
Each CRR band is associated with an external rating grade byreference to long-run default rates for that grade, represented by
the average of issuer-weighted historical default rates. This
mapping between internal and external ratings is indicative andmay vary over time.

Retail lending(Unaudited)

Retail lending credit quality is based on a 12-month point-in-time(‘PIT’) probability-weighted probability of default (‘PD’).

A centralised impairment engine performs the expected credit loss(‘ECL’) calculation using data, which is subject to a number of

22

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Credit quality classification(Unaudited)
Sovereign debt
securities
and bills
External credit
ratingOther debt
securities
and bills

Wholesale lending
and derivatives

External credit
ratingInternal credit
ratingRetail lending

12-month Baselprobability ofdefault %Internal credit
rating

12 monthprobabilityweighted PD %Quality classification1, 2Strong

BBB and above

A- and above

CRR 1 to CRR 2

0 – 0.169

Band 1 and 2

0.000 – 0.500

Good

BBB- to BB

BBB+ to BBB-

CRR 3

0.170 – 0.740

Band 30.501 – 1.500

BB- to B andunratedBB+ to B andunratedCRR 4 to CRR 5

0.741 – 4.914

Band 4 and 5

1.501 – 20.000

Sub-standard

B- to CB- to CCRR 6 to CRR 8

4.915 – 99.999

Band 620.001 – 99.999

Credit impaired

Default

Default

CRR 9 to CRR 10

100

Band 7

100

Satisfactory

1
2

Customer risk rating (‘CRR’).
12-month point-in-time (‘PIT’) probability-weighted probability of default (‘PD’).

Quality classification definitions‘Strong’ exposures demonstrate a strong capacity to meet financial commitments, with negligible or low probability of default and/or low levels of
expected loss.
‘Good’ exposures require closer monitoring and demonstrate a good capacity to meet financial commitments, with low default risk.
‘Satisfactory’ exposures require closer monitoring and demonstrate an average-to-fair capacity to meet financial commitments, with moderate default risk.
‘Sub-standard’ exposures require varying degrees of special attention and default risk is of greater concern.
‘Credit-impaired’ exposures have been assessed as described on Note 1.2(i) on the Consolidated Financial Statements.

Renegotiated loans and forbearance

Impairment assessment(Audited)(Audited)‘Forbearance’ describes concessions made on the contractual
terms of a loan in response to an obligor’s financial difficulties.

For details of our impairment policies on loans and advances andfinancial investments, see note 1.2(i) on the Consolidated Financial
Statements.

A loan is classed as ‘renegotiated’ when we modify thecontractual payment terms on concessionary terms because wehave significant concerns about the borrowers’ ability to meet
contractual payments when due.
Non-payment-related concessions (e.g. covenant waivers), while
potential indicators of impairment, do not trigger identification as
renegotiated loans.
Loans that have been identified as renegotiated retain thisdesignation until maturity or derecognition.
For details of our policy on derecognised renegotiated loans, seenote 1.2(i) on the Consolidated Financial Statements.

Credit quality of renegotiated loans(Unaudited)

On execution of a renegotiation, the loan will also be classified as
credit impaired if it is not already so classified. In wholesalelending, all facilities with a customer, including loans that have notbeen modified, are considered credit impaired following theidentification of a renegotiated loan.
Wholesale renegotiated loans are classified as credit-impaired until
there is sufficient evidence to demonstrate a significant reductionin the risk of non-payment of future cash flows, observed over aminimum one-year period, and there are no other indicators of
impairment. Personal renegotiated loans are deemed to remain
credit impaired until repayment, write-off or derecognition.

Write-off of loans and advances(Audited)

For details of our policy on the write-off of loans and advances,
see note 1.2(i) on the Consolidated Financial Statements.
Unsecured personal facilities, including credit cards, are generally
written off at between 150 and 210 days past due. The standard
period runs until the end of the month in which the accountbecomes 180 days contractually delinquent. Write-off periods may
be extended, generally to no more than 360 days past due.
However, in exceptional circumstances, they may be extended
further.
For secured facilities, write-off should occur upon repossession ofcollateral, receipt of proceeds via settlement, or determination thatrecovery of the collateral will not be pursued.
Any secured assets maintained on the balance sheet beyond 60
months of consecutive delinquency-driven default require
additional monitoring and review to assess the prospect ofrecovery.
There are exceptions in a few countries where local regulation orlegislation constrain earlier write-off, or where the realisation ofcollateral for secured real estate lending takes more time. In theevent of bankruptcy or analogous proceedings, write-off may
occur earlier than the maximum periods stated above. Collection
procedures may continue after write-off.

Renegotiated loans and recognition of expected credit losses(Audited)

For retail lending, unsecured renegotiated loans are generally
segmented from other parts of the loan portfolio. Renegotiatedexpected credit loss assessments reflect the higher rates of losses
typically encountered with renegotiated loans. For wholesalelending, renegotiated loans are typically assessed individually.
Credit risk ratings are intrinsic to the impairment assessments. The
individual impairment assessment takes into account the higher
risk of the future non-payment inherent in renegotiated loans.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

23

Risk

Summary of credit risk
The following disclosure presents the gross carrying/nominal amount of financial instruments to which the impairment requirements in
HKFRS 9 are applied and the associated allowance for expected credit losses ('ECL').
Summary of financial instruments to which the impairment requirements in HKFRS 9 are applied(Audited)
2019
Gross
carrying/
nominalamountAt 31 Dec
Loans and advances to customers at amortised cost
Loans and advances to banks

Other financial assets measured at amortised cost2018

Allowance for
ECL1

Gross carrying/nominal amount

Allowance for
ECL1

HK$m

HK$m

HK$m

HK$m

3,738,269(17,394)

3,545,258(16,556)

328,934(29)

338,177(26)

1,540,963(341)

1,436,433(167)– cash and balances at central banks

202,747(1)

205,660—– items in the course of collection from other banks

21,140—25,380—– Hong Kong Government certificates of indebtedness

298,944—

280,854—– reverse repurchase agreements – non-trading

422,333—

406,327—– financial investments

434,523(223)

367,521(120)– prepayments, accrued income and other assets

161,276(117)

150,691(47)

Amounts due from Group companies

85,385—58,631—

Total gross carrying amount on-balance sheet

5,693,551(17,764)

5,378,499(16,749)

Loans and other credit related commitments

1,630,005(560)

1,490,711(376)

41,163(62)50,307(280)

1,671,168(622)

1,541,018(656)

7,364,719(18,386)

6,919,517(17,405)

Fair value

Allowance for
ECL

Fair value

Allowance for
ECL

HK$m

HK$m

HK$m

HK$m

1,457,362(64)

1,497,767(44)

Financial guarantee
Total nominal amount off-balance sheet

At 31 Dec
Debt instruments measured at Fair Value through Other Comprehensive Income (‘FVOCI’)2

1 For retail overdrafts and credit cards, the total ECL is recognised against the financial asset unless the total ECL exceeds the gross carrying amountof the financial asset, in which case the ECL is recognised against the loan commitment.
2 Debt instruments measured at FVOCI continue to be measured at fair value with the allowance for ECL as a memorandum item. Change in ECL isrecognised in 'Change in expected credit losses and other credit impairment charges' in the income instatement.

The following table provides an overview of the group’s credit risk by stage and industry, and the associated ECL coverage. The financial
assets recorded in each stage have the following characteristics:• Stage 1: These financial assets are unimpaired and without significant increase in credit risk on which a 12-month allowance for ECL
is recognised.
• Stage 2: A significant increase in credit risk has been experienced on these financial assets since initial recognition for which a lifetime
ECL is recognised.
• Stage 3: There is objective evidence of impairment and the financial assets are therefore considered to be in default or otherwise
credit impaired on which a lifetime ECL is recognised.
• POCI: Financial assets that are purchased or originated at a deep discount are seen to reflect the incurred credit losses on which alifetime ECL is recognised.

24

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Summary of credit risk (excluding debt instruments measured at FVOCI) by stage distribution and ECL coverage by industry sector(Audited)
Gross carrying/nominal amount

Allowance for ECL

ECL coverage %Stage 1

Stage 2

Stage 3

POCI

Total

Stage 1

Stage 2

Stage 3

POCI

Total Stage 1

Stage 2

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Stage 3

POCI

Total

%

%

%

%

Loans andadvances tocustomers%

3,423,956

296,522

16,6391,152

3,738,269(3,480)(4,615)(8,999)(300) (17,394)– personal

1,351,575

45,606

5,575—

1,402,756(1,732)(2,646)(1,325)– corporate1

1,850,316

222,819

10,9141,149

2,085,198(1,622)(1,844)(7,525)– financial
institutions2

222,065

28,097150

3250,315

(126)

(125)

(149)

(3)

Loans andadvances to
banks

0.1

1.6

54.1

26.0

0.5

(5,703)

0.1

5.8

23.8

—

0.4

(297) (11,288)

0.1

0.8

68.9

25.8

0.5

(403)

0.1

0.4

99.3

100.0

0.2

—

328,355579——

328,934

(26)

(3)

—

—

(29)

0.0

0.5

—

—

0.0

Other
financialassets1,530,910

9,884

167

2

1,540,963

(214)

(77)

(50)

—

(341)

0.0

0.8

29.9

—

0.0

Loan andother creditrelated
commitments

1,601,934

27,967104—

1,630,005

(303)

(236)

(21)

—

(560)

0.0

0.8

20.2

—

0.0

– personal

1,158,805

5,311

69

—

1,164,185

—

(1)

—

—

(1)

—

0.0

—

—

0.0

– corporate1

378,362

18,49535—

396,892

(293)

(230)

(21)

—

(544)

0.1

1.2

60.0

—

0.1

– financial
institutions2

64,767

4,161

—

—

68,928

(10)

(5)

—

—

(15)

0.0

0.1

—

—

0.0

Financialguarantee

34,496

6,634

33

—

41,163

(29)

(20)

(13)

—

(62)

0.1

0.3

39.4

—

0.2

– personal

4,377

—

3

—

4,380

—

—

(3)

—

(3)

—

—

100.0

—

0.1

– corporate1

28,530

6,410

30

—

34,970

(29)

(20)

(10)

—

(59)

0.1

0.3

33.3

—

0.2

– financial
institutions2

1,589

224

—

—

1,813

—

—

—

—

—

—

—

—

—

—

6,919,651

341,586

16,943

1,154

7,279,334(4,052)(4,951)(9,083)(300) (18,386)

0.1

1.4

53.6

26.0

0.3

At 31 Dec
2019

The above table does not include balances due from Group companies.
1 Includes corporate and commercial.
2 Includes non-bank financial institutions.

Unless identified at an earlier stage, all financial assets are deemed to have suffered a significant increase in credit risk when they are 30
days past due ('DPD') and are transferred from stage 1 to stage 2. The following disclosure presents the ageing of stage 2 financial assets
by those less than 30 and greater than 30 days past due and therefore presents those amounts classified as stage 2 due to ageing (30DPD) and those identified at an earlier stage (less than 30 DPD).`
Stage 2 days past due analysis for loans and advances to customers(Audited)
Gross carrying amount

Allowance for ECL

Of which:

Of which:

Of which:

Of which:

ECL coverage %Of which:

Of which:

Stage 2

1 to 29DPD1

30 and >DPD1Stage 2

1 to 29DPD1

30 and >DPD1Stage 2

1 to 29DPD1

30 and >
DPD1

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

%

%

%

Loans and advances to customers
at amortised cost

296,522

8,254

3,911

(4,615)

(255)

(434)

1.6

3.1

11.1

– personal

45,606

6,505

3,494

(2,646)

(217)

(396)

5.8

3.3

11.3

– corporate and commercial

222,819

1,687

417

(1,844)

(38)

(38)

0.8

2.3

9.1

– non-bank financial institutions

28,097

62

—

(125)

—

—

0.4

—

—

At 31 Dec 20191 Days past due (‘DPD’). Up to date accounts in Stage 2 are not shown in amounts.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

25

Risk

Summary of credit risk (excluding debt instruments measured at FVOCI) by stage distribution and ECL coverage by industry sector(continued)(Audited)
Gross carrying/nominal amount
Stage
1

Stage
2

Stage
3

POCI

HK$m

HK$m

HK$m

Loans andadvances tocustomers

3,345,371

180,142– personal

1,219,173

42,395– corporate1

1,919,264– financial
institutions2
Loans andadvances tobanks

Allowance for ECL

ECL coverage %

Total

Stage
1

Stage
2

Stage
3

Total

Stage
1

Stage
2

POCI

Stage
3

HK$m

HK$m

HK$m

HK$m

HK$m

POCI

Total

HK$m

HK$m

%

%

%

%

%

19,024721

3,545,258(3,014)(3,713)

5,431—

1,266,999(1,625)(2,763)(9,549)(280)(16,556)

0.1

2.1

50.2

38.8

0.5

(1,412)—(5,800)

0.1

6.5

26.0

—

131,234

13,407721

2,064,626(1,297)

0.5

(920)

(8,017)(280)(10,514)

0.1

0.7

59.8

38.8

0.5

206,934

6,513

186

—

213,633

(92)

(30)

(120)

—

(242)

0.0

0.5

64.5

—

0.1

337,079

1,098

—

—

338,177

(24)

(2)

—

—

(26)

0.0

0.2

—

—

0.0

Other
financialassets1,427,193

9,170

70

—

1,436,433

(140)

(27)

—

—

(167)

0.0

0.3

—

—

0.0

Loan andother creditrelated
commitments

1,464,749

25,847115—

1,490,711

(275)

(101)

—

—

(376)

0.0

0.4

—

—

0.0

– personal

1,024,061

8,102

4

—

1,032,167

(1)

(3)

—

—

(4)

0.0

0.0

—

—

0.0

– corporate1

384,855

15,559111—

400,525

(262)

(97)

—

—

(359)

0.1

0.6

—

—

0.1

– financial
institutions2

55,833

2,186

—

—

58,019

(12)

(1)

—

—

(13)

0.0

0.0

—

—

0.0

Financialguarantee

43,261

6,349

697

—

50,307

(26)

(33)

(221)

—

(280)

0.1

0.5

31.7

—

0.6

– personal

4,562

1

5

—

4,568

—

—

(1)

—

(1)

—

—

20.0

—

0.0

– corporate1

34,978

6,254

692

—

41,924

(25)

(33)

(220)

—

(278)

0.1

0.5

31.8

—

0.7

– financial
institutions2

3,721

94

—

—

3,815

(1)

—

—

—

(1)

0.0

—

—

—

0.0

6,617,653

222,606

19,906721

6,860,886(3,479)(3,876)(9,770)(280)(17,405)

0.1

1.7

49.1

38.8

0.3

At 31 Dec
2018

The above table does not include balances due from Group companies.
1 Includes corporate and commercial.
2 Includes non-bank financial institutions.

Stage 2 days past due analysis for loans and advances to customers (continued)(Audited)
Gross carrying amount

Allowance for ECL

Of which:

Of which:

Stage 2

1 to 29 DPD1

30 and >
DPD1

HK$m

HK$m

Loans and advances to customers

180,142– personal

42,395– corporate and commercial

ECL coverage %Of which:

Of which:

Stage 2

1 to 29 DPD1

30 and >DPD1

Of which:

Of which:

Stage 2

1 to 29 DPD1

30 and >
DPD1

HK$m

HK$m

HK$m

HK$m

%

%

%

7,632

3,733

(3,713)

6,366

3,443

(2,763)

(270)

(332)

2.1

3.5

8.9

(229)

(310)

6.5

3.6

131,234

1,264

80

9.0

(920)

(41)

(22)

0.7

3.2

27.5

6,513

2

210

(30)

—

—

0.5

—

—

At 31 Dec 2018

– non-bank financial institutions

1

Days past due (‘DPD’). Up to date accounts in Stage 2 are not shown in amounts.

26

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Credit exposure
Maximum exposure to credit risk
(Audited)

This section provides information on balance sheet items as well as loan and other credit-related commitments.
‘Maximum exposure to credit risk’ table
The following table presents our maximum exposure before taking account of any collateral held or other credit enhancements (unless such enhancements
meet accounting offsetting requirements). The table excludes financial instruments whose carrying amount best represents the net exposure to credit risk,
and it excludes equity securities as they are not subject to credit risk. For the financial assets recognised on the balance sheet, the maximum exposure tocredit risk equals their carrying amount; for financial guarantees and other guarantees granted, it is the maximum amount that we would have to pay if theguarantees were called upon. For loan commitments and other credit-related commitments, it is generally the full amount of the committed facilities.

Other credit risk mitigants
There are arrangements in place that reduce our maximum exposure to credit risk. These include a charge over collateral on borrowers’
specific assets, such as residential properties, collateral held in the form of financial instruments that are not held on the balance sheet
and short positions in securities. In addition, for financial assets held as part of linked insurance/investment contracts the risk
is predominantly borne by the policyholder.
Collateral available to mitigate credit risk is disclosed in the Collateral section on pages 36-39.
Maximum exposure to credit risk before collateral held or other credit enhancements(Audited)
2019

2018

HK$m

HK$m

Cash and balances at central banks

202,746

205,660

Items in the course of collection from other banks

21,14025,380Hong Kong Government certificates of indebtedness

298,944

280,854

Trading assets

445,298439,363

Derivatives

280,642

292,869

Financial assets designated at fair value

33,46433,023

Reverse repurchase agreements – non-trading

422,333

406,327

Loans and advances to banks

328,905

338,151

Loans and advances to customers

3,720,875

3,528,702

Financial investments

1,891,661

1,865,168

Amounts due from Group companies

87,63270,455

Other assets

165,497

159,483

Total on-balance sheet exposure to credit risk

7,899,137

7,645,435

Total off-balance sheet

3,346,414

3,171,280

Financial guarantees and other similar contracts

315,257

291,915

Loan and other credit-related commitments

3,031,157

2,879,365

At 31 Dec

11,245,551

10,816,715

Total exposure to credit risk remained broadly unchanged in 2019with loans and advances continuing to be the largest element.

Credit deterioration of financial instruments(Audited)
A summary of our current policies and practices regarding the identification,
treatment and measurement of stage 1, stage 2, stage 3 (credit impaired) and
POCI financial instruments can be found in note 1.2(i) on the Consolidated
Financial Statements.

Measurement uncertainty and sensitivity analysis
of ECL estimates(Audited)

The recognition and measurement of expected credit losses (‘ECL’)
involves the use of significant judgement and estimation. We form
multiple economic scenarios based on economic forecasts, apply
these assumptions to credit risk models to estimate future credit
losses, and probability-weight the results to determine an
unbiased ECL estimate.

Methodology
We use multiple economic scenarios to reflect assumptions about
future economic conditions, starting with three economic
scenarios based on consensus forecast distributions,
supplemented by alternative or additional economic scenarios
and/or management adjustments where, in management’s
judgement, the consensus forecast distribution does notadequately capture the relevant risks.

The three economic scenarios represent the ’most likely outcome’and two less likely outcomes, referred to as the Upside andDownside scenarios. Each outer scenario is consistent with aprobability of 10%, while the Central scenario is assigned theremaining 80%, according to the decision of the group’s senior
management. This weighting scheme is deemed appropriate forthe unbiased estimation of ECL in most circumstances.
Economic assumptions in the Central consensus economic
scenario are set using consensus forecasts which represent the
average of forecasts of external economists. Reliance on external
forecasts helps ensure that the Central scenario is unbiased andmaximises the use of independent information. The Upside andDownside scenarios are selected with reference to externallyavailable forecast distributions and are designed to be cyclical, inthat GDP growth, inflation and unemployment usually revert backto the Central scenario after the first three years for major
economies. We determine the maximum divergence of GDP
growth from the Central scenario using the 10th and the 90th
percentile of the entire distribution of forecast outcomes for major
economies. While key economic variables are set with reference toexternal distributional forecasts, we also align the overall narrativeof the scenarios to the macroeconomic risks described in thegroup’s ‘Top and emerging risks’. This ensures that scenarios
remain consistent with the more qualitative assessment of theserisks. We project additional variable paths using an external
provider’s global macro model.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

27

Risk

The Upside and Downside scenarios are generated once a year,
reviewed at each reporting date to ensure that they are an
appropriate reflection of managements view and updated if
economic conditions change significantly. The Central scenario isgenerated every quarter. For quarters without updates to outerscenarios, wholesale and retail credit risk use the updated central
scenario to approximate the impact of the most recent outerscenarios.
Additional scenarios are created as required, to address thoseforward-looking risks that management considers are notadequately captured by the consensus. At the reporting date, we
deployed additional scenarios to address the impact ofdeteriorating trade relations between China and the US on key
Asian economies and to address the possibility of a further
deterioration in economic growth in Hong Kong.

The consensus Upside scenario
The economic forecast distribution of risks (as captured byconsensus probability distributions of GDP growth) has shown adecrease in upside risks across our main markets over the courseof 2019. In the first two years of the Upside scenario, global real
GDP growth rises before converging to the Central scenario.
Increased confidence, de-escalation of trade tensions and removalof trade barriers, expansionary fiscal policy, stronger oil prices aswell as calming of geopolitical tensions are the risk themes that
support the Upside scenario.
The following table describes key macroeconomic variables andthe probabilities assigned in the consensus Upside scenario.
Upside scenario (average 2020-2024)
Hong Kong

MainlandChina

GDP growth rate (%)

2.2

5.9

Inflation (%)

2.5

2.7

Unemployment (%)

2.9

3.9

The consensus Central scenario

Short–term interest rate (%)

1.2

3.9

The Central scenario is one of moderate growth over the forecast
period 2020-2024. Global GDP growth is expected to be 2.8% on
average over the period, which is marginally lower than the
average growth rate over the period 2014-2018. Across the key
markets, we note that:

10-year treasury bond yields (%)

2.5

N/A

Property price growth (%)

5.0

5.8

Equity price growth (%)

6.9

10.7

Probability (%)

10.0

10.0

Description of Consensus Economic Scenarios
The economic assumptions presented in this section have been
formed internally by the group specifically for the purpose of
calculating expected credit loss.

• Expected average rates of GDP growth over the 2020-2024
period are lower than average growth rates achieved over the
2014-2018 period in all of our key markets. For China, it isconsistent with the theme of ongoing rebalancing from anexport-oriented economy to deeper domestic consumption.
Short–term expectations of economic growth in Hong Kongdeteriorated sharply in the second half of 2019.
• The unemployment rate is expected to rise over the forecasthorizon in most of our major markets.
• Inflation is expected to be stable and will remain close tocentral bank targets in our core markets over the forecast
period.
• Major central banks lowered their main policy interest rates in2019 and are expected to continue to maintain a low interest
rate environment over the projection horizon. The US Federal
Reserve Board has resumed asset purchases to provide liquidity
and the European Central bank is expected to restart its asset
purchase programmes.
• The West Texas Intermediate oil price is forecast to average
US$59 per barrel over the projection period.
The following table describes key macroeconomic variables andthe probabilities assigned in the consensus Central scenario.
Central scenario (average 2020–2024)
Hong Kong

MainlandChina

GDP growth rate (%)

1.9

5.6

Inflation (%)

2.2

2.4

Unemployment (%)

3.1

4.0

Short–term interest rate (%)

1.1

3.8

10-year treasury bond yields (%)

2.4

N/A

Property price growth (%)

3.8

4.6

Equity price growth (%)

5.1

7.9

Probability (%)

50.0

80.0

Note: N/A – not required in credit models.

The Downside scenarios
The consensus Downside scenario
The distribution of risks (as captured by consensus probability
distributions of GDP growth) has shown a marginal increase indownside risks over the course of 2019 for Hong Kong. In the
Downside scenario, global real GDP growth declines for two years
before recovering towards its long-run trend. House price growtheither stalls or contracts and equity markets correct abruptly in our
major markets in this scenario. The potential slowdown in global
demand would drive commodity prices lower and result in an
accompanying fall in inflation. Central banks would be expected toenact loose monetary policy, which in some markets would resultin a reduction in the key policy interest rate. The scenario is
consistent with key in our 'Top and emerging risks', which include
an intensification of global protectionism and trade barriers, a
slowdown in China, further risks to economic growth in Hong
Kong and weaker commodity prices.
The following table describes key macroeconomic variables andthe probabilities assigned in the consensus Downside scenario.
Downside scenario (average 2020-2024)
Hong Kong

MainlandChina

GDP growth rate (%)

1.4

5.6

Inflation (%)

1.9

2.1

Unemployment (%)

3.3

4.0

Short–term interest rate (%)

(0.1)

3.6

10-year treasury bond yields (%)

1.2

N/A

Property price growth (%)

2.3

3.9

Equity price growth (%)

(0.7)

1.1

Probability (%)

10.0

0.0

Note: N/A – not required in credit models.

Note: N/A – not required in credit models.

28

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

The alternative Downside scenarios

How economic scenarios are reflected in the wholesalecalculation of ECL

Alternative Downside scenarios have been created to reflect
management’s view of risk in some of our key markets.
Asia-Pacific alternative Downside scenario
Two alternative Downside scenarios have been implemented for
key Asia-Pacific markets to represent management’s view of
economic uncertainty arising from trade and tariff tensions
between China and the US and the current economic situation in
Hong Kong. These scenarios and their associated probabilities aredescribed below.
Asia-Pacific alternative Downside scenario 1
A continuation of trade- and tariff-related tensions throughout
2019 resulted in management modelling an alternative Downside
scenario for eight of our key Asia-Pacific markets. This scenario
models the effects of a significant escalation in global tensions,
stemming from trade disputes but going beyond increases intariffs to affect non-tariff barriers, cross-border investment flows
and threats to the international trade architecture. This scenario
assumes actions that lie beyond currently enacted and proposed
tariffs and has been modelled as an addition to the threeconsensus-driven scenarios for these economies.

The Group has developed a globally consistent methodology forthe application of forward economic guidance into the calculationof ECL by incorporating forward economic guidance into theestimation of the term structure of probability of default (‘PD’) andloss given default (‘LGD’). For PDs, we consider the correlation of
forward economic guidance to default rates for a particularindustry in a country. For LGD calculations we consider thecorrelation of forward economic guidance to collateral values andrealisation rates for a particular country and industry. PDs and
LGDs are estimated for the entire term structure of each
instrument.
For impaired loans, LGD estimates take into account independent
recovery valuations provided by external consultants whereavailable, or internal forecasts corresponding to anticipatedeconomic conditions and individual company conditions. In
estimating the ECL on impaired loans that are individuallyconsidered not to be significant, the group incorporates forward
economic guidance proportionate to the probability-weighted
outcome and the Central scenario outcome for non-stage 3
populations.

Key macroeconomic variables are shown in the table below:

How economic scenarios are reflected in the retailcalculation of ECL

Average 2020-2024

The Group has developed and implemented a globally consistentmethodology for incorporating forecasts of economic conditions
into ECL estimates. The impact of economic scenarios on PD ismodelled at a portfolio level. Historic relationships between
observed default rates and macro-economic variables areintegrated into HKFRS 9 ECL estimates by leveraging economic
response models. The impact of these scenarios on PD ismodelled over a period equal to the remaining maturity ofunderlying asset or assets. The impact on LGD is modelled formortgage portfolios by forecasting future loan-to-value (‘LTV’)
profiles for the remaining maturity of the asset by leveraging
national level forecasts of the house price index and applying thecorresponding LGD expectation.

Hong Kong

MainlandChina

GDP growth rate (%)

0.8

5.2

Inflation (%)

1.6

2

Unemployment (%)

5.1

4.3

Short–term interest rate (%)

0.7

2.9

10-year treasury bond yields (%)

1.6

N/A

Property price growth (%)

(3.7)

2.6

Equity price growth (%)

(3.3)

(1.6)

Probability (%)

20.0

10.0

Note: N/A – not required in credit models.

Asia-Pacific alternative Downside scenario 2
A deep cyclical recessionary scenario has been modelled to reflect
Hong Kong-specific risks and the possibility of a further
deterioration in the economic environment. This scenario has been
applied to Hong Kong only and has been assigned a 10%
probability.
Average 2020–2024
Hong Kong

GDP growth rate (%)(0.1)

Inflation (%)

1.3

Unemployment (%)

5.1

Short–term interest rate (%)

0.4

10-year treasury bond yields (%)

1.4

Property price growth (%)(3.7)

Equity price growth (%)(8.4)

Probability (%)

10.0

The conditions that resulted in departure from the consensus
economic forecasts will be reviewed regularly as economic
conditions change in future to determine whether theseadjustments continue to be necessary.

Economic scenarios sensitivity analysis of ECL
estimates
Management considered the sensitivity of the ECL outcome
against the economic forecasts as part of the ECL governanceprocess by recalculating the ECL under each scenario describedabove for selected portfolios, applying a 100% weighting to eachscenario in turn. The weighting is reflected in both thedetermination of significant increase in credit risk as well as themeasurement of the resulting ECL.
The ECL calculated for the Upside and Downside scenarios should
not be taken to represent the upper and lower limits of possible
actual ECL outcomes. The impact of defaults that might occur infuture under different economic scenarios is captured byrecalculating ECL for loans in stages 1 and 2 at the balance sheet
date. The population of stage 3 loans (in default) at the balance
sheet date is unchanged in these sensitivity calculations. Stage 3
ECL would only be sensitive to changes in forecasts of future
economic conditions if the LGD of a particular portfolio wassensitive to these changes.
There is a particularly high degree of estimation uncertainty innumbers representing tail risk scenarios when assigned a 100%weighting.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

29

Risk

For wholesale credit risk exposures, the sensitivity analysis
excludes ECL and financial instruments related to defaulted
obligors because the measurement of ECL is relatively moresensitive to credit factors specific to the obligor than future
economic scenarios, and it is impracticable to separate the effectof macroeconomic factors in individual assessments.
For retail credit risk exposures, the sensitivity analysis includes
ECL for loans and advances to customers related to defaulted
obligors. This is because the retail ECL for secured mortgage
portfolios including loans in all stages is sensitive tomacroeconomic variables.

Retail analysis
HKFRS 9 ECL sensitivity to future economic conditions1
Hong
Kong

Malaysia

Singapore

Australia

2,718

732

467

296

ECL coverage of loans andadvances to customers at
31 December 20192
Reported ECL (HK$m)
Consensus scenarios
Central scenario (HK$m)

2,306

732

452

288

We also considered developments after the balance sheet dateand concluded that they did not necessitate any adjustment to theapproach or judgements taken on 31 December 2019.

Upside scenario (HK$m)

2,197

662

444

249

Downside scenario (HK$m)

2,383

826

452

351

Wholesale analysis

Asia-Pacific alternative
Downside scenario 1 (HK$m)

4,128

857

623

389

HKFRS 9 ECL sensitivity to future economic conditions1

Asia-Pacific alternative
Downside scenario 2 (HK$m)

4,206

N/A

N/A

N/A

Gross carrying amount/nominal amount (HK$m)

792,061

45,48063,590134,423

Hong Kong

MainlandChina

ECL coverage of financial instruments
subject to significant measurement
uncertainty at 31 December 20192
Reported ECL (HK$m)

2,555

966

Central scenario (HK$m)

1,895

919

Upside scenario (HK$m)

1,877

740

Downside scenario (HK$m)

1,901

826

4,284

1,168

5,452

N/A

3,256,617

810,092

Alternative scenarios

1 ECL sensitivities exclude portfolios using less complex modelling
approaches.
2 ECL sensitivity includes only on-balance sheet financial instruments
to which HKFRS 9 impairment requirements are applied.

Consensus scenarios

Alternative scenarios
Asia-Pacific alternative Downside scenario 1(HK$m)
Asia-Pacific alternative Downside scenario 2(HK$m)
Gross carrying amount/nominal amount3(HK$m)

1 Excludes ECL and financial instruments relating to defaulted obligors
because the measurement of ECL is relatively more sensitive to credit
factors specific to the obligor than future economic scenarios.
2 Includes off-balance sheet financial instruments that are subject tosignificant measurement uncertainty.
3 Includes low credit-risk financial instruments such as Debt
instruments at FVOCI, which have low ECL coverage ratios under all
the above scenarios. Coverage ratios on loans and advances tocustomers including loan commitments and financial guarantees are
typically higher.

The changes in sensitivity from 31 December 2018 is reflective ofchanges in lending volumes, credit quality and movements inforeign exchange. In Hong Kong, an additional downside scenario
was introduced during 2019 where an increase in severity ofalternative downside scenario partially offset by changes in credit
quality is observed.
Overall, as the level of uncertainty, economic forecasts, historicaleconomic variable correlations or credit quality changes,
corresponding changes in the ECL sensitivity would occur.

Post-model adjustments
In the context of HKFRS 9, post-model adjustments are short-term
increases or decreases to the ECL at either a customer or portfolio
level to account for late breaking events, model deficiencies andexpert credit judgement applied following management review
and challenge. We have internal governance in place to regularly
monitor post-model adjustments and where possible to reduce thereliance on these through model recalibration or redevelopment as
appropriate.

ECL coverage rates reflect the underlying observed credit defaults,
the sensitivity to economic environment, extent of security and theeffective maturity of the book. Hong Kong is typically a shortdated book with low defaults, which is reflected in the low ECL
coverage ratio.

30

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Reconciliation of changes in gross carrying/nominal amount and allowances for placings with andadvances to banks and loans and advances to customers, including loan commitments and financial
guarantees
The following disclosure provides a reconciliation by stage of the group’s gross carrying/nominal amount and allowances for loans andadvances to banks and customers, including loan commitments and financial guarantees. Movements are calculated on a quarterly basis
and therefore fully capture stage movements between quarters. If movements were calculated on a year-to-date basis they would onlyreflect the opening and closing position of the financial instrument.
The transfers of financial instruments represents the impact of stage transfers upon the gross carrying/nominal amount and associatedallowance for ECL.
The net remeasurement of ECL arising from stage transfers represents the increase or decrease due to these transfers, for example,
moving from a 12-month (stage 1) to a lifetime (stage 2) ECL measurement basis. Net remeasurement excludes the underlying CRR/PD
movements of the financial instruments transferring stage. This is captured, along with other credit quality movements in the ‘changes inrisk parameters – credit quality’ line item.
Changes in ‘New financial assets originated or purchased’, ‘assets derecognised (including final repayments)’ and ‘changes to risk
parameters – further lending/repayments’ represent the impact from volume movements within the group’s lending portfolio.
Reconciliation of changes in gross carrying/nominal amount and allowances for loans and advances to banks and customers, including
loan commitments and financial guarantees(Audited)Stage 1Grosscarrying/
nominalamountStage 2

Allowance
for ECLGross
carrying/
nominalamountStage 3

Allowance
for ECLGross
carrying/
nominalamount

POCI

Total

Allowance
for ECLGross
carrying/
nominalamountAllowance
for ECLGross
carrying/
nominalamountAllowance
for ECL

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

At 1 Jan 2019

5,190,396(3,339)213,434(3,849)19,836(9,772)

721

(279)

5,424,387(17,239)

Transfers of financial instruments:(199,043)(1,999)192,106

2,829

6,937

(830)

—

—

—

—

– transfers from stage 1 to stage 2(424,655)

904

424,655

(904)

—

—

—

—

—

—

– transfers from stage 2 to stage 1

227,072(2,849)(227,072)

2,849

—

—

—

—

—

—

– transfers to stage 3(1,987)48(6,513)

1,056

8,500

(1,104)

—

—

—

—

– transfers from stage 3

527

(102)

1,036

(172)

(1,563)

274

—

—

—

—

Net remeasurement of ECL arisingfrom transfer of stage

—

1,657

—

(1,887)

—

(215)

—

—

—

New financial assets originated andpurchased

1,655,668(1,347)

—

—

—

—

555

—

1,656,223(1,347)

Assets derecognised (including
final repayments)(1,132,107)

274(77,234)590(4,991)

1,078

(18)

—

(1,214,350)

1,942

Changes to risk parameters –further lending/repayment(445)(104,136)

757

3,871

289

850

363

(152)

7

(99,567)

1,416

Changes in risk parameters – credit
quality—207—(2,880)—(4,989)

—

(64)

—

(7,726)

Changes to model used for ECL
calculation

—

(50)

—

39

—

113

—

—

—

102

Assets written off

—

—

—

—

(4,842)

4,842

(41)

41

(4,883)

4,883

Credit-related modifications that
resulted in derecognition

—

—

—

—

(980)

394

—

—

(980)

394

Foreign exchange(7,733)

16

(479)

(2)

63

(37)

(2)

(1)

(8,151)(24)

Others(19,395)

(15)

3

(3)

(98)

21

89

(4)

(19,401)(1)

5,383,650(3,839)331,701(4,874)

16,775(9,032)

1,152

(300)

5,733,278(18,045)

At 31 Dec 2019
ECL income statement charge forthe year(6,058)Recoveries

863

Others(197)

Total ECL income statement
charge for the year

(5,392)

At 31 Dec 2019Year ended 31 Dec 2019

Gross carrying/nominal amount

Allowance for ECL

ECL charge

HK$m

HK$m

HK$m

As above

5,733,278(18,045)(5,392)Other financial assets measured at amortised cost

1,540,963

(341)

(134)

5,093

—

—

N/A

N/A

(123)

Non-trading reverse repurchase agreement commitments
Performance and other guarantees not considered for HKFRS 9
Amounts due from Group companies

85,385——

Summary of financial instruments to which the impairment requirements in
HKFRS 9 are applied/Summary consolidated income statement

7,364,719(18,386)(5,649)Debt instruments measured at FVOCI

1,457,362

(64)

(23)

N/A

(18,450)(5,672)

Total allowance for ECL/total income statement ECL charge for the year

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

31

Risk

Reconciliation of changes in gross carrying/nominal amount and allowances for loans and advances to banks and customers, including
loan commitments and financial guarantees (continued)(Audited)Stage 1Grosscarrying/
nominalamountStage 2

Allowance
for ECLGross
carrying/
nominalamountStage 3

Allowance
for ECLGross
carrying/
nominalamount

POCI

Total

Allowance
for ECLGross
carrying/
nominalamountAllowance
for ECLGross
carrying/
nominalamountAllowance
for ECL

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

4,852,623(3,365)

280,319(4,277)

17,713(9,239)

1,231

(185)

5,151,886(17,066)

Transfers of financial instruments:(33,980)(2,276)

21,3993,214

12,581

(938)

—

—

—

—

– transfers from stage 1 to stage 2(324,248)

789

324,248

(789)

—

—

—

—

—

—

– transfers from stage 2 to stage 1

295,728(3,109)(295,728)

3,109

—

—

—

—

—

—

(5,481)50(8,862)

1,064

14,343(1,114)

—

—

—

—

– transfers from stage 3

21

(6)

1,741

(170)

(1,762)

176

—

—

—

—

Net remeasurement of ECL arisingfrom transfer of stage

—

1,819

—

(1,800)

—

(262)

—

—

—

(243)

At 1 Jan 2018

– transfers to stage 3

Net new and further lending/repayments1

466,876(872)(83,068)

173(5,105)

2,434

(500)

11

378,203

1,746

Changes in risk parameters - credit
quality

—

1,170

—

(1,177)—(7,040)

—

(114)

—

(7,161)

Changes to model used for ECL
calculation

—

—

—

—

—

—

—

—

—

—

Assets written off

—

—

—

—

(4,974)

4,973

(6)

6

(4,980)4,979

Foreign exchange and otherAt 31 Dec 2018(95,123)

185(5,216)

18

(379)

300

(4)

3

(100,722)

506

5,190,396(3,339)213,434(3,849)19,836(9,772)

721

(279)

5,424,387(17,239)

ECL income statement charge forthe year(5,658)Recoveries

940

Others(21)

Total ECL income statement charge
for the year

(4,739)At 31 Dec 2018Year ended 31 Dec 2018

Gross carrying/nominal
amountAllowance for ECL

ECL charge

HK$m

HK$m

HK$m

As above

5,424,387(17,239)(4,739)Other financial assets measured at amortised cost

1,436,433

(167)

4

66

—

—

Non-trading reverse repurchase agreement commitments
Performance and other guarantees not considered for HKFRS 9

N/A

N/A

5

58,631——

Summary of financial instruments to which the impairment requirements in HKFRS 9 areapplied/Summary consolidated income statement

6,919,517(17,406)(4,730)Debt instruments measured at FVOCI

1,497,767

(44)

10

N/A

(17,450)(4,720)

Amounts due from Group companies

Total allowance for ECL/total income statement ECL charge for the year

1 The 31 December 2018 comparative 'Reconciliation of changes in gross carrying/nominal amount and allowances for loans and advances tobanks and customers' disclosure presents 'New financial assets originated or purchased', 'Assets derecognised (including final repayments)' and'Changes to risk parameters – further lending/repayments' under 'Net new lending and further lending/repayments'. To provide greater
granularity, these amounts have been separately presented in the 31 December 2019 disclosure.

32

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Credit quality
Credit quality of financial instruments(Audited)

We assess the credit quality of all financial instruments that are subject to credit risk. The credit quality of financial instruments is a pointin-time assessment of the probability of default of financial instruments, whereas stages 1 and 2 are determined based on relative
deterioration of credit quality since initial recognition. Accordingly, for non-credit-impaired financial instruments, there is no direct
relationship between the credit quality assessment and stages 1 and 2, though typically the lower credit quality bands exhibit a higher
proportion in stage 2.
The five credit quality classifications each encompass a range of granular internal credit rating grades assigned to wholesale and retaillending businesses and the external ratings attributed by external agencies to debt securities, as shown in the table below.
Distribution of financial instruments by credit quality at 31 December 2019
(Audited)
Gross carrying/notional amount
StrongGood

Satisfactory

Substandard

Creditimpaired

Total

Allowance
for ECL

Net

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Loans and advances to customers held at
amortised cost

1,997,523

946,831755,183

21,067

17,665

3,738,269(17,394)

3,720,875– personal

1,173,323

138,094

81,345

4,419

5,575

1,402,756(5,703)

1,397,053– corporate and commercial

707,662

731,917617,079

16,602

11,9382,085,198(11,288)2,073,910– non-bank financial institutions

116,538

76,82056,75946

152

250,315(403)

249,912Loans and advances to banks

308,236

19,338

1,357

3

—

328,934(29)

328,905

Cash and balances at central banks

197,770

3,946

1,031

—

—

202,747(1)

202,746

Items in the course of collection from otherbanks

21,140————21,140—21,140Hong Kong Government certificates ofindebtedness

298,944

—

—

—

—

298,944—

298,944

Reverse repurchase agreements – non-trading

286,338

99,55536,440——422,333—

422,333

Financial investments held at amortised cost

382,384

46,887

5,252

—

—

434,523(223)

434,300

Prepayments, accrued income and other assets

82,72538,62738,922833

169

161,276(117)

161,159

1,382,729

60,202

9,301

—

—

1,452,232(64)

1,452,168

378,656

39,057

26,683905—

445,301—445,301

In-scope for HKFRS 9 impairment

Debt instruments measured at fair value
through other comprehensive income1
Out-of-scope for HKFRS 9 impairment
Trading assets
Other financial assets designated and otherwise
mandatorily measured at fair value throughprofit or loss

22,850

3,702

3,174

—

—

29,726—29,726

Derivatives

168,448

44,520

3,336

41

—

216,345—

216,3455,527,743

1,302,665

880,679

22,84917,834

7,751,770(17,828)

7,733,942

71%

17%

11%

0%

0%

100%

—

—

1,639,786

678,914415,286

13,650303

2,747,939(561)

2,747,378

113,138

108,045

71,562

3,222

324

296,291(213)

296,078

1,752,924

786,959

486,848

16,872627

3,044,230(774)

3,043,456

Total gross carrying amount on-balance
sheet
Percentage of total credit quality
Loan and other credit related commitments2
Financial guarantee and similar contracts
Total nominal off-balance sheet amountThe Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

33

Risk

Distribution of financial instruments by credit quality at 31 December 2018 (continued)(Audited)
Gross carrying/notional amount
StrongGood

Satisfactory

Substandard

Creditimpaired

Total

Allowance for
ECL

Net

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Loans and advances to customers held at
amortised cost

1,867,142

881,026

758,398

19,123

19,5693,545,258(16,556)

3,528,702– personal

1,052,365

116,82188,755

3,627

5,431

1,266,999(5,800)1,261,199– corporate and commercial

713,295

702,871

619,057

15,451

13,952

2,064,626(10,514)2,054,112– non-bank financial institutions

101,482

61,33450,58645

186

213,633(242)

213,391Loans and advances to banks

311,304

22,434

4,439

—

—

338,177(26)

338,151

Cash and balances at central banks

200,977

3,890

793

—

—

205,660—

205,660

Items in the course of collection from otherbanks

25,380————25,380—25,380Hong Kong Government certificates ofindebtedness

280,854

—

—

—

—

280,854—

280,854

Reverse repurchase agreements – non-trading

294,944

68,87242,511——

406,327—

406,327

Financial investments held at amortised cost

321,495

41,044

4,982

—

—

367,521(120)

367,401

Prepayments, accrued income and other assets

83,74832,19734,283393

70

150,691(47)

150,644

1,422,307

67,108

9,111

—

—

1,498,526(44)

1,498,482

381,629

37,71919,717298—

439,363—439,363

In-scope for HKFRS 9 impairment

Debt instruments measured at fair value
through other comprehensive income1
Out-of-scope for HKFRS 9 impairment
Trading assets
Other financial assets designated and otherwise
mandatorily measured at fair value throughprofit or loss

22,286

3,183

3,159

—

—

28,628—28,628Derivatives

165,327

43,362

5,011

159

—

213,859—

213,859

5,377,393

1,200,835

882,404

19,973

19,6397,500,244(16,793)

7,483,451

72%

16%

12%

0%

0%

100%

—

—

2,139,267

261,579

145,681

2,248

115

2,548,890(376)

2,548,514

Financial guarantee and similar contracts

97,697104,379

69,593

1,628

1,169

274,466(314)

274,152

Total nominal off-balance sheet amount

2,236,964

365,958

215,274

3,876

1,284

2,823,356(690)

2,822,666

Total gross carrying amount on-balance sheet
Percentage of total credit quality
Loan and other credit related commitments2

The above table does not include balances due from Group companies.
1 For the purposes of this disclosure, gross carrying value is defined as the amortised cost of a financial asset, before adjusting for any loss
allowance. As such the gross carrying value of debt instruments at FVOCI as presented above will not reconcile to the balance sheet as it excludes
fair value gains and losses.
2 In 2018, revocable loan and other commitments, which are out-of-scope of HKFRS 9 are presented within the 'Strong' classification.

34

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Distribution of financial instruments to which the impairment requirements in HKFRS 9 are applied, by credit quality and stage
allocation(Audited)
Gross carrying/notional amount
StrongGood

Satisfactory

Substandard

Creditimpaired

Total

Allowance
for ECL

Net

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Loans and advances to banks

308,236

19,338

1,357

3

—

328,934(29)

328,905– stage 1

307,968

19,313

1,071

3

—

328,355(26)

328,329– stage 2

268

25

286

—

—

579

(3)

576

– stage 3

—

—

—

—

—

—

—

—

– POCI

—

—

—

—

—

—

—

—

Loans and advances to customers at amortised cost

1,997,523

946,831755,183

21,067

17,665

3,738,269(17,394) 3,720,875– stage 1

1,990,700

859,196569,372

4,688—

3,423,956(3,480) 3,420,476– stage 2

6,823

87,635

185,811

16,253—

296,522(4,615)291,907– stage 3

—

—

—

—

16,63916,639(8,999)7,640– POCI

—

—

—

126

1,026

1,152

(300)

852

Other financial assets measured at amortised cost

1,269,301

189,015

81,645833

169

1,540,963(341) 1,540,622– stage 1

1,266,894

185,925

77,914177—

1,530,910(214) 1,530,696– stage 2

2,407

3,090

3,731

656

—

9,884

(77)

9,807

– stage 3

—

—

—

—

167

167

(50)

117

– POCI

—

—

—

—

2

2

—

2

Loan and other credit-related commitments

1,246,440

285,938

94,4363,087

104

1,630,005(560) 1,629,445– stage 1

1,244,851

273,593

81,6011,889—

1,601,934(303) 1,601,631– stage 2

1,589

12,345

12,835

1,198—

27,967(236)

27,731– stage 3

—

—

—

—

104

104

(21)

83

– POCI

—

—

—

—

—

—

—

—

Financial guarantees

10,52016,774

12,860976

33

41,163(62)

41,101– stage 1

10,224

15,108

9,069

95

—

34,496(29)

34,467– stage 2

296

1,666

3,791

881

—

6,634

(20)

6,614

– stage 3

—

—

—

—

33

33

(13)

20

– POCI

—

—

—

—

—

—

—

—

4,832,020

1,457,896

945,481

25,966

17,971

7,279,334(18,386) 7,260,948– stage 1

1,382,708

60,180

9,301

—

—

1,452,189(64) 1,452,125– stage 2

21

22

–

—

—

43

—

43

– stage 3

—

—

—

—

—

—

—

—

– POCI

—

—

—

—

—

—

—

—

1,382,729

60,202

9,301

—

—

1,452,232

At 31 Dec 2019
Debt instruments at FVOCI1At 31 Dec 2019(64) 1,452,168`

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

35

Risk

Distribution of financial instruments to which the impairment requirements in HKFRS 9 are applied, by credit quality and stage
allocation (continued)(Audited)
Gross carrying/notional amount
StrongGood

Satisfactory

Substandard

Creditimpaired

Total

Allowance
for ECL

Net

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Loans and advances to banks

311,304

22,434

4,439

—

—

338,177(26)

338,151– stage 1

311,01222,022

4,045

—

—

337,079(24)

337,055– stage 2

292

412

394

—

—

1,098

(2)

1,096

– stage 3

—

—

—

—

—

—

—

—

– POCI

—

—

—

—

—

—

—

—

Loans and advances to customers at amortised cost

1,867,142

881,026

758,398

19,123

19,5693,545,258(16,556)

3,528,702– stage 1

1,861,473

840,372

639,8123,714—

3,345,371(3,014)

3,342,357– stage 2

5,669

40,654

118,586

15,233—

180,142(3,713)

176,429– stage 3

—

—

—

—

19,02419,024(9,549)9,475– POCI

—

—

—

176

545

721

(280)

441

Other financial assets measured at amortised cost

1,207,398

146,00382,569393

70

1,436,433(167)

1,436,266– stage 1

1,204,886

143,493

78,72094—

1,427,193(140)

1,427,053– stage 2

2,512

2,510

3,849

299

—

9,170

(27)

9,143

– stage 3

—

—

—

—

70

70

—

70

– POCI

—

—

—

—

—

—

—

—

Loan and other credit-related commitments

1,081,090

261,578

145,681

2,247

115

1,490,711(376)

1,490,335– stage 1

1,078,356

250,973

134,399

1,021—

1,464,749(275)

1,464,474– stage 2

2,734

10,605

11,282

1,226—

25,847(101)

25,746– stage 3

—

—

—

—

115

115

—

115

– POCI

—

—

—

—

—

—

—

—

Financial guarantees

14,791

19,70014,675444

697

50,307(280)

50,027– stage 1

14,37018,051

10,77961—

43,261(26)

43,235– stage 2

421

1,649

3,896

383

—

6,349

(33)

6,316

– stage 3

—

—

—

—

697

697

(221)

476

– POCI

—

—

—

—

—

—

—

—

4,481,725

1,330,741

1,005,762

22,207

20,4516,860,886(17,405)

6,843,481– stage 1

1,422,307

67,108

9,110

—

—

1,498,525(44)

1,498,481– stage 2

—

—

1

—

—

1

—

1

– stage 3

—

—

—

—

—

—

—

—

At 31 Dec 2018
Debt instruments at FVOCI1– POCIAt 31 Dec 2018

—

—

—

—

—

—

—

—

1,422,307

67,108

9,111

—

—

1,498,526(44)

1,498,482

The above table does not include balances due from Group companies.
1 For the purposes of this disclosure, gross carrying value is defined as the amortised cost of a financial asset, before adjusting for any loss
allowance. As such the gross carrying value of debt instruments at FVOCI as presented above will not reconcile to the balance sheet as it excludes
fair value gains and losses.

Credit-impaired loans(Audited)

We determine that a financial instrument is credit impaired and instage 3 by considering relevant objective evidence, primarily
whether:• contractual payments of either principal or interest are past due
for more than 90 days;• there are other indications that the borrower is unlikely to pay,such as when a concession has been granted to the borrower
for economic or legal reasons relating to the borrower’s
financial condition; and• the loan is otherwise considered to be in default. If such
unlikeliness to pay is not identified at an earlier stage, it isdeemed 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.

Collateral and other credit enhancements(Audited)

Although collateral can be an important mitigant of credit risk, it is
the group’s general practice to lend on the basis of the customer’sability to meet their obligations out of cash flow resources rather
36

than placing primary reliance on collateral and other credit riskenhancements. Depending on the customer’s standing and thetype of product, facilities may be provided without any collateral orother credit enhancements. For other lending, a charge overcollateral is obtained and considered in determining the credit
decision and pricing. In the event of default, the bank may utilise
the collateral as a source of repayment.
Depending on its form, collateral can have a significant financial
effect in mitigating our exposure to credit risk. Where there issufficient collateral, an expected credit loss is not recognised. Thisis the case for reverse repurchase agreements and for certain
loans and advances to customers where the loan to value (‘LTV’) isvery low.
Mitigants may include a charge on borrowers’ specific assets,such as real estate or financial instruments. Other credit risk
mitigants include short positions in securities and financial assets
held as part of linked insurance/investment contracts where therisk is predominantly borne by the policyholder. Additionally, risk
may be managed by employing other types of collateral and credit
risk enhancements, such as second charges, other liens andunsupported guarantees. Guarantees are normally taken from
corporates and export credit agencies. Corporates would normallyprovide guarantees as part of a parent/subsidiary relationship andspan a number of credit grades. The export credit agencies will
normally be investment grade.
Certain credit mitigants are used strategically in portfolio

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019management activities. While single name concentrations arise inportfolios managed by Global Banking and Corporate Banking, it is
only in Global Banking that their size requires the use of portfolio
level credit mitigants. Across Global Banking, risk limits andutilisations, maturity profiles and risk quality are monitored andmanaged proactively. This process is key to the setting of risk
appetite for these larger, more complex, geographically distributed
customer groups. While the principal form of risk management
continues to be at the point of exposure origination, through thelending decision-making process, Global Banking also utilises loan
sales and credit default swap (‘CDS’) hedges to manage
concentrations and reduce risk. These transactions are theresponsibility of a dedicated Global Banking portfolio management
team. Hedging activity is carried out within agreed credit
parameters, and is subject to market risk limits and a robust
governance structure. Where applicable, CDSs are entered into
directly with a central clearing house counterparty. Otherwise, ourexposure to CDS protection providers is diversified among mainlybanking counterparties with strong credit ratings.
CDS mitigants are held at portfolio level and are not reported in
the presentation below.

Collateral on loans and advances
The collateral measured in the following tables consists offixed first charges on real estate, and charges over cash andmarketable financial instruments. The values in the tables
represent the expected market value on an open market basis; noadjustment has been made to the collateral for any expected costsof recovery. Marketable securities are measured at their fair value.
Other types of collateral such as unsupported guarantees andfloating charges over the assets of a customer’s business are notmeasured in the following tables. While such mitigants have value,
often providing rights in insolvency, their assignable value is not
sufficiently certain and they are therefore assigned no value fordisclosure purposes.
The LTV ratios presented are calculated by directly associatingloans and advances with the collateral that individually anduniquely supports each facility. When collateral assets are sharedby multiple loans and advances, whether specifically or, moregenerally, by way of an all monies charge, the collateral value is
pro-rated across the loans and advances protected by thecollateral.
For credit-impaired loans, the collateral values cannot be directlycompared with impairment allowances recognised. The LTV
figures use open market values with no adjustments.
Impairment allowances are calculated on a different basis, byconsidering other cash flows and adjusting collateral values forcosts of realising collateral.
Personal lending
The following table provides a quantification of the value of fixedcharges we hold over specific assets where we have a history of
enforcing, and are able to enforce, collateral in satisfying a debt in
the event of the borrower failing to meet its contractual
obligations, and where the collateral is cash or can be realised bysale in an established market. The collateral valuation excludes any
adjustments for obtaining and selling the collateral and, inparticular, loans shown as not collateralised or partiallycollateralised may also benefit from other forms of credit
mitigants.

Residential mortgages including loan commitments by level of collateral(Audited)
2019
Gross
carrying/
nominalamount2018

ECL
coverageGrosscarrying/
nominalamountECL
coverage

HK$m

%

HK$m

%

1,044,885

0.0

965,1640.0– less than 70%

914,6650.0

859,476

0.0– 71% to 90%

108,8130.0

89,8210.0– 91% to 100%

21,4070.0

15,8670.1

Partially collateralised (A):

2,525

—

3,121

0.0

– collateral value on A

2,445

Stage 1
Fully collateralised
LTV ratio:

Total

2,792

1,047,410

0.0

968,285

0.0

26,7480.3

20,6380.4– less than 70%

19,4300.1

15,9130.2– 71% to 90%

6,743

0.7

4,277

0.7

– 91% to 100%

575

2.3

448

2.9

Partially collateralised (B):

151

6.6

93

4.3

– collateral value on B

139

Stage 2
Fully collateralised
LTV ratio:

Total

83

26,8990.4

20,731

0.4

1,997

6.9

1,694

9.3

Stage 3
Fully collateralised
LTV ratio:– less than 70%

1,433

3.4

1,210

4.9

– 71% to 90%

422

13.5

371

16.4

– 91% to 100%

142

22.5

113

32.7

Partially collateralised (C):

97

59.8

88

43.2

– collateral value on C

85

Total
At 31 Dec

80

2,094

9.4

1,782

10.9

1,076,403

0.0990,798

0.0

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

37

Risk

Other personal lending
Other personal lending consists primarily of personal loans,
overdrafts and credit cards, all of which are generally unsecured,
except lending to private banking customers which are generally
secured.
Commercial real estate loans and advances

physical inspections. For CRR 1–7, local valuation policies
determine the frequency of review on the basis of local market
conditions because of the complexity of valuing collateral forcommercial real estate. For CRR 8–10, almost all collateral would
have been revalued within the last three years. In Hong Kong,
market practice is typically for lending to major property
companies to be either secured by guarantees or unsecured.

The value of commercial real estate collateral is determined byusing a combination of external and internal valuations andCommercial real estate loans and advances including loan commitments by level of collateral(Audited)
2019
Gross
carrying/
nominalamount2018

ECL
coverageGrosscarrying/
nominalamountECL
coverage

HK$m

%

HK$m

%

Not collateralised

344,0100.0

352,258

0.0

Fully collateralised

387,7960.1

363,7290.1

Partially collateralised (A):27,1550.1

31,1070.1– collateral value on A

15,724

Total

758,9610.1

747,0940.0

Not collateralised

5,326

0.9

10,2280.2

Fully collateralised

17,781

1.0

19,4400.6

Partially collateralised (B):

589

0.3

1,235

0.8

– collateral value on B

423

Stage 1

17,246

Stage 2

Total

23,696702
1.0

30,903

0.5—

Stage 3Not collateralised

—

—

—

Fully collateralised

165

9.1

129

0.8

—

—

—

—

165

9.1

129

0.8

Not collateralised

—

—

—

—

Fully collateralised

—

—

—

—

Partially collateralised (D):

—

—

—

—

– collateral value on D—

Partially collateralised (C):– collateral value on C
Total

—

—

POCI

Total
At 31 Dec

Corporate, commercial and non-bank financial institutions lending
Other corporate, commercial and financial (non-bank) loans areanalysed separately in the following table. For financing activities
in other corporate and commercial lending, collateral value is notstrongly correlated to principal repayment performance.

—

—

—

—

—

782,8220.1

778,126

0.1

performance of secondary sources of repayment should it provenecessary to rely on them.
Accordingly, the following table reports values only for customers
with CRR 8–10, recognising that these loans and advances
generally have valuations that are comparatively recent.

Collateral values are generally refreshed when an obligor’s generalcredit performance deteriorates and we have to assess the likely

38

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Other corporate, commercial and non-bank financial institutions loans and advances including loan commitments by level of collateral(Audited)
2019
Gross
carrying/
nominalamount
HK$m

Not collateralised
Fully collateralised

2018

ECL coverageGrosscarrying/
nominalamount

ECL coverage

%

HK$m

%

2,164,436

0.1

2,156,281

0.0345,3860.1

352,225

0.1

Partially collateralised (A):242,4330.1

260,184

0.1– collateral value on A

103,251

Stage 1

Total

108,264

2,752,255

0.1

2,768,690

0.1

Not collateralised

191,455

0.6

149,977

0.4

Fully collateralised

108,2290.6

34,7400.6

Partially collateralised (B):37,0160.3

27,6080.4– collateral value on B

16,629

Total

336,700

0.6

212,325

0.4

Not collateralised

6,815

78.4

8,339

69.1

Fully collateralised

2,005

46.0

2,536

34.8

Partially collateralised (C):

2,353

60.5

3,361

51.6

– collateral value on C

1,046

Total

11,17368.8

14,23658.9

Not collateralised

706

11.5

204

20.1

Fully collateralised

200

0.5

243

0.8

Partially collateralised (D):

246

88.6

274

86.5

Stage 2

10,987

Stage 3

1,237

POCI

– collateral value on D

233

Total
At 31 Dec

269

1,152

26.0

721

38.8

3,101,280

0.4

2,995,972

0.4

1 31 December 2018 balances have been restated to include HK$79bn of undrawn commitments not previously identified for disclosure.

Other credit risk exposures

Derivatives(Unaudited)(Unaudited)

In addition to collateralised lending described above, other credit
enhancements are employed and methods used to mitigate credit
risk arising from financial assets. These are summarised below:

We participate in transactions exposing us to counterparty credit
risk. Counterparty credit risk is the risk of financial loss if thecounterparty to a transaction defaults before satisfactorily settlingit. It arises principally from over-the-counter (‘OTC’) derivatives andsecurities financing transactions and is calculated in both thetrading and non-trading books. Transactions vary in value by
reference to a market factor such as an interest rate, exchange
rate or asset price.

• Some securities issued by governments, banks and otherfinancial institutions may benefit from additional credit
enhancements provided by government guarantees that cover
the assets.
• Debt securities issued by banks and financial institutions
include asset-backed securities (‘ABSs’) and similar
instruments, which are supported by underlying pools offinancial assets. Credit risk associated with ABSs is reduced
through the purchase of credit default swap (‘CDS’) protection

The counterparty risk from derivative transactions is taken into
account when reporting the fair value of derivative positions. The
adjustment to the fair value is known as the credit value
adjustment (‘CVA’).

• The group’s maximum exposure to credit risk includes financial
guarantees and similar contracts granted, as well as loan andother credit-related commitments. Depending on the terms of
the arrangement, we may use additional credit mitigation if aguarantee is called upon or a loan commitment is drawn andsubsequently defaults.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

39

Risk

Liquidity and funding risk

• monitoring liquidity and funding ratios against internal andregulatory requirements;(Audited)• maintaining a diverse range of funding sources with adequate
back-up facilities;

Overview
Liquidity risk is the risk that we do not have sufficient financial
resources to meet our obligations as they fall due or that we canonly do so at an excessive cost. Liquidity risk arises frommismatches in the timing of cash flows.
Funding risk is the risk that funding considered to be sustainable,
and therefore used to fund assets, is not sustainable over time.
Funding risk arises when illiquid asset positions cannot be fundedat the expected terms and when required.

Liquidity and funding risk profile
We maintain a comprehensive liquidity and funding risk
management framework (‘LFRF’), which aims to allow us towithstand severe liquidity stresses. It is based on global policies
that are designed to be adaptable to different business models,markets and regulations. The LFRF comprises policies, metrics andcontrols designed to ensure that group and entity management
have oversight of our liquidity and funding risks in order tomanage them appropriately.
We manage liquidity and funding risk at an operating entity level
to ensure that obligations can be met in the jurisdiction where
they fall due, generally without reliance on other parts of thegroup. Operating entities are required to meet internal minimum
requirements and any applicable regulatory requirements at all
times. These requirements are set against the group’s
implementation of the liquidity coverage ratio (‘LCR’) and the net
stable funding ratio (‘NSFR’). Each entity is required to undertake aqualitative and quantitative assessment of the contractual andbehavioural profile of its assets and liabilities when setting internal
limits in order to reflect their expected behaviour underidiosyncratic, market-wide and combined stress scenarios.

• managing the concentration and profile of term funding;• managing contingent liquidity commitment exposures within predetermined limits;• maintaining debt financing plans;• monitoring of depositor concentration in order to avoid undue
reliance on large individual depositors and ensuring asatisfactory overall funding mix; and• maintaining liquidity and funding contingency plans. These
plans identify early indicators of stress conditions and describe
actions to be taken in the event of difficulties arising fromsystemic or other crises, while minimising adverse long-term
implications for the business.

Governance
ALCM teams apply the LFRF at both an individual entity and grouplevel, and are responsible for the implementation of Group-wideand local regulatory policy at a legal entity level. Balance SheetManagement ('BSM') has responsibility for cash and liquidity
management.
Liquidity Risk Management carry out independent review,
challenge and assurance of the appropriateness of the risk
management activities undertaken by ALCM and BSM. Their work
includes setting control standards, advice on policy
implementation, and review and challenge of reporting.
Internal Audit provide independent assurance that risk is managed
effectively.

Management of liquidity and funding risk
Liquidity coverage ratio

Structure and organisation(Unaudited)

Asset, Liability and Capital Management (‘ALCM’) teams are
responsible for the application of the LFRF at a local operating
entity level. The elements of the LFRF are underpinned by a robust
governance framework, the two major elements of which are:

The LCR aims to ensure that a bank has sufficient unencumberedhigh-quality liquid assets (‘HQLA’) to meet its liquidity needs in a
30 calendar day liquidity stress scenario.

• Asset and Liability Management Committees (‘ALCOs’) at thegroup and entity level; andAt 31 December 2019, all the group’s principal operating entities
were well above regulatory minimums and above the internally
expected levels.

• annual internal liquidity adequacy assessment process (‘ILAAP’)
used to validate risk tolerance and set risk appetite.

Net stable funding ratio

All operating entities are required to prepare an internal liquidity
adequacy assessment ('ILAA') document at appropriate frequency.
The final objective of the ILAA, approved by the relevant ALCOs, isto verify that the entity and subsidiaries maintain liquidity
resources which are adequate in both amount and quality at all
times, there is no significant risk that its liabilities cannot be met
as they fall due, and a prudent funding profile is maintained.

HSBC uses the NSFR as a basis for ensuring operating entities
raise sufficient stable funding to support their business activities.
The NSFR requires institutions to maintain minimum amount of
stable funding based on assumptions of asset liquidity.

The Board is ultimately responsible for determining the types andmagnitude of liquidity risk that the group is able to take andensuring that there is an appropriate organisation structure formanaging this risk. Under authorities delegated by the Board, thegroup ALCO is responsible for managing all ALCM issues
including liquidity and funding risk management. The group ALCO
delegates to the group Tactical Asset and Liability Management
Committee (‘TALCO’) the task of reviewing various analyses of thegroup pertaining to sites’ liquidity and funding.
Compliance with liquidity and funding requirements is monitored
by local ALCO who report to the RMM and Executive Committee
on a regular basis. This process includes:• maintaining compliance with relevant regulatory requirementsof the operating entity;(Unaudited)

At 31 December 2019, all the group’s principal operating entities
were above the internally expected levels.

Depositor concentration and term funding maturity
concentration(Unaudited)

The LCR and NSFR metrics assume a stressed outflow based on a
portfolio of depositors within retail, corporate and financial deposit
segments. The validity of these assumptions is challenged if theportfolio of depositors is not large enough to avoid depositor
concentration.
Operating entities are exposed to term refinancing concentration
risk if the current maturity profile results in future maturities being
overly concentrated in any defined period.
At 31 December 2019, all the group’s principal operating entities
were above the internally expected levels.

• projecting cash flows under various stress scenarios andconsidering the level of liquid assets necessary in relation
thereto;40

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Sources of funding

Additional contractual obligations(Audited)(Unaudited)

Our primary sources of funding are customer current accounts
and customer savings deposits payable on demand or at short
notice. We issue wholesale securities (secured and unsecured) to
supplement our customer deposits and change the currency mix,
maturity profile or location of our liabilities.

Under the terms of our current collateral obligations underderivative contracts (which are ISDA compliant CSA contracts),
the additional collateral required to post in the event of one-notch
and two-notch downgrade in credit ratings is immaterial.

Currency mismatch in the LCR(Unaudited)

The LFRF requires all operating entities to monitor material single
currency LCR. Limits are set to ensure that outflows can be met,
given assumptions on stressed capacity in the FX swap markets.

Liquidity and funding risk in 2019Market Risk
(Audited)(Unaudited)

Overview

The group is required to calculate its LCR and NSFR on aconsolidated basis in accordance with rule 11(1) of The Banking(Liquidity) Rules ('BLR'). The group is required to maintain both
LCR and NSFR of not less than 100%.

Market risk is the risk that movements in market factors, such as
foreign exchange rates, interest rates, credit spreads, equity prices
and commodity prices, will reduce our income or the value of ourportfolios. Exposure to market risk is separated into two portfolios:
trading portfolios and non-trading portfolios.

The average LCRs for the period are as follows:

Market risk management

Quarter ended

Average LCRs

Further details of the group’s liquidity information disclosures canbe viewed in the Banking Disclosure Statement 2019, which will
be available in the Regulatory Disclosure Section of our website:www.hsbc.com.hk.

31 Dec31 Dec

2019

2018

%

%

163.5

161.0

The liquidity position of the group remained strong in 2019. The
average LCR increased by 2.5% from 161.0% for the quarter
ended 31 December 2018 to 163.5% for the quarter ended
31 December 2019, mainly as a result of the increase in customer
deposits exceeding the growth in loans and advances tocustomers.

Key developments in 2019
There were no material changes to our policies and practices forthe management of market risk in 2019.

Governance and structure
The following diagram summarises the main business areas wheretrading and non-trading market risks reside, and the market risk
measures used to monitor and limit exposures.

The majority of HQLA included in the LCR are Level 1 assets as
defined in the BLR, which consist mainly of government debt
securities.

Risk types

The total weighted amount of HQLA for the period are as follows:
Weighted amount (averagevalue) at quarter ended
31 Dec31 Dec

2019

2018

HK$m

HK$m

1,528,908

1,489,744

Level 2A assets

80,174

67,333

Level 2B assets

10,788

9,638

1,619,870

1,566,715

Level 1 assets

Total

The NSFRs for the period are as follows:
Quarter ended

Net stable funding ratio

31 Dec31 Dec

2019

2018

%

%

145.8

149.7

The funding position of the group remained robust in 2019,highlighting a surplus of stable funding relative to the required
stable funding requirement. The NSFR decreased by 3.9% from
149.7% for the quarter ended 31 December 2018 to 145.8% for
the quarter ended 31 December 2019.
Interdependent assets and liabilities included in the group's NSFR
are certificates of indebtedness held and legal tender notes issued.

Trading risk

Non-trading risk

• Foreign exchange andcommodities• Interest rates• Credit spreads• Equities• Structural foreign exchange• Interest rates• Credit spreads

Global business

GB&M incl BSM1

Risk measure

VaR | Sensitivity | Stress
Testing

1

GB&M, BSM1,
GPB, CMB and RBWM
VaR | Sensitivity | Stress
Testing

Balance Sheet Management ('BSM'), for external reporting
purposes, forms part of the Corporate Centre while daily operations
and risk are managed within GB&M.

Where appropriate, we apply similar risk management policies andmeasurement techniques to both trading and non-trading
portfolios. Our objective is to manage and control market risk
exposures to optimise return on risk while maintaining a market
profile consistent with our established risk appetite. Strategies
range from the use of traditional market instruments, such as
interest rate swaps, to more sophisticated hedging strategies toaddress a combination of risk factors arising at portfolio level.

Key risk management processes(Audited)

Monitoring and limiting market risk exposures
Our objective is to manage and control market risk exposureswhile maintaining a market profile consistent with our risk
appetite.
We use a range of tools to monitor and limit market risk exposures
including sensitivity analysis, VaR and stress testing.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

41

Risk

Sensitivity analysis

Stress testing(Unaudited)(Audited)

Sensitivity analysis measures the impact of individual market
factor movements on specific instruments or portfolios, includinginterest rates, foreign exchange rates and equity prices. We use
sensitivity measures to monitor the market risk positions withineach risk type. Granular sensitivity limits are set primarily fortrading desks with consideration of market liquidity, customer
demand and capital constraints, among other factors.

Stress testing is an important procedure that is integrated into ourmarket risk management framework to evaluate the potential
impact on portfolio values of more extreme, although plausible,
events or movements in a set of financial variables. In such
scenarios, losses can be much greater than those predicted by
VaR modelling.

Value at risk
Value at risk (‘VaR’) is a technique for estimating potential losses
on risk positions as a result of movements in market rates andprices over a specified time horizon and to a given level ofconfidence. The use of VaR is integrated into market risk
management and calculated for all trading positions regardless of
how we capitalise them. In addition, we calculate VaR for nontrading portfolios to have a complete picture of risk. Where we do
not calculate VaR explicitly, we use alternative tools assummarised in the ‘Stress testing’ section below.
Our models are predominantly based on historical simulation thatincorporates the following features:• historical market rates and prices, which are calculated withreference to foreign exchange rates, commodity prices, interest
rates, equity prices and the associated volatilities;• potential market movements which are calculated withreference to data from the past two years; and• these are calculated to a 99% confidence level and using a oneday holding period.
The models also incorporate the effect of option features on theunderlying exposures. The nature of the VaR models means thatan increase in observed market volatility will lead to an increase in
VaR without any changes in the underlying positions.

Stress testing is implemented at legal entity, regional and overall
Group levels. A set of scenarios is used consistently across all
regions within the Group. The risk appetite around potential stresslosses for the Group is set and monitored against a referral limit.
Market risk reverse stress tests are designed to identify
vulnerabilities in our portfolios by looking for scenarios that lead toloss levels considered severe for the relevant portfolio. These
scenarios may be quite local or idiosyncratic in nature, andcomplement the systematic top-down stress testing.
Stress testing and reverse stress testing provide senior
management with insights regarding the ‘tail risk’ beyond VaR, forwhich our appetite is limited.

Back-testing
We routinely validate the accuracy of our VaR models by backtesting them with both actual and hypothetical profit and loss
against the corresponding VaR numbers. Hypothetical profit andloss excludes non-modelled items such as fees, commissions andrevenue of intra-day transactions.
The actual number of profits or losses in excess of VaR over thisperiod can be used to gauge how well the models are performing.
A VaR model is deemed satisfactory if it experiences less than fiveprofit or loss exceptions in a 250-day period.
We back-test our VaR at various levels of our group entity
hierarchy.

VaR model limitations

Market risk in 2019

Although a valuable guide to risk, VaR should always be viewed in
the context of its limitations. For example:(Unaudited)• the use of historical data as a proxy for estimating future
market moves may not encompass all potential market events,
particularly those that are extreme in nature.
• the use of a one-day holding period for risk management
purposes of trading and non-trading books assumes that thisshort period is sufficient to hedge or liquidate all positions.
• the use of a 99% confidence level by definition does not take
into account losses that might occur beyond this level ofconfidence.
• VaR is calculated on the basis of exposures outstanding at theclose of business and therefore does not reflect intra-day
exposures.

Risk not in VaR framework(Unaudited)

The risks not in VaR (‘RNIV’) framework aims to capture andcapitalise material market risks that are not adequately covered inthe VaR model.

The market environment in year 2019 was dominated by headline
geopolitical events of US-China trade tensions, uncertainty of the
UK’s exit from the European Union, and the busy election calendar
in Asia. Amid the prospect of economic slowdown, Asian central
banks and governments responded by monetary and fiscal easing
and are expected to ease further. In 2020, the market backdrop ofcontinuing trade and geopolitical tensions as well as the upcoming
US presidential election could add to the market uncertainty andvolatilities.

Trading portfolios(Audited)

Value at risk of the trading portfolios
Trading VaR predominantly resides within Global Markets.
Total trading VaR (excluding Risk not in VaR) was lower as at
31 December 2019 compared to 31 December 2018 due toreduction in credit VaR and interest rate VaR, as trading positions
were managed down.

Risk factors are reviewed on a regular basis and are either
incorporated directly in the VaR models, where possible, or
quantified through either the VaR-based RNIV approach or a stresstest approach within the RNIV framework. While VaR-based RNIVs
are calculated by using historical scenarios, stress-type RNIVs are
estimated on the basis of stress scenarios whose severity iscalibrated to be in line with the capital adequacy requirements.
The outcome of the VaR-based RNIV approach is included in theoverall VaR calculation but excluded from the VaR measure used
for regulatory back-testing. In addition, stressed VaR also capturesrisk factors considered in the VaR-based RNIV approach. Stresstype RNIVs include a de-peg risk measure to capture risk topegged and heavily-managed currencies.

42

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

The trading VaR for the year is shown in the table below.
Trading value at risk, 99% 1 day1
(Audited)
Foreignexchange andcommodityInterest rate

EquityCreditspreadPortfolio
diversification2

Total3,4

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

(110)

140

At 31 Dec 2019Year end

48

90

50

24

Average

38

102

38

34

157

Maximum

58

145

63

81

210

Year end

43

123

51

42

Average

35

150

30

33

163

Maximum

59

199

58

75

222

At 31 Dec 2018
(123)

136

1 Trading portfolios comprise positions arising from the market-making and warehousing of customer-derived positions.
2 Portfolio diversification is the market risk dispersion effect of holding a portfolio containing different risk types. It represents the reduction inunsystematic market risk that occurs when combining a number of different risk types, for example, interest rate, equity and foreign exchange,
together in one portfolio. It is measured as the difference between the sum of the VaR by individual risk type and the combined total VaR. A
negative number represents the benefit of portfolio diversification. As the maximum and minimum occur on different days for different risk types,
it is not meaningful to calculate a portfolio diversification benefit for these measures.
3 The total VaR includes HK$38m Risk not in VaR ('RNIV') for the year ended 31 December 2019.
4 The RNIV was excluded for year 2018. 2018 year end total VaR including RNIV was HK$187m.

Non-trading portfolios

Sensitivity of economic value of equity(Unaudited)

Economic value of equity (‘EVE’) represents the present value ofthe future banking book cash flows that could be distributed toequity providers under a managed run-off scenario. This equates
to the current book value of equity plus the present value of future
net interest income in this scenario. EVE can be used to assess the
economic capital required to support interest rate risk in thebanking book (‘IRRBB’). An EVE sensitivity is the extent to which
the EVE value will change due to pre-specified movements ininterest rates, where all other economic variables are held
constant. Operating entities are required to monitor EVE sensitivity
as a percentage of Tier 1 capital resources.

Banking book interest rate risk is the risk of an adverse impact toearnings or capital due to changes in market interest rates. The
risk arises from timing mismatches in the repricing of non-tradedassets and liabilities and is the potential adverse impact ofchanges in interest rates on earnings and capital. In its
management of the risk, the group aims to mitigate the impact of
future interest rate movements which could reduce future netinterest income, while balancing the cost of hedging activities tothe current revenue stream. Monitoring the sensitivity of projected
net interest income under varying interest rate scenarios is a key
part of this.
In order to manage structural interest rate risk, non-traded assets
and liabilities are transferred to Balance Sheet Management(‘BSM’) based on their repricing and maturity characteristics. For
assets and liabilities with no defined maturity or repricing
characteristics, behaviouralisation is used to assess the interest
rate risk profile. BSM manages the banking book interest rate
positions transferred to it within the approved limits. Local ALCOs
are responsible for monitoring and reviewing their overall
structural interest rate risk position. Interest rate
behaviouralisation policies have to be formulated in line with theGroup’s behaviouralisation policies and approved at least annually
by local ALCOs.

Sensitivity of net interest income
A principal part of our management of non-traded interest rate risk
is to monitor the sensitivity of expected net interest income atleast quarterly under varying interest rate scenarios, where allother economic variables are held constant.
Sensitivity of net interest income reflects the group’s sensitivity ofearnings due to changes in market interest rates. Entities forecast
net interest income sensitivities across a range of interest ratescenarios based on a static balance sheet assumption. Balance
sheet projection is modelled based on no management actions i.e.
the risk profile at the month end is assumed to remain constantthroughout the forecast horizon.

Structural foreign exchange exposures(Unaudited)

Structural foreign exchange exposures represent net investments
in subsidiaries, branches and associates, the functional currenciesof which are currencies other than the HK dollar. An entity’sfunctional currency is normally that of the primary economic
environment in which the entity operates.
Exchange differences on structural exposures are recognised in‘Other comprehensive income’.
Our structural foreign exchange exposures are managed with theprimary objective of ensuring, where practical, that ourconsolidated capital ratios and the capital ratios of individual
banking subsidiaries are largely protected from the effect ofchanges in exchange rates. We hedge structural foreign exchange
exposures only in limited circumstances.
The group had the following structural foreign currency exposuresthat were not less than 10% of the total net structural foreign
currency positions:
LCYm

HK$m equivalent

201,509

225,392

189,054215,266

At 31 Dec 2019
Renminbi
At 31 Dec 2018
Renminbi

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

43

Risk

Resilience risk

response methods, alternative delivery channels and recovery
options.

(Unaudited)

The Resilience Risk team oversees the identification, management
and control of resilience risks.

Overview
Resilience risk is the risk that we are unable to provide criticalservices to our customers, affiliates and counterparties, as a resultof sustained and significant operational disruption.
Resilience risk arises from failures or inadequacies in processes,
people, systems or external events. These may be driven by rapid
technological innovation, changing behaviours of our consumers,
cyber-threats, cross-border dependencies and third-party
relationships.

Resilience risk management
Key developments in 2019
In May 2019, in line with our simplified risk taxonomy, we formed
a new Resilience Risk sub-function to ensure our operations
continue functioning when an operational disturbance occurs. Our
resilience strategy is focused on the establishment of robust backup plans, detailed response methods, alternative delivery channels
and recovery options. Resilience risk was formed to simplify theway we interact with our stakeholders and to deliver clear,consistent and credible responses globally. Investment in
information technology ('IT') Resilience is central to thiscommitment. Designing and implementing IT Systems that
continue to be available to use, in the face of adverse conditions isa key objective. We seek to ensure that we understand the root
cause of IT failures and learn lessons both from our own
experiences and those of others.
We have undertaken a number of initiatives to develop and embed
the new sub-function:• We recruited and consolidated personnel from previously
independent risk functions, in Information and Cyber Security;
Protective Security; Business Continuity and IncidentManagement; Third-party; and Systems, Data Integrity andTransaction Processing.
• We adopted a new model that allows us to provide a globallyconsistent view across Resilience Risk in order to strengthening
risk management oversight.
• We developed a target operating model to set out our desired
state for the function. We identified areas where we need todevelop the resilience risk vision.
• We used internal and external channels to recruit a leadershipteam that is aligned to our core values of being open,
dependable and connected.

Governance and structure
Resilience Risk provides guidance and stewardship to ourbusinesses and global functions about how we can prevent, adapt,and learn from resilience-related threats when something goes
wrong. We view resilience through six lenses: strategic change
and emerging threats; third-party risk; information and data
resilience; payments and processing resilience; systems and cyber
resilience; and protective security risk.
The Resilience Risk Management Committee oversees resiliencerisk and has accountability to the Global Risk Management Board.
The Resilience Risk Management Committee is supported by its
subcommittees that provide oversight over each of the respective
Resilience Risk sub-teams.

Key risk management processes
Operational resilience is our ability to adapt operations to continuefunctioning when an operational disturbance occurs. We measure
resilience in terms of the maximum disruption period or the impact
tolerance that we are willing to accept for a business service.
Resilience risk cannot be managed down to zero, so weconcentrate on critical business and strategic change programmesthat have the highest potential to threaten our ability to provide
continued service to our customers. Our resilience strategy isfocused on the establishment of robust back-up plans, detailed
44

Regulatory compliance risk
(Unaudited)

Overview
Regulatory compliance risk is the risk that we fail to observe theletter and spirit of all relevant laws, codes, rules, regulations andstandards of good market practice, which as a consequence incurfines and penalties and suffer damage to our business.
Regulatory compliance risk arises from the risks associated withbreaching our duty to our customers and other counterparties,
inappropriate market conduct and breaching other regulatory
requirements.

Regulatory compliance risk management
Key developments in 2019
There were no material changes to the practices for the
management of regulatory compliance risk in 2019, except for the
initiatives that we undertook to raise our standards in relation to
the conduct of our business, as described below under ‘Conductof business’.

Governance and structure
The Regulatory Compliance sub-function provides independent,
objective oversight and challenge, and promotes a complianceorientated culture that supports the business in delivering fairoutcomes for customers, maintaining the integrity of financial
markets and achieving the group's strategic objectives.
Regulatory Compliance is part of the Compliance function, which
is headed by the Group Chief Compliance Officer. Regulatory
Compliance is structured as a global sub-function with regionaland country Regulatory Compliance teams, which support andadvise each global business and global function.

Key risk management processes
We regularly review our policies and procedures. Global policies
and procedures require the prompt identification and escalation of
any actual or potential regulatory breach to Regulatory
Compliance. Reportable events are escalated to the RMM and the
Risk Committee, as appropriate.

Conduct of businessIn 2019, we continued to promote and encourage good conduct
through our people’s behaviour and decision making in order todeliver fair outcomes for our customers, and to maintain financial
market integrity. During 2019:• We developed and implemented a set of principles to govern
the ethical management and use of data and artificial
intelligence (‘AI’), which includes support of digital products
and services. This was complemented with training of ourpeople to use customer data appropriately.
• We continued to focus on the needs of vulnerable customers in
our product and process design. In specific markets, we
provided awareness and training initiatives, and we also
deployed staff with specialist knowledge of conditions such as
dementia. Financial inclusion initiatives progressed in specificmarkets, combating financial abuse and developing financial
education schemes for older customers.
• We further defined roles and responsibilities for our people aspart of the enterprise risk management framework across thegroup to consider the customer in decision making and action.
• We delivered our fifth annual global mandatory training courseon conduct, and reinforced the importance of conduct byhighlighting examples of good conduct.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019• We continued the expansion of recognition programmes acrossbusiness areas for our people when they deliver exceptional
service, when working directly with customers or in supporting
roles.

Financial crime and fraud risk
(Unaudited)

Overview
Financial crime and fraud risk is the risk that we knowingly or
unknowingly help parties to commit or to further potentially illegal
activity. Financial crime and fraud risk arises from day-to-day
banking operations.

Financial crime and fraud risk management
Key developments in 2019
During 2019, we continued to increase our efforts to strengthen
our ability to combat financial crime. We integrated into our dayto-day operations the majority of the financial crime risk corecapabilities delivered through the Global Standards programme,
which we set up in 2013 to enhance our risk management
policies, processes and systems. We have begun several initiatives
to define the next phase of financial crime risk management.
•

We continued to strengthen our anti-fraud capabilities,
focusing on threats posed by new and existing technologies,
and have delivered a comprehensive fraud training programme
to our people.

•

We continued to invest in the use of artificial intelligence ('AI')
and advanced analytics techniques to develop a financial crime
risk management framework for the future.

•

We launched advanced anti-money laundering (‘AML’) andsanctions automation systems to detect and disrupt financial
crime in international trade. These systems are designed tostrengthen our ability to fight financial crime through thedetection of suspicious activity and possible criminal networks.

Governance and structure
Since establishing a global framework of Financial Crime Risk
Management Committees in the first quarter of 2018, we havecontinued to strengthen and review the effectiveness of ourgovernance framework to manage financial crime risk. Formal
governance committees are held across all countries, territories,
regions and lines of business, and are chaired by the respective
chief executive officers. They help to enable compliance with theletter and the spirit of all applicable financial crime compliancelaws and regulations, as well as our own standards, values andpolicies relating to financial crime risks.

Key risk management processes
We continued to deliver a programme to further enhance thepolicies and controls around identifying and managing the risks ofbribery and corruption across our business. Our transformation
programme continued to focus on our anti-fraud and anti-tax
evasion capabilities. Further enhancements have been made to ourgovernance and policy frameworks, and to the management
information reporting process which demonstrates theeffectiveness of our financial crime controls.
We are investing in the next generation of capabilities to fightfinancial crime by applying advanced analytics and AI. We remaincommitted to enhancing our risk assessment capabilities and todelivering more proactive risk management.
Working in partnership with the public sector and other financial
institutions is vital to managing financial crime risk. We are astrong proponent of public-private partnerships and participate in
information-sharing initiatives around the world to better
understand these risks so that they can be mitigated more
effectively.

Skilled Person/Independent Consultant
Following expiration in December 2017 of the anti-money
laundering Deferred Prosecution Agreement entered into with the
US Department of Justice (‘DoJ’), the then Monitor has continued
to work in his capacity as a Skilled Person under Section 166 of
the Financial Services and Markets Act under the Direction issued
by the UK Financial Conduct Authority (‘FCA’) in 2012. He has also
continued to work in his capacity as an Independent Consultant
under a cease-and-desist order issued by the US Federal Reserve
Board (‘FRB’).
The Skilled Person has assessed HSBC’s progress towards being
able to effectively manage its financial crime risk on a business-asusual basis. The Skilled Person issued several reports in 2019. The
Skilled Person has noted that HSBC continues to make material
progress towards its financial crime risk target end state in termsof key systems, processes and people. Nonetheless, the Skilled
Person has identified some areas that require further work before
HSBC reaches a business-as-usual state. Reflective of HSBC’s
significant progress in strengthening its financial crime risk
management capabilities, HSBC’s engagement with the current
Skilled Person will be terminated and a new Skilled Person with anarrower mandate will be appointed to assess the remaining areasthat require further work in order for HSBC to transition fully tobusiness-as-usual financial crime risk management. The FCA also
intends to take steps to maintain global oversight of HSBC’s
management of financial crime risk.
The Independent Consultant completed his sixth annual
assessment, which was primarily focused on HSBC’s Sanctions
programme. The Independent Consultant concluded that HSBC
continues to make significant strides toward establishing aneffective Sanctions compliance programme, commending HSBC’smaterial progress since the fifth annual assessment in 2018.
However, he has determined that certain areas within HSBC’s
sanctions compliance programme require further work. A seventh
annual assessment will take place in the first quarter of 2020. The
Independent Consultant will continue to carry out an annual Officeof Foreign Assets Control compliance review, at the FRB’s
discretion.

Model risk
(Unaudited)

Overview
Model risk is the potential for adverse consequences frombusiness decisions informed by models, which can be exacerbatedby errors in methodology, design or the way they are used. Modelrisk arises in both financial and non-financial contexts wheneverbusiness decision making includes reliance on models.

Key developments in 2019
In September 2019, we carried out a number of initiatives tofurther develop and embed the new Model Risk Management subfunction, including:•We appointed a Regional Head of Model Risk Management in
Asia-Pacific.

•

We refined the model risk policy to enable a more risk-based
approach to model risk management.

•

We conducted a full review of model governance arrangements
overseeing model risk across the group, resulting in a range ofenhancements to the underlying structure to improve
effectiveness and increase business engagement.

•

We designed a new target operating model for Model Risk
Management, referring to internal and industry best practice.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

45

Risk

Governance and structure

Stress and scenario testing

We have placed greater focus on our model risk activities during
2019. To reflect this, Group has created the role of Chief Model
Risk Officer, which for group is undertaken by the Head of Model
Risk Management. Model Risk Management is structured as a
sub-function within Regional Risk Strategy. Regional Model Risk
Management support and advise all areas of the group, headed by
the Regional Model Risk Steward.

(Unaudited)

Key risk management processes
We regularly review our model risk management policies andprocedures, and require the first line of defence to demonstratecomprehensive and effective controls based on a library of model
risk controls provided by Model Risk Management.
Model Risk Management reports on model risk to senior
management through use of the risk map and regular key updates.
We also review the effectiveness of these processes, including theregional model oversight committee structure, to ensure
appropriate understanding and ownership of model risk isembedded in the businesses and functions.

Insurance manufacturing operations risk
management(Audited)

Overview
Insurance risk is the risk that, over time, the cost of insurance
policies written, including claims and benefits, may exceed thetotal amount of premiums and investment income received. The
cost of claims and benefits can be influenced by many factors,
including mortality and morbidity experience, as well as lapse andsurrender rates.

Insurance manufacturing operations risk
management
Key developments in 2019
(Unaudited)

There were no material changes to our policies and practices forthe management of risks arising in our insurance manufacturing
operations in 2019.

Governance(Unaudited)

Insurance risks are managed to a defined risk appetite, which isaligned to the group's risk appetite and risk management
framework, including the group’s ‘Three lines of defence’ model.
The group's Insurance Risk Management Meeting oversees thecontrol framework globally and is accountable to the RBWM Risk
Management Meeting on risk matters relating to insurance
business.
The monitoring of the risks within the insurance operations iscarried out by the Insurance Risk teams. Specific risk functions,
including wholesale credit & market risk, operational risk,
information security risk and financial crime compliance, support
insurance risk teams in their respective areas of expertise.

Stress testing forms a key part of the risk management framework
for the insurance business. Where in scope we participate in local
and Group-wide regulatory stress tests, including the Bank ofEngland stress test of the banking system, the Hong Kong
Monetary Authority stress test, and individual country insurance
regulatory stress tests. These have highlighted that a key risk
scenario for the insurance business is a prolonged low interest
rate environment. In order to mitigate the impact of this scenario,
the insurance operations have a range of strategies that could be
employed, repricing current products to reflect lower interest
rates, moving towards less capital intensive products, anddeveloping investment strategies to optimise the expected returns
against the cost of economic capital.

Key risk management processes
Market risk
(Audited)

All our insurance manufacturing subsidiaries have market riskmandates that specify the investment instruments in which they
are permitted to invest and the maximum quantum of market riskthat they may retain. They manage market risk by using, among
others, some or all of the techniques listed below, depending on
the nature of the contracts written:• We are able to adjust bonus rates to manage the liabilities topolicyholders for products with discretionary participating
features (‘DPF’). The effect is that a significant portion of themarket risk is borne by the policyholder.
• We use asset and liability matching where asset portfolios are
structured to support projected liability cash flows. The groupmanages its assets using an approach that considers asset
quality, diversification, cash flow matching, liquidity, volatility
and target investment return. It is not always possible to match
asset and liability durations, due to several factors such as
uncertainty over the receipt of all future premiums, the timingof claims and because the forecast payment dates of liabilities
may exceed the duration of the longest dated investments
available. We use models to assess the effect of a range of
future scenarios on the values of financial assets andassociated liabilities, and ALCOs employ the outcomes indetermining how best to structure asset holdings to support
liabilities.
• We use derivatives to protect against adverse market
movements to better support liability cash flows.
• For new products with investment guarantees, we consider thecost when determining the level of premiums or the pricestructure.
• We periodically review products identified as higher risk, suchas those that contain investment guarantees and embedded
optionality features linked to savings and investment products,
for active management.
• We design new products to mitigate market risk, such aschanging the investment return sharing portion between
policyholders and the shareholder.
• We exit, to the extent possible, investment portfolios whoserisk is considered unacceptable.
• We reprice premiums charged to policyholders.

46

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Credit risk

HSBC’s bancassurance model(Audited)

We operate an integrated bancassurance model which provides
insurance products principally for customers with whom we havea banking relationship. The insurance contracts we sell relate to
the underlying needs of our banking customers, which we canidentify from our point-of-sale contacts and customer knowledge.
For the products we manufacture, the majority of sales are ofsavings and investment products.

Our insurance manufacturing subsidiaries are responsible for thecredit risk, quality and performance of their investment portfolios.
Our assessment of the creditworthiness of issuers andcounterparties is based primarily upon internationally recognised
credit ratings, internal credit ratings, and other publicly available
information.
Investment credit exposures are monitored against limits by our
insurance manufacturing subsidiaries and are aggregated andreported to the Group Insurance Credit Risk and Group Credit Risk
functions. Stress testing is performed on investment credit
exposures using credit spread sensitivities and default
probabilities.
We use a number of tools to manage and monitor credit risk.
These include a credit report containing a watch-list ofinvestments with current credit concerns, primarily investmentsthat may be at risk of future impairment or where highconcentrations to counterparties are present in the investment
portfolio. Sensitivities to credit spread risk are assessed andmonitored regularly.

Liquidity risk
(Audited)

Risk is managed by cash flow matching and maintaining sufficient
cash resources, investing in high credit-quality investments withdeep and liquid markets, monitoring investment concentrations
and restricting them where appropriate, and establishingcommitted contingency borrowing facilities.
Insurance manufacturing subsidiaries complete quarterly liquidity
risk reports and an annual review of the liquidity risks to which
they are exposed.

Insurance risk
(Unaudited)

The group primarily uses the following techniques to manage andmitigate insurance risk:• a formalised product approval process covering product design,pricing and overall proposition management (for example,
management of lapses by introducing surrender charges);• underwriting policy;• claims management processes; and• reinsurance which cedes risks above our acceptable thresholds
to an external reinsurer thereby limiting our exposure.

Insurance manufacturing operations risk in 2019
(Unaudited)

By focusing largely on personal and small and medium-sizedenterprise businesses, we are able to optimise volumes anddiversify individual insurance risks. We choose to manufacture
these insurance products in HSBC subsidiaries based on anassessment of operational scale and risk appetite. Manufacturing
insurance allows us to retain the risks and rewards associatedwith writing insurance contracts by keeping part of theunderwriting profit and investment income within the group.
We have life insurance manufacturing operations in: Hong Kong,
Singapore and mainland China. We also have a life insurance
manufacturing associate in India.
Where we do not have the risk appetite or operational scale to bean effective insurance manufacturer, we engage with a handful ofleading external insurance companies in order to provide
insurance products to our customers through our banking networkand direct channels. These arrangements are generally structured
with our exclusive strategic partners and earn the group a
combination of commissions, fees and a share of profits. We
distribute insurance products in all of our geographical regions.
Insurance products are sold through all global businesses, but
predominantly by RBWM and CMB through our branches anddirect channels.

Measurement(Unaudited)

The risk profile of our insurance manufacturing businesses ismeasured using an economic capital approach. Assets andliabilities are measured on a market value basis and a capitalrequirement is defined to ensure that there is a less than onein-200 chance of insolvency over a one-year time horizon, given
the risks that the businesses are exposed to. The methodology forthe economic capital calculation is largely aligned to the panEuropean Solvency II insurance capital regulation. The economic
capital coverage ratio (economic net asset value divided by the
economic capital requirement) is a key risk appetite measure.
Insurance entities in Asia manage their economic capital coverratios against their appetite and tolerance as approved by theirrespective Boards. The tables below show the composition ofassets and liabilities by contract type. 92% (2018: 92%) of both
assets and liabilities are derived from Hong Kong.

The majority of the risk in our insurance business derives frommanufacturing activities and can be categorised as financial risk orinsurance risk. Financial risks include market risk, credit risk andliquidity risk. Insurance risk is the risk, other than financial risk, ofloss transferred from the holder of the insurance contract to
HSBC, the issuer.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

47

Risk

Balance sheet of insurance manufacturing subsidiaries by type of contract(Audited)
Non-linked

Unit-linked

Shareholders' assets
and liabilities

Total

HK$m

HK$m

HK$m

HK$m

Financial assets

501,625

41,89334,940578,458– financial assets designated and otherwise mandatorily measured at fair value

103,90240,563

124

144,589

957

4

4

965

374,630342

31,508406,480

At 31 Dec 2019

– derivatives– financial investments measured at amortised cost
– financial investments measured at fair value through other comprehensive income

4,126

—

395

4,521

– other financial assets1

18,010984

2,909

21,903

Reinsurance assets

28,031

44—

28,075——61,07561,075

Other assets and investment properties

13,0152

3,898

16,915

Total assets

542,671

41,93999,913

684,523

PVIF2

Liabilities under investment contracts designated at fair value

30,231

6,793—

37,024

Liabilities under insurance contracts

494,181

34,579—528,760

Deferred tax3

20

118

9,780

9,918

Other liabilities——

17,116

17,116

Total liabilities

524,432

41,49026,896592,818——

91,70591,705

524,432

41,490118,601

684,523

Financial assets

447,459

41,32534,503523,287– financial assets designated at fair value

82,266

40,106

1,206

123,578

912

—

1

913

347,894547

32,023

380,464

Total equity
Total equity and liabilities
At 31 Dec 2018

– derivatives– financial investments – held-to-maturity– financial investments – available-for-sale

3,444

—

—

3,444

– other financial assets1

12,943672

1,273

14,888

Reinsurance assets

19,04539—

19,084——

48,522

48,522Other assets and investment properties

14,879—3,230

18,109Total assets

481,383

41,36486,255609,002

PVIF2

Liabilities under investment contracts designated at fair value

30,4206,218—

36,638

Liabilities under insurance contracts

433,668

34,921—

468,589

Deferred tax3

224

109

7,890

8,223

Other liabilities——

15,10915,109Total liabilities

464,312

41,24822,999528,559——

80,44380,443464,312

41,248103,442

609,002

Total equity
Total equity and liabilities

1 Comprise mainly loans and advances to banks, cash and inter-company balances with other non-insurance legal entities.
2 Present value of in-force long-term insurance business.
3 ‘Deferred tax’ includes the deferred tax liabilities arising on recognition of PVIF.

Key risk types
The key risks for our insurance operations are market risks (inparticular interest rate and equity) and credit risks, followed byinsurance underwriting risks and operational risks. Liquidity risk,
while significant for the bank, is minor for our insurance
operations.

Market risk
(Audited)

Description and exposure
Market risk is the risk of changes in market factors affecting
capital or profit. Market factors include interest rates, equity andgrowth assets and foreign exchange rates.
Our exposure varies depending on the type of contract issued.
Our most significant life insurance products are contracts withdiscretionary participating features (‘DPF’) issued in Hong Kong.
These products typically include some form of capital guarantee orguaranteed return on the sums invested by the policyholders, towhich discretionary bonuses are added if allowed by the overall
performance of the funds. These funds are primarily invested inbonds, with a proportion allocated to other asset classes toprovide customers with the potential for enhanced
returns.

48

DPF products expose the group to the risk of variation in asset
returns, which will impact our participation in the investment
performance. In addition, in some scenarios the asset returns canbecome insufficient to cover the policyholders' financial
guarantees, in which case the shortfall has to be met by the group.
Reserves are held against the cost of such guarantees, calculated
by stochastic modelling.
Where local rules require, these reserves are held as part ofliabilities under insurance contracts. Any remainder is accounted
for as a deduction from the present value of in-force (‘PVIF’) longterm insurance business on the relevant product. The following
table shows the total reserve held for the cost of guarantees, therange of investment returns on assets supporting these products
and the implied investment return that would enable the businessto meet the guarantees.
For unit-linked contracts, market risk is substantially borne by thepolicyholders, but some market risk exposure typically remains as
fees earned are related to the market value of the linked assets.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Sensitivities
Where appropriate, the effects of the sensitivity tests on profit
after tax and total equity incorporate the impact of the stress on
the PVIF. The relationship between the profit and total equity andthe risk factors is non-linear; therefore the results disclosed should
not be extrapolated to measure sensitivities to different levels ofstress. For the same reason, the impact of the stress is not
symmetrical on the upside and downside. The sensitivities reflect
the established risk sharing mechanism with policyholders forparticipating products, and are stated before allowance formanagement actions which may mitigate the effect of changes in
the market environment. The sensitivities presented allow foradverse changes in policyholders’ behaviour that may arise in
response to changes in market rates.
The following table illustrates the effects of selected interest rate,equity price and foreign exchange rate scenarios on our profit for
the year and the total equity of our insurance manufacturingsubsidiaries.

Sensitivity of the group’s insurance manufacturing subsidiaries to market risk factors(Audited)
31 Dec 201931 Dec 2018

Effect on profit
after tax

Effect on total
equityEffect on profit
after tax

Effect on total
equity

HK$m

HK$m

HK$m

HK$m

+100 basis points parallel shift in yield curves

(538)

(929)

(229)

(547)

-100 basis points parallel shift in yield curves

38

429

81

399

10% increase in equity prices

1,814

1,814

1,433

1,433

10% decrease in equity prices(1,366)(1,840)(1,840)(1,366)

10% increase in USD exchange rate compared to all currencies

327

327

267

267

10% decrease in USD exchange rate compared to all currencies

(327)

(327)

(267)

(267)

Credit risk

Capital and Liquidity risk

(Audited)(Audited)

Description and exposure

Description and exposure

Credit risk is the risk of financial loss if a customer or counterparty
fails to meet their obligation under a contract. It arises in two mainareas for our insurance manufacturers:

Liquidity risk is the risk that an insurance operation, thoughsolvent, either does not have sufficient financial resources
available to meet its obligations when they fall due, or can securethem only at excessive cost.

• risk associated with credit spread volatility and default by debt
security counterparties after investing premiums to generate areturn for policyholders and shareholders; and• risk of default by reinsurance counterparties and nonreimbursement for claims made after ceding insurance risk.
The amounts outstanding at the balance sheet date in respect ofthese items are shown in the table on page 48.
The credit quality of the reinsurers’ share of liabilities underinsurance contracts is assessed as ‘strong’ or ‘good’ (as definedon page 23), with 100% of the exposure being neither past due
nor impaired (2018: 100%).

The following table shows the expected undiscounted cash flows
for insurance liabilities at 31 December 2019. The liquidity risk
exposure is wholly borne by the policyholders in the case of unitlinked business and is shared with the policyholders for
non-linked insurance.
The profile of the expected maturity of insurance contracts at
31 December 2019 remained comparable with 2018.
The remaining contractual maturity of investment contract
liabilities is included in the table on page 100.

Credit risk on assets supporting unit-linked liabilities ispredominantly borne by the policyholders. Therefore our exposure
is primarily related to liabilities under non-linked insurance andinvestment contracts and shareholders’ funds. The credit quality of
insurance financial assets is included in the table on page 33. The
risk associated with credit spread volatility is to a large extent
mitigated by holding debt securities to maturity, and sharing a
degree of credit spread experience with policyholders.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

49

Risk

Expected maturity of insurance contract liabilities(Audited)
Expected cash flows (undiscounted)
Within 1 year

1-5 years

5-15 years

Over 15 years

Total

HK$m

HK$m

HK$m

HK$m

HK$m

Non-linked insurance contracts

46,115

152,561

319,151482,671

1,000,498

Unit-linked

8,110

19,913

14,154

8,940

51,11754,225

172,474

333,305

491,611

1,051,615

Non-linked insurance contracts

42,868144,817

291,726

383,026

862,437

Unit-linked

6,999

19,35016,285

11,04053,67449,867

164,167

308,011394,066

916,111

At 31 Dec 2019

At 31 Dec 2018

Insurance risk
Description and exposure(Unaudited)

Insurance risk is the risk of loss through adverse experience, ineither timing or amount, of insurance underwriting parameters(non-economic assumptions). These parameters include mortality,
morbidity, longevity, lapses and unit costs.
The principal risk we face is that, over time, the cost of thecontract, including claims and benefits may exceed the total
amount of premiums and investment income received. The tableon page 49 analyses our life insurance risk exposures by type ofcontract.

Mortality and morbidity risk is typically associated with life
insurance contracts. The effect on profit of an increase in mortality
or morbidity depends on the type of business being written.
Sensitivity to lapse rates depends on the type of contracts being
written. In general, for life insurance contracts a policy lapse has
two offsetting effects on profits, which are the loss of future
income on the lapsed policy and the existence of surrender charge
recouped at policy lapse. The net impact depends on the relative
size of these two effects which varies with the type of contracts.
Expense rates risk is the exposure to a change in the cost ofadministering insurance contracts. To the extent that increased
expenses cannot be passed on to policyholders, an increase in
expense rates will have a negative effect on our profits.

Sensitivities(Audited)

The table below shows the sensitivity of profit and total equity toreasonably possible changes in non-economic assumptions acrossall our insurance manufacturing subsidiaries.
Sensitivity analysis(Audited)
2019

2018

HK$m

HK$m

10% increase in mortality and/or morbidity rates

(509)

(448)

10% decrease in mortality and/or morbidity rates

507

454

10% increase in lapse rates

(496)

(408)

Effect on profit after tax and total equity at 31 Dec

10% decrease in lapse rates

564

468

10% increase in expense rates

(314)

(304)

10% decrease in expense rates

310

297

50

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Capital
Capital management(Audited)

Our approach to capital management is driven by our strategicand organisational requirements, taking into account theregulatory, economic and commercial environment in which we
operate.
It is our objective to maintain a strong capital base to support thedevelopment of our business and to meet regulatory capitalrequirements at all times. To achieve this, our policy is to holdcapital in a range of different forms and all capital raising is agreed
with major subsidiaries as part of their individual and the group’s
capital management processes.
The policy on capital management is underpinned by a capitalmanagement framework, which enables us to manage our capitalin a consistent manner. The framework defines regulatory capitaland economic capital as the two primary measures for the
management and control of capital.
Capital measures:• economic capital is the internally calculated capital requirement
to support risks to which we are exposed and forms a core partof the internal capital adequacy assessment process; and• regulatory capital is the capital which we are required to hold inaccordance with the rules established by regulators.
Our capital management process is articulated in our annual
capital plan which is approved by the Board. The plan is drawn up
with the objective of maintaining both an appropriate amount of
capital and an optimal mix between the different components ofcapital. Each subsidiary manages its own capital to support its
planned business growth and meet its local regulatory
requirements within the context of the approved annual group
capital plan. In accordance with the Capital Management
Framework, capital generated by subsidiaries in excess of planned
requirements is returned to the Bank, normally by way ofdividends.
The bank is the primary provider of capital to its subsidiaries andthese investments are substantially funded by the Bank’s own
capital issuance and profit retention. As part of its capitalmanagement process, the Bank seeks to maintain a prudent
balance between the composition of its capital and that of its
investment in subsidiaries.
The principal forms of capital are included in the following
balances on the consolidated balance sheet: share capital, other
equity instruments, retained earnings, other reserves andsubordinated liabilities.

For market risk, the group uses an internal models approach to
calculate its general market risk for the risk categories of interest
rate and foreign exchange (including gold) exposures, and equity
exposures. The group also uses an internal models approach to
calculate its market risk in respect of specific risk for interest rate
exposures and equity exposures. The group uses the standardised(market risk) approach for calculating other market risk positions,as well as trading book securitisation exposures, and thestandardised (operational risk) approach to calculate its
operational risk.
During the year, the individual entities within the group and thegroup itself complied with all of the externally imposed capitalrequirements of the HKMA.

Basel III
(Unaudited)

The Basel III capital rules set out the minimum CET1 capitalrequirement of 4.5% and total capital requirement of 8%. The
Banking (Capital) (Amendment) Rules 2014 came into effect on
1 January 2015 to implement the Basel III capital buffer
requirements in Hong Kong. The requirements were phased-infrom 2016 to 2019, in line with the Basel phase-in arrangements,
and reached full implementation in 2019. At 31 December 2019,the capital buffers applicable to the group include the Capital
Conservation Buffer (‘CCB’), the Countercyclical Capital Buffer(‘CCyB’) and the Higher Loss Absorbency (‘HLA’) requirement for
Domestic Systemically Important Banks (‘D-SIB’). The CCB isdesigned to ensure banks build up capital outside periods of stressat 2.5%. The CCyB is set on an individual country basis and is built
up during periods of excess credit growth to protect against future
losses. On 14 October 2019, the HKMA reduced the CCyB for
Hong Kong to 2.0% from 2.5% with immediate effect. On 24
December 2019, the HKMA maintained the D-SIB designation as
well as HLA requirements at 2.5% for the group.
In December 2018, the Financial Institutions (Resolution) (Lossabsorbing Capacity Requirements – Banking Sector) Rules (‘LAC’)in Hong Kong were passed into legislation, with transition periods
provided for their implementation. The group is classified as amaterial subsidiary under the LAC and therefore is subject to the
LAC requirements to maintain its internal LAC risk-weighted ratio
and the internal LAC leverage ratio at or above specified minimum.

Leverage ratio(Unaudited)

Basel III introduces a simple non risk-based leverage ratio as acomplementary measure to the risk-based capital requirements. It
aims to constrain the build-up of excess leverage in the banking
sector, introducing additional safeguards against model risk andmeasurement errors. The ratio is a volume-based measurecalculated as Basel III tier 1 capital divided by total on- and offbalance sheet exposures.

Externally imposed capital requirements

At(Unaudited)

The Hong Kong Monetary Authority (‘HKMA’) supervises the groupon both a consolidated and solo-consolidated basis and therefore
receives information on the capital adequacy of, and sets capitalrequirements for, the group as a whole and on a solo-consolidated
basis. Individual banking subsidiaries and branches are directly
regulated by their local banking supervisors, who set and monitor
their capital adequacy requirements. In most jurisdictions, nonbanking financial subsidiaries are also subject to the supervisionand capital requirements of local regulatory authorities.
The group uses the advanced internal ratings-based approach to
calculate its credit risk for the majority of its non-securitisation
exposures. For securitisation exposures, the group uses the
securitisation internal ratings-based approach, securitisation
external ratings-based approach, securitisation standardised
approach or securitisation fall-back approach to determine credit
risk for its banking book securitisation exposures. For counterparty
credit risk, the group uses both the current exposure method andan internal models approach to calculate its default risk exposures.

Leverage ratio
Capital and leverage ratio exposure
measureTier 1 capital
Total exposure measure

31 Dec31 Dec

2019

2018

%

%

6.7

6.5

HK$m

HK$m

537,460

501,5038,078,204

7,741,301

The increase in the leverage ratio from 31 December 2018 to
31 December 2019 was mainly due to an increase in Tier 1 capital,
partly offset by a rise in the exposure measure.
Further details regarding the group’s leverage position can beviewed in the Banking Disclosure Statement 2019, which will beavailable in the Regulatory Disclosures section of our website:www.hsbc.com.hk.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201951

Capital

Capital adequacy at 31 December 2019

Capital ratios(Unaudited)(Unaudited)At

The following tables show the capital ratios, RWAs and capitalbase as contained in the ‘Capital Adequacy Ratio’ return submitted
to the HKMA on a consolidated basis under the requirements ofsection 3C(1) of the Banking (Capital) Rules.
The basis of consolidation for financial accounting purposes is
described in note 1 on the Consolidated Financial Statements anddiffers from that used for regulatory purposes. Further informationon the regulatory consolidation basis and a full reconciliation
between the group’s accounting and regulatory balance sheets
can be viewed in the Banking Disclosure Statement 2019, which
will be available in the Regulatory Disclosures section of our
website www.hsbc.com.hk. Subsidiaries not included in thegroup's consolidation for regulatory purposes are securities andinsurance companies and the capital invested by the group inthese subsidiaries is deducted from regulatory capital, subject tocertain thresholds.
The Bank and its banking subsidiaries maintain regulatory reserves
to satisfy the provisions of the Banking Ordinance and local
regulatory requirements for prudential supervision purposes. At
31 December 2019, the effect of this requirement is to reduce theamount of reserves which can be distributed to shareholders by
HK$23,979m (31 December 2018: HK$26,883m).
We closely monitor and consider future regulatory change andcontinue to evaluate the impact upon our capital requirements ofregulatory developments. This includes the Basel III reforms
package, over which there remains a significant degree of
uncertainty due to the number of national discretions within
Basel’s reforms. It remains premature to provide details of an
impact although we currently anticipate the potential for an
increase for RWAs.

31 Dec31 Dec

2019

2018

%

%

Common equity tier 1 (‘CET1’) capital
ratio

17.2

16.5

Tier 1 capital ratio

18.8

17.8

Total capital ratio

21.0

19.8

Risk-weighted assets by risk type
(Unaudited)At
31 DecCredit risk

2018

HK$m

HK$m

2,318,266

2,290,786

Counterparty credit risk

79,75879,956

Market risk

97,908117,826

Operational risk
Total

355,448

325,3442,851,380

2,813,912

Risk-weighted assets by global business(Unaudited)At
31 DecRetail Banking and Wealth Management

31 Dec

2019

2018

HK$m

HK$m

494,029481,268

1,009,183

988,602

Global Banking and Markets

859,744896,143

Global Private Banking

29,08037,022

Corporate Centre

459,344

410,877

2,851,380

2,813,912

Commercial Banking

Total

52

31 Dec2019

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Capital base(Unaudited)

The following table sets out the composition of the group’s capital base under Basel III at 31 December 2019.
Capital base(Unaudited)At
31 Dec31 Dec

2019

2018

HK$m

HK$m

Shareholders’ equity

690,104

645,810– shareholders’ equity per balance sheet

814,678752,758– revaluation reserve capitalisation issue(1,454)(1,454)– other equity instruments(44,615)(35,879)– unconsolidated subsidiaries(78,505)(69,615)

Non-controlling interests

27,45926,034– non-controlling interests per balance sheet

64,60360,162– non-controlling interests in unconsolidated subsidiaries(10,316)(9,316)– surplus non-controlling interests disallowed in CET1

(26,828)(24,812)

Regulatory deductions to CET1 capital(225,922)(208,070)

Common equity tier 1 (‘CET1’) capital– valuation adjustments(1,554)(1,599)– goodwill and intangible assets(20,132)(17,215)– deferred tax assets net of deferred tax liabilities(2,214)(2,378)– cash flow hedging reserve– changes in own credit risk on fair valued liabilities– defined benefit pension fund assets

41

63

2,013

(198)

(45)

(24)

– significant Loss-absorbing capacity (‘LAC’) investments in unconsolidated financial sector entities(105,426)(99,407)– property revaluation reserves1(74,626)(60,429)– regulatory reserve(23,979)(26,883)

Total CET1 capital

491,641

463,774

Total AT1 capital before regulatory deductions

45,81937,729– perpetual subordinated loans

44,61535,879– allowable non-controlling interests in AT1 capital

1,204

1,850

Total AT1 capital

45,81937,729Total tier 1 capital

537,460

501,503

Total tier 2 capital before regulatory deductions

68,34061,178– perpetual subordinated debt2

3,114

3,133

– term subordinated debt

14,83913,944– property revaluation reserves1

34,236

27,847– impairment allowances and regulatory reserve eligible for inclusion in tier 2 capital

16,151

16,254

Regulatory deductions to tier 2 capital(6,866)(5,501)– significant LAC investments in unconsolidated financial sector entities(6,866)(5,501)

Total tier 2 capital

61,47455,677

Total capital

598,934

557,180

Additional tier 1 (‘AT1’) capital

Tier 2 capital

1 Includes the revaluation surplus on investment properties which is reported as part of retained earnings and adjustments made in accordancewith the Banking (Capital) Rules issued by the HKMA.
2 This Tier 2 capital instrument is grandfathered under Basel III and will be phased out in full after 31 December 2021.

A detailed breakdown of the group’s CET1 capital, AT1 capital, Tier 2 capital and regulatory deductions can be viewed in the Banking
Disclosure Statement 2019, which will be available in the Regulatory Disclosures section of our website www.hsbc.com.hk.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201953

Statement of Director’s Responsibilities | Independent Auditor’s ReportStatement of Directors’ Responsibilities
The following statement, which should be read in conjunction with the Auditor’s statement of their responsibilities set out in their reporton pages 55-59, is made with a view to distinguishing for shareholders the respective responsibilities of the Directors and of the Auditor
in relation to the Consolidated Financial Statements.
The Directors of The Hongkong and Shanghai Banking Corporation Limited (‘the Bank’) are responsible for the preparation of the Bank’s
Annual Report and Accounts, which contains the Consolidated Financial Statements of the Bank and its subsidiaries (together ‘thegroup’), in accordance with applicable law and regulations.
The Hong Kong Companies Ordinance requires the Directors to prepare for each financial year the consolidated financial statements forthe group and the balance sheet for the Bank.
The Directors are responsible for ensuring adequate accounting records are kept that are sufficient to show and explain the group’stransactions, such that the group’s consolidated financial statements give a true and fair view.
The Directors are responsible for preparing the consolidated financial statements that give a true and fair view and are in accordance with
Hong Kong Financial Reporting Standards (‘HKFRSs’) issued by the Hong Kong Institute of Certified Public Accountants. The Directors
have elected to prepare the Bank’s balance sheet on the same basis.
The Directors, whose names and functions are set out in the ‘Report of the Directors’ on pages 3-7 of this Annual Report and Accounts,
confirm to the best of their knowledge that:• the Consolidated Financial Statements, which have been prepared in accordance with HKFRSs and in accordance with the applicableset of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the group; and• the management report represented by the Financial Review, the Risk and Capital Reports includes a fair review of the development
and performance of the business and the position of the group, together with a description of the principal risks and uncertainties thatthe group faces.

On behalf of the Board

Laura Cha
Chairman
18 February 2020

54

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Independent Auditor’s Report
To the shareholder of The Hongkong and Shanghai Banking Corporation Limited (incorporated in
Hong Kong with limited liability)
OpinionWhat we have audited
The consolidated financial statements of The Hongkong and Shanghai Banking Corporation Limited (‘the Bank’) and its subsidiaries(together ‘the group’) set out on pages 60 to 117, which comprise:• the consolidated balance sheet as at 31 December 2019;• the consolidated income statement for the year then ended;• the consolidated statement of comprehensive income for the year then ended;• the consolidated statement of changes in equity for the year then ended;• the consolidated statement of cash flows for the year then ended; and• the notes1 on the consolidated financial statements, which include a summary of significant accounting policies.
1 Certain required disclosures as described in Note 1.1(d) have been presented elsewhere in the Annual Report and Accounts 2019, rather than in
the notes to the consolidated financial statements. These are cross-referenced from the consolidated financial statements and are identified asaudited.

Our opinion
In our opinion, the consolidated financial statements give a true and fair view of the consolidated financial position of the group as at
31 December 2019, and of its consolidated financial performance and its consolidated cash flows for the year then ended in accordancewith Hong Kong Financial Reporting Standards (‘HKFRSs’) issued by the Hong Kong Institute of Certified Public Accountants (‘HKICPA’)and have been properly prepared in compliance with the Hong Kong Companies Ordinance.

Basis for Opinion
We conducted our audit in accordance with Hong Kong Standards on Auditing (‘HKSAs’) issued by the HKICPA. Our responsibilities
under those standards are further described in the Auditor's Responsibilities for the Audit of the consolidated financial statements sectionof our report.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Independence
We are independent of the group in accordance with the HKICPA’s Code of Ethics for Professional Accountants (‘the Code’), and we havefulfilled our other ethical responsibilities in accordance with the Code.

Key Audit Matters
Key audit matters are those matters that, in our professional judgement, were of most significance in our audit of the consolidated
financial statements of the current period. These matters were addressed in the context of our audit of the consolidated financial
statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.
Key audit matters identified in our audit are summarised as follows:• IT access management• Investment in associate – Bank of Communications Co., Limited (‘BoCom’)• The present value of in-force long-term insurance business (‘PVIF’) and liabilities under non-linked life insurance contracts• Impairment of loans and advances to customers.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201955

Independent Auditor’s Report

IT access management
Nature of the Key Audit Matter

Matters discussed with the Audit Committee

Our audit approach relies extensively on automated controls and therefore on The significance of IT controls to our audit and the status of the remediation
the effectiveness of controls over IT systems.
was discussed at the Audit Committee meetings during the year.
In previous years, we identified and reported that controls over access toapplications, operating systems and data in the financial reporting process
required improvements. Access management controls are critical to ensurethat changes to applications and underlying data are made in an appropriatemanner. Appropriate access and change controls contribute to mitigating therisk of potential fraud or errors as a result of changes to applications and data.
Management implemented remediation activities that have contributed toprogress being made in reducing the risk over access management in thefinancial reporting process. Controls continue to require some improvement
going forward.
How our audit addressed the Key Audit Matter

Access rights were tested over applications, operating systems and databases relied upon for financial reporting. Specifically, the audit tested that:• new access requests for joiners were properly reviewed and authorised;• user access rights were removed on a timely basis when an individual left or moved role;• access rights to applications, operating systems and databases were periodically monitored for appropriateness; and• highly privileged access was restricted to appropriate personnel.
Other areas that were independently assessed included password policies, security configurations, controls over changes to code, data and configurations,and that the ability to make such change via privileged operating system or database access in the production environment was appropriately restricted.
Where control deficiencies were identified, a range of other procedures were performed:• where access outside of policy was identified, we understood the nature of the access, and, where required, obtained additional evidence on whether
that access had been exploited;• testing of controls to manage the monitoring of business access, including access that would allow a user to potentially override segregations of duty;
and• substantive testing of whether users inappropriately hold access to key functionality underpinning financial reporting processes, specific year-end
reconciliations (i.e. custodian, bank account and suspense account reconciliations) and confirmations with external counterparties.
Relevant references in the Annual Report and Accounts 2019

Risk: Top and Emerging Risks, page 16;

Investment in associate – Bank of Communications Company, Limited (‘BoCom’)
Nature of the Key Audit Matter

Matters discussed with the Audit Committee

At 31 December, the market value of the Bank’s investment in BoCom,based on the share price, was HK$70.1bn lower than the carrying value. Thisis considered an indicator of potential impairment. An impairment test was
performed by the Bank using a value in use ('VIU') model to estimate theinvestment’s value assuming it continues to be held in perpetuity rather thansold. The VIU was HK$19.4bn in excess of the carrying value. On this basis
no impairment was recorded and the share of BoCom’s profits has beenrecognised in the consolidated income statement.
The VIU model is based on the requirements of the relevant accounting
standard and is dependent on many assumptions, both short-term and longterm in nature. These assumptions, which are judgemental, are derived froma combination of management estimates, analysts’ forecasts and market
data.

We discussed the appropriateness of these assumptions with the Audit
Committee, particularly those for which variations had the most significant
impact on the carrying value of the VIU. We focused on the assumptions
relating to forecasted cash flows and the impact of meeting regulatory
capital requirements. We also discussed with the Audit Committee theeffective tax rate and loan impairment rate assumptions and consideredreasonably possible alternatives. Our discussions and focus on assumptions
was driven by consideration of the current levels of uncertainty and theoverall outlook for the Chinese banking market, the broader Chinese
economy and the impact of China-US trade tensions.

How our audit addressed the Key Audit Matter• We assessed the appropriateness of the methodology used to estimate the VIU.
• A reasonable range for the discount rate used within the model was independently calculated with the assistance of our valuation experts and comparedto the discount rate used by management.
• We challenged the basis for determining assumptions and the inputs used. We obtained corroborating information for inputs into assumptions fromexternal market information, third-party sources, including analyst reports, and historical publicly available BoCom information.
• We performed sensitivity analysis on key assumptions used, both individually and in aggregate.
• The controls in place over the model, and its mathematical accuracy, were tested.
• We observed meetings in September and November 2019 between management and senior BoCom executive management, held specifically to identify
facts and circumstances impacting assumptions relevant to the determination of the VIU.
• We read and assessed the disclosures made in the Annual Report and Accounts 2019 in relation to BoCom, specifically giving consideration to thesensitivity disclosures and the variations in assumptions that would result in an impairment.
• Representations were obtained from HSBC that assumptions used were consistent with information currently available to them, both as a shareholder
and to which HSBC are entitled through their participation on BoCom's Board of Directors.
Relevant references in the Annual Report and Accounts 2019

Financial Review, page 9Note 1: Basis of preparation and significant accounting policies, page 66-75
Note 14: Interests in associates and joint ventures, page 90-93

56

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

The present value of in-force long-term insurance business (‘PVIF’) and liabilities under non-linked life insurance contracts
Nature of the Key Audit Matter

Matters discussed with the Audit Committee

The group has recorded an asset for PVIF of HK$61.1bn and liabilities under
non-linked life insurance contracts of HK$467.9bn as at
31 December 2019. The determination of these balances requires the use of
appropriate actuarial methodologies and also highly judgemental
assumptions, including assumptions over long-term economic returns,
longevity, mortality, persistency and expenses. Small movements in theseassumptions can have a material impact on the PVIF asset and the liabilities
under non-linked life insurance contracts.

We discussed with the Audit Committee the results of our testingprocedures over key assumptions used in the valuation of the PVIF asset andthe liabilities under non-linked life insurance contracts including testing ofchanges made during the reporting period to the models and to the basis of
the determination of key assumptions.

How our audit addressed the Key Audit Matter

The controls in place for the determination of the valuation of the PVIF asset and the liabilities under non-linked life insurance contracts were tested.
Specifically, these included controls over:• policy data reconciliations from the policyholder administration system to the actuarial valuation system,• assumptions setting,• review and determination of valuation methodologies,• restriction of user access to the actuarial models, and• production and approval of the actuarial results.
With the assistance of our actuarial experts, the appropriateness of the models, methodologies and assumptions used were assessed for reasonableness.
Specifically, these included assumptions in respect of:• economic assumptions, including discount rate and long term investment return assumptions;• operating assumptions and policyholder behaviour, such as longevity, mortality, morbidity and persistency; and• future costs of obtaining and maintaining the insurance business.
Our challenge and evaluation of the key judgements and assumptions made by management included whether these were supported by relevant
experience and market information.
Relevant references in the Annual Report and Accounts 2019

Risk: Risks of insurance manufacturing operations, page 46-50
Note 1: Basis of preparation and significant accounting policies, page 66-75
Note 3: Insurance business, page 78-79
Note 15: Goodwill and intangible assets, page 93-94

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201957

Independent Auditor’s Report

Impairment of loans and advances to customers
Nature of the Key Audit Matter

Matters discussed with the Audit Committee

This is the second year that expected credit losses (‘ECL’) have beenreported under HKFRS 9. The underlying processes and controls havecontinued to mature during the year, with an increased focus on backtesting. The Bank has also updated certain ECL models during the year.
The credit environment appears to have remained relatively benign during
the year, in part due to low interest rates globally. However, there are a
growing number of specific risks.
We continued to critically assess the more judgemental decisions made bymanagement, in particular the severity and likelihood of various economic
scenarios (including the base, upside and various downside scenarios) thatform part of the forward economic guidance and their impact on ECL. We
also considered: the controls over the determination of customer credit
ratings and probabilities of default, and the impact they had on thedetermination of significant increases in credit risk; the appropriateness ofpost model adjustments made to reflect model and data limitations; and theestimation of specific impairment for wholesale exposures that had
defaulted.

At each Audit Committee meeting, there were discussions on changes madeto models and the inputs into them; the impact of evolving geopolitical risks,such as the social unrest in Hong Kong and the US-China trade tensions andimpairment of significant wholesale exposures.

How our audit addressed the Key Audit Matter• We performed risk based substantive testing of models that were updated during the year, including independently rebuilding the modelling for certain
assumptions.
• We independently reviewed the updates to the scripts used in the underlying tool to calculate ECL to ensure that they reflected approved updates tomodels, parameters and inputs.
• We tested controls over the inputs of critical data into source systems and the flow and transformation of data between source systems to theimpairment calculation engine. Substantive testing was performed over the critical data used in the year end ECL calculation.
• We tested the review and challenge of multiple economic scenarios by an expert panel and internal governance committee, and assessed thereasonableness and likelihood of these scenarios using our economics experts. Relevant economic, political and other events were considered inassessing the reasonableness of alternative downside scenarios. The severity and magnitude of the scenarios were compared to external forecasts anddata from historical economic downturns, and the sensitivities of the scenarios on the ECL were considered.
• We observed challenge forums to assess the ECL output and approval of post model adjustments.
• We tested the approval of the key inputs, assumptions and discounted cash-flows that support the impairment allowances for a sample of significant
individually assessed loans.
Relevant references in the Annual Report and Accounts 2019

Risk: Credit Risk, page 22-39
Note 1: Basis of preparation and significant accounting policies, page 66-75
Note 2(e): Operating profit – Change in expected credit losses and other credit impairment charges, page 77
Note 10: Loans and advances to customers, page 87

Other Information
The directors of the Bank are responsible for the other information. The other information comprises the information included in the
Financial Highlights, Report of the Directors, Financial Review, Risk, Capital and Statement of Directors' Responsibilities sections of theAnnual Report and Accounts 2019 (but does not include the consolidated financial statements and our auditor’s report thereon), which
we obtained prior to the date of this auditor’s report, and the Banking Disclosure Statement 2019 and the list of the directors of theBank's subsidiary undertakings (consolidated in the financial statements) during the period from 1 January 2019 to 18 February 2020,
which are expected to be made available to us after the date of this auditor’s report.
Our opinion on the consolidated financial statements does not cover the other information and we do not and will not express any formof assurance conclusion thereon, apart from the specific information presented therein that is identified as being an integral part of theconsolidated financial statements and, therefore, covered by our audit opinion on the consolidated financial statements.
In connection with our audit of the consolidated financial statements, our responsibility is to read the other information identified above
and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our
knowledge obtained in the audit or otherwise appears to be materially misstated.
If, based on the work we have performed on the other information that we obtained prior to the date of this auditor’s report, we conclude
that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in thisregard.
When we read the Banking Disclosure Statement 2019 and the list of the directors of the Bank's subsidiary undertakings (consolidated in
the financial statements) during the period from 1 January 2019 to 18 February 2020, if we conclude that there is a material
misstatement therein, we are required to communicate the matter to the Audit Committee and take appropriate action considering ourlegal rights and obligations.

58

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Responsibilities of Directors and the Audit Committee for the Consolidated Financial Statements
The directors of the Bank are responsible for the preparation of the consolidated financial statements that give a true and fair view inaccordance with HKFRSs issued by the HKICPA and the Hong Kong Companies Ordinance, and for such internal control as the directors
determine is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether
due to fraud or error.
In preparing the consolidated financial statements, the directors are responsible for assessing the group’s ability to continue as a going
concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors
either intend to liquidate the group or to cease operations, or have no realistic alternative but to do so.
The Audit Committee is responsible for overseeing the group’s financial reporting process.

Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements
Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material
misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. We report our opinion solely toyou, as a body, in accordance with Section 405 of the Hong Kong Companies Ordinance and for no other purpose. We do not assume
responsibility towards or accept liability to any other person for the contents of this report. Reasonable assurance is a high level ofassurance, but is not a guarantee that an audit conducted in accordance with HKSAs will always detect a material misstatement when it
exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably
be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements.
As part of an audit in accordance with HKSAs, we exercise professional judgement and maintain professional scepticism throughout theaudit. We also:• Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design
and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis
for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as
fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
• Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on the effectiveness of the group's internal control.
• Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures
made by the directors.
• Conclude on the appropriateness of the directors' use of the going concern basis of accounting and, based on the audit evidence
obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the group’s ability tocontinue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’sreport to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion.
Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions
may cause the group to cease to continue as a going concern.
• Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, andwhether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fairpresentation.
• Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the group to
express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of thegroup audit. We remain solely responsible for our audit opinion.
We communicate with the Audit Committee regarding, among other matters, the planned scope and timing of the audit and significant
audit findings, including any significant deficiencies in internal control that we identify during our audit.
We also provide the Audit Committee with a statement that we have complied with relevant ethical requirements regarding
independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our
independence, and where applicable, related safeguards.
From the matters communicated with the Audit Committee, we determine those matters that were of most significance in the audit of
the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our
auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we
determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be
expected to outweigh the public interest benefits of such communication.
The engagement partner on the audit resulting in this independent auditor’s report is Mr. Mervyn Robert John Jacob.

PricewaterhouseCoopers
Certified Public Accountants
Hong Kong, 18 February 2020

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201959

Consolidated Financial Statements

Consolidated Financial Statements
Consolidated income statement
for the year ended 31 December

Net interest income

2019

2018

Notes

HK$m

HK$m

2a

130,903

126,463– interest income

191,322

170,065– interest expense(60,419)(43,602)41,50544,231

Net fee income

2b– fee income

53,09954,585– fee expense(11,594)(10,354)

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

2c36,38832,070Net income/(expense) from assets and liabilities of insurance businesses, including related derivatives, measured at fairvalue through profit or loss

2c

14,257(5,561)

Changes in fair value of designated debts issued and related derivatives1

2c

(305)

(327)

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

2c

118

(217)

Gains less losses from financial investments
Net insurance premium income

3

Other operating income

2d

Total operating income
Net insurance claims and benefits paid and movement in liabilities to policyholders

3

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

2e

Net operating income

638

501

60,27560,67815,758

10,470299,537

268,308(80,156)(57,839)

219,381

210,469(5,672)(4,720)213,709205,749

Employee compensation and benefits

4(38,048)(40,793)

General and administrative expenses

2f(44,769)(39,989)

Depreciation and impairment of property, plant and equipment

2g(8,230)(4,686)

Amortisation and impairment of intangible assets(2,447)(1,956)

Total operating expenses(93,494)(87,424)

Operating profit

120,215

118,325

Share of profit in associates and joint ventures

16,21816,258

Profit before tax

136,433

134,583

Tax expense

5

Profit for the year

(21,393)(22,467)

115,040

112,116

104,200

102,132

Attributable to:– ordinary shareholders of the parent company– other equity holders

1,522

881

– non-controlling interests

9,318

9,103

115,040

112,116

Profit for the year

1 The definition has been updated to include debt instruments which are issued for funding purposes and are designated under the fair value option
to reduce an accounting mismatch, previously reported under 'Net income from financial instruments held for trading and managed on a fairvalue basis'. Comparatives have been re-presented to conform to current year's presentation.

60

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Consolidated statement of comprehensive income
for the year ended 31 December
2019

2018

HK$m

HK$m

115,040

112,116

Debt instruments at fair value through other comprehensive income

1,674

826

– fair value gains

2,782

908

– fair value (gains)/losses transferred to the income statement

(606)

142

Profit for the year
Other comprehensive income/(expense)
Items that will be reclassified subsequently to profit or loss when specific conditions are met:

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

23

(9)

(525)

(215)

Cash flow hedges

5131– fair value gains

681

1,264

– fair value gains reclassified to the income statement(673)(1,125)– income taxes
Share of other comprehensive income/(expense) of associates and joint ventures
Exchange differences

(3)

(8)

167

(146)

(3,606)(18,098)

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

3,673

8,826

– fair value gains

4,426

10,626– income taxes(753)(1,800)Equity instruments designated at fair value through other comprehensive income

2,854

(581)

– fair value gains/(losses)

2,859

(576)

– income taxes

(5)

(5)

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

(2,060)(199)– before income taxes(2,467)(241)– income taxes

407

42

Remeasurement of defined benefit asset/liability

192

(910)

– before income taxes

245(1,091)– income taxes

(53)

181

2,899

(10,151)

117,939

101,965

106,187

91,915

Other comprehensive income/(expense) for the year, net of tax
Total comprehensive income for the year
Attributable to:– ordinary shareholders of the parent company– other equity holders

1,522

881

– non-controlling interests

10,2309,169

Total comprehensive income for the year

117,939

101,965

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201961

Consolidated Financial Statements

Consolidated balance sheet
at 31 December
2019

2018

HK$m

HK$m

Cash and balances at central banks

202,746

205,660

Items in the course of collection from other banks

21,14025,380Hong Kong Government certificates of indebtedness

298,944

280,854

Notes

AssetsTrading assets

7622,761

558,838

Derivatives

8

280,642

292,869

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

9

153,511

132,859

Reverse repurchase agreements – non-trading

422,333

406,327

Loans and advances to banks

328,905

338,151

Loans and advances to customers

10

3,720,875

3,528,702

Financial investments

11

1,900,298

1,871,026

Amounts due from Group companies

33

87,63270,455Interests in associates and joint ventures

14

151,917

142,885

Goodwill and intangible assets

15

81,643

65,104

Property, plant and equipment

16

137,930

112,080

Deferred tax assets

5

2,179

2,315

Prepayments, accrued income and other assets

17

248,258

229,949

8,661,714

8,263,454

Hong Kong currency notes in circulation

298,944

280,854

Items in the course of transmission to other banks

25,57633,806

Repurchase agreements – non-trading

106,396

70,279Deposits by banks

179,819

164,664
5,207,666

Total assets
Liabilities

Customer accounts

18

5,432,424

Trading liabilities

19

87,532

81,194

Derivatives

8292,231295,553

Financial liabilities designated at fair value

20

160,291

161,143

Debt securities in issue

21

106,933

58,236Retirement benefit liabilities

4

2,595

3,369

Amounts due to Group companies

33

311,111

396,487

Accruals and deferred income, other liabilities and provisions

22

203,252

196,665

Liabilities under insurance contracts

3528,760

468,589

Current tax liabilities

12,614

3,337

Deferred tax liabilities

529,88924,513

Subordinated liabilities

23

4,066

4,081

Preference shares

24

—

98

7,782,433

7,450,534
172,335

Total liabilities
EquityShare capital

25

172,335

Other equity instruments

26

44,61535,879Other reserves

133,099

114,949

Retained earnings

464,629

429,595

Total shareholders’ equity

814,678752,758

Non-controlling interests

64,60360,162

Total equity

879,281812,920

8,661,714

8,263,454

Total liabilities and equity

62

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Consolidated statement of cash flows
for the year ended 31 December

Profit before tax

2019

2018

HK$m

HK$m

136,433

134,583

Adjustments for non-cash items:
Depreciation and amortisation1
Net gain from investing activities
Share of profits in associates and joint ventures(Gain)/loss on disposal of subsidiaries, businesses, associates and joint ventures
Change in expected credit losses gross of recoveries and other credit impairment charges

10,677

6,657

(790)

(1,071)(16,218)(16,258)

14

(38)

6,535

4,720

Provisions

568

51

Share-based payment expense

878

881

Other non-cash items included in profit before tax
Elimination of exchange differences(16,869)(3,861)

4,819

15,723

Changes in operating assets and liabilities
Change in net trading securities and derivatives(78,600)(65,937)

Change in loans and advances to banks and customers(189,346)(299,137)

Change in reverse repurchase agreements – non-trading(33,521)(61,887)

Change in financial assets designated and otherwise mandatorily measured at fair value through profit or loss

(20,652)

1,176

6,146

113,636

Change in deposits by banks and customer accounts

239,913

71,688Change in repurchase agreements – non-trading

36,117

23,109Change in debt securities in issue

48,697

19,842

Change in other assets

Change in financial liabilities designated at fair value(852)(8,605)(28,243)

166,634

Dividends received from associates

4,962

4,948

Contributions paid to defined benefit plans

(391)

(576)

(9,420)(18,216)

Change in other liabilities

Tax paid
Net cash from operating activities

100,857

88,062

Purchase of financial investments(836,492)(822,067)

Proceeds from the sale and maturity of financial investments

762,125756,630

Purchase of property, plant and equipment(3,334)(1,646)

Proceeds from sale of property, plant and equipment and assets held for sale

1,828

11,820

Proceeds from disposal of customer loan portfolios

2,057

2,542

Net investment in intangible assets(6,019)(4,691)

Net cash inflow on sale of subsidiaries

299—

Net cash from investing activities(79,536)(57,412)

Issue of ordinary share capital and other equity instruments

8,617

21,142

Redemption of preference shares and other equity instruments—(20,975)

Subordinated loan capital issued2—

79,834

Subordinated loan capital repaid2—(42,986)

Dividends paid to shareholders of the parent company and non-controlling interests(74,015)(52,508)

Net cash from financing activities(65,398)(15,493)

Net increase/(decrease) in cash and cash equivalents(44,077)

15,157

Cash and cash equivalents at 1 Jan3

721,609

718,038

Exchange differences in respect of cash and cash equivalents

132(11,586)

677,664

721,609– cash and balances at central banks

202,746

205,660– items in the course of collection from other banks

21,14025,380– loans and advances to banks of one month or less

217,879

179,952

Cash and cash equivalents at 31 Dec3,4
Cash and cash equivalents comprise– net settlement accounts and cash collateral

18,706—– reverse repurchase agreements with banks of one month or less

155,587

165,654– treasury bills, other bills and certificates of deposit less than three months

87,182

178,769– less: items in the course of transmission to other banks(25,576)(33,806)

Cash and cash equivalents at 31 Dec3,4

677,664

721,609

Interest received was HK$195,528m (2018: HK$166,441m), interest paid was HK$62,557m (2018: HK$41,583m) and dividends received
were HK$5,410m (2018: HK$178m).
1
2

3
4

The impact on right-of-use assets has been recognised from 1 January 2019 following the adoption of HKFRS 16. Comparatives have not been
restated.
Changes in subordinated liabilities (including those issued to Group companies) during the year included amounts from repayment and reissuance with no cash movement, and non-cash changes from foreign exchange losses (HK$1,012m) and fair value gain after hedging(HK$9,736m).
In 2019, the group included settlement accounts with bank counterparties of one month or less on a net basis. Comparatives have not been represented.
At 31 December 2019 HK$110,076m (2018: HK$122,899m) was not available for use by the group, of which HK$66,943m (2018: HK$71,783m)
related to mandatory deposits at Central banks.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201963

Consolidated Financial Statements

Consolidated statement of changes in equity
for the year ended 31 December
Other reserves

Sharecapital

At 31 Dec 2018
Impact on transition to HKFRS 16

Otherequityinstruments

Retainedearnings

Property
revaluation
reserve

Financialassets at
FVOCI
reserve

Cashflow
Foreignhedge exchange
reserve
reserve

Other1
HK$m

HK$m

HK$m

HK$m

(24,649) 78,830

752,758

60,162812,920

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

172,335

35,879429,595

57,914

2,953

(99)

HK$m

—

—

—

13,483——

172,335

35,879429,595

71,397

2,953

(99)

Profit for the year——

105,722

—

—

—

—

Other comprehensive income/(expense)(net of tax)——

(1,949)

3,395

4,006

(5)

– debt instruments at fair value
through other comprehensive
income

—

—

—

—

1,676

– equity instruments designated at fairvalue through other comprehensive
income————– cash flow hedges

—

—

—

—

– changes in fair value of financial
liabilities designated at fair value
upon initial recognition arising fromchanges in own credit risk——

(2,058)– property revaluation

—

—

—

– remeasurement of defined benefit
asset/liability

—

—

112

– share of other comprehensive
income/(expense) of associates andjoint ventures——– exchange differences——

Total comprehensive income/(expense) for the year——

Other equity instruments issued2—

44,615

Other equity instruments repaid2—

Dividends paid3
Movement in respect of share-based
payment arrangements
Transfers and other movements4

At 1 Jan 2019

At 31 Dec 2019

64

—

Total
shareNonholders’ controlling
equityinterests

Total
equity—13,483—

13,483(24,649) 78,830

766,241

60,162

826,403—

105,722

9,318

115,040(3,469)

9

1,987

912

2,899

—

—

—

1,676

(2)

1,674

2,169

—

—

—

2,169

685

2,854

—

(5)

—

—

(5)

10

5

—

—

—

—

—

(2,058)(2)(2,060)

3,395

—

—

—

—

3,395

278

3,673

—

—

—

—

—

112

80

192

(3)

—

161

—

—

9

167

—

167

—

—

—

—

(3,469)—(3,469)(137)(3,606)

103,773

3,395

4,006

(5)

(3,469)9

107,709

10,230117,939

—

—

—

—

—

—

44,615—44,615(35,879)

—

—

—

—

—

—

(35,879)—(35,879)——(68,369)

—

—

—

—

—

(68,369)(5,646)(74,015)

—

—

(42)

—

—

—

—

249

207

2

209

—

—

(328)

(2,779)

—

—

—

3,261

154

(145)

9

172,335

44,615

464,62972,013

6,959

(104)

(28,118) 82,349

814,678

64,603879,281

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Consolidated statement of changes in equity (continued)
for the year ended 31 December
Other reserves

Sharecapital

At 31 Dec 20177
Impact on transition to HKFRS 9

Other
equityinstruments

Retainedearnings

Property
revaluation
reserve

Financialassets at
FVOCI
reserve7

Cash
flow
hedge
reserve

Foreignexchangereserve

1

Other

Total
shareholders’equityNoncontrollinginterests

Total
equity

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

151,360

14,737

406,966

58,381

6,825

(197)

(6,948)65,356

696,480

56,506752,986——(7,478)—(4,512)———(11,990)(323)(12,313)

151,360

14,737399,488

58,381

2,313

(197)

(6,948)65,356684,490

56,183740,673

Profit for the year——

103,013

—

—

—

—

—

103,0139,103

112,116

Other comprehensive income/(expense) (net of tax)

—

—

(890)

8,050

228

98

(17,701)(2)(10,217)66(10,151)– debt instruments at fair value
through other comprehensive
income

—

—

—

—

734

—

—

—

734

92

826

– equity instruments designated atfair value through othercomprehensive income

—

—

—

—

(367)

—

—

—

(367)

(214)

(581)

– cash flow hedges

—

—

—

—

—

98

—

—

98

33

131

– changes in fair value of financial
liabilities designated at fair value
upon initial recognition arisingfrom changes in own credit risk

—

—

(197)

—

—

—

—

—

(197)

(2)

(199)

– property revaluation

—

—

—

8,050

—

—

—

—

8,050

776

8,826

– remeasurement of defined
benefit asset/liability

—

—

(688)

—

—

—

—

—

(688)

(222)

(910)

– share of other comprehensive
expense of associates and joint
ventures

—

—

(5)

—

(139)

—

—

(2)

(146)

—

(146)

– exchange differences

—

—

—

—

—

—

(17,701)—(17,701)(397)(18,098)

Total comprehensive income/(expense) for the year——

102,123

8,050

228

98

(17,701)(2)

92,796

9,169

101,965

Other equity instruments issued2—

21,142

—

—

—

—

—

—

21,142—

21,142

Dividends paid3——(47,440)

—

—

—

—

—

(47,440)(5,068)(52,508)

At 1 Jan 2018

Movement in respect of sharebased payment arrangements

—

—

(234)

—

—

—

—

246

12

10

22

Transfers and other movements4,5,6

20,975—(24,342)(8,517)412——

13,230

1,758

(132)

1,626

At 31 Dec 2018

172,335

35,879429,595

57,914

2,953

(99)

(24,649)

78,830752,758

60,162812,920

1 The other reserves mainly comprise share of associates’ other reserves, purchase premium arising from transfer of business from fellow
subsidiaries, property revaluation reserve relating to transfer of properties to a fellow subsidiary and the share-based payment reserve. The sharebased payment reserve is used to record the amount relating to share awards and options granted to employees of the group directly by HSBC
Holdings plc.
2 In 2019, there were US$1,100m additional tier 1 capital instruments issued (2018: US$2,700m). In addition, US$4,600m of additional tier 1
capital instruments were repaid and reissued in 2019 with no actual cash movement (2018: nil).
3 Including distributions paid on perpetual subordinated loans classified as equity under HKFRS.
4 The movements include transfers from retained earnings to other reserves in associates according to local regulatory requirements, and from theproperty revaluation reserve to retained earnings in relation to depreciation of revalued properties.
5 Ordinary share capital includes preference shares which have been redeemed or bought back via payment out of distributable profits in previous
years. In 2018, the Bank redeemed HK$20,975m of preference shares and made a transfer from retained earnings to share capital.
6 The movement from property revaluation reserve to other reserves in 2018 included HK$7,169m relating to transfer of properties to a fellow
subsidiary as part of the Recovery and Resolution Plan as set out in the Report of the Directors.
7 The balance at 31 December 2017 represents the HKAS 39 Available-for-sale fair value reserve as at 31 December 2017.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201965

Notes on the Consolidated Financial Statements

Notes on the Consolidated Financial Statements
1

Basis of preparation and significant accounting policies

1.1 Basis of preparation(a)Compliance with Hong Kong Financial Reporting Standards

The consolidated financial statements of The Hongkong and Shanghai Banking Corporation Limited (‘the Bank’) and its subsidiaries(together ‘the group’) have been prepared in accordance with Hong Kong Financial Reporting Standards (‘HKFRSs’) as issued by theHong Kong Institute of Certified Public Accountants (‘HKICPA’) and accounting principles generally accepted in Hong Kong. These
consolidated financial statements also comply with the requirements of the Hong Kong Companies Ordinance (Cap. 622) which areapplicable to the preparation of the financial statements.

Standards adopted during the year ended 31 December 2019HKFRS 16 'Leases'
On 1 January 2019, the group adopted the requirements of HKFRS 16 and recognised lease liabilities in relation to leases which had
previously been classified as ‘operating leases’ in accordance with HKAS 17 ‘Leases’. These liabilities were measured at the present
value of the remaining lease payments, discounted at the lessee’s incremental borrowing rate as at 1 January 2019. The associated rightof-use (‘ROU’) assets were measured at the amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease
payments or provisions for onerous leases recognised on balance sheet at 31 December 2018. In addition, the following practical
expedients permitted by the standard were applied:• Reliance was placed on previous assessments on whether leases were onerous;• Operating leases with a remaining lease term of less than 12 months as at 1 January 2019 were treated as short-term leases; and• Initial direct costs were not included in the measurement of ROU assets for leases previously accounted for as operating leases.
The differences between HKAS 17 and HKFRS 16 are summarised in the table below:
HKAS 17HKFRS 16

Leases were classified as either finance or operating leases.
Payments made under operating leases were charged to
profit or loss on a straight-line basis over the period of thelease.

Leases are recognised as an ROU asset and a corresponding liability at the date at which theleased asset is made available for use. Lease payments are allocated between the liability andfinance cost. The finance cost is charged to profit or loss over the lease term so as toproduce a constant period rate of interest on the remaining balance of the liability. The ROU
asset is depreciated over the shorter of the ROU asset’s useful economic life and the leaseterm on a straight-line basis.
In determining lease term, the group considers all facts and circumstances that create an
economic incentive to exercise an extension option or not exercise a termination option overthe planning horizon of five years.
In general, it is not expected that the discount rate implicit in the lease is available so thelessee’s incremental borrowing rate is used. This is the rate that the lessee would have to pay
to borrow the funds necessary to obtain an asset of a similar value in a similar economic
environment with similar terms and conditions. The rates are determined for each economic
environment in which the group operates by adjusting swap rates with funding spreads (owncredit spread) and cross-currency basis where appropriate.

The group adopted the requirements of HKFRS 16 retrospectively, with the cumulative effect of initially applying the standard recognised
as an adjustment to the opening balance of retained earnings at that date. Comparatives were not restated. In relation to the operatingleases that were under HKAS 17 'Leases', the adoption of the standard increased assets by HK$9.2bn reported under ‘Property, plant andequipment’ and increased lease liabilities by the same amount reported under 'Accruals and deferred income, other liabilities andprovisions' with no effect on net assets or retained earnings.
In addition, as a consequence of HKFRS 16, properties previously reported under ‘Prepayments, accrued income and other assets’ as
operating leases and held at cost were reclassified to ‘Property, plant and equipment’ and measured at fair value. The implementation
increased ‘Property, plant and equipment’ by HK$16.3bn and increased deferred tax liabilities by HK$2.7bn, with the net impact taken to
the 'Property Revaluation Reserve'.
The overall impact of the above is to increase ‘Property, plant and equipment’ by HK$25.5bn, increase 'Accruals and deferred income,other liabilities and provisions' by HK$9.2bn, increase 'Deferred tax liabilities' by HK$2.7bn, increase 'Property Revaluation Reserve' by
HK$13.5bn and decrease ‘Prepayments, accrued income and other assets’ by HK$136m.
Interest Rate Benchmark Reform: Amendments to HKFRS 9 and HKAS 39 ‘Financial Instruments’
Amendments to HKFRS 9 and HKAS 39 issued in November 2019 modify specific hedge accounting requirements so that entities apply
those hedge accounting requirements assuming that the interest rate benchmark on which the hedged cash flows and cash flows of thehedging instrument are based is not altered as a result of interest rate benchmark reform. These amendments replace the need forspecific judgements to determine whether certain hedge accounting relationships that hedge the variability of cash flows or interest raterisk exposures for periods after the interest rate benchmarks are expected to be reformed or replaced continue to qualify for hedge
accounting as at 31 December 2019. For example, in the context of cash flow hedging, the amendments require the interest ratebenchmark on which the hedged cash flows are based, or on which the cash flows of the hedging instrument are based, to be assumed
to be unaltered over the period of the documented hedge relationship, while uncertainty over the interest rate benchmark reform exists.
The HKICPA is expected to provide further guidance on the implication for hedge accounting during the reform process and after thereform uncertainty is resolved.
These amendments apply from 1 January 2020 with early adoption permitted. The group has adopted the amendments that apply to
HKAS 39 from 1 January 2019 and has made the additional disclosures as required by the amendments. Further information is included
in note 8.

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The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

(b)Future accounting developments

Minor amendments to HKFRSs
The HKICPA has published a number of minor amendments to HKFRSs which are effective from 1 January 2020. The group expects they
will have an insignificant effect, when adopted, on the Consolidated Financial Statements.

Major new HKFRSs
HKFRS 17 ‘Insurance Contracts’
HKFRS 17 ‘Insurance Contracts’ was issued in January 2018 and sets out the requirements that an entity should apply in accounting for
insurance contracts it issues and reinsurance contracts it holds. HKFRS 17 is currently effective from 1 January 2021. However, theHKICPA 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 HKFRS 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.

(c)Foreign currencies

Items included in each of the group’s entities are measured using the currency of the primary economic environment in which the entity
operates (the ‘functional currency’). The group’s consolidated financial statements are presented in Hong Kong dollars.
Transactions in foreign currencies are recorded at the rate of exchange on the date of the transaction. Assets and liabilities denominatedin 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 inother 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 Hong
Kong dollars are translated into the group’s presentation currency at the reporting date. Exchange differences arising are recognised inother comprehensive income. On disposal of a foreign operation, exchange differences previously recognised in other comprehensive
income are reclassified to the income statement.

(d)Presentation of information

Certain disclosures required by HKFRSs have been included in the sections marked as ('Audited') in this Annual Report and Accounts asfollows:• Consolidated income statement and balance sheet data by global business are included in the 'Financial Review' on page 8.
• Disclosures concerning the nature and extent of risks relating to banking and insurance activities are included in the ‘Risk' section on
pages 20 to 43 and pages 46 to 50 as specified as ‘Audited’.
• Capital disclosures are included in the ‘Capital’ section on page 51 as specified as ‘Audited’.
In accordance with the group’s 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 Risk section and the Capital section goes beyond
the minimum levels required by accounting standards, statutory and regulatory requirements. In addition, the group assesses goodpractice recommendations issued from time to time by relevant regulators and standard setters and will assess the applicability andrelevance of such guidance, enhancing disclosures where appropriate.

(e)

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 note 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 bymanagement for the purposes of the Consolidated Financial Statements. Management’s selection of the group’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 ofjudgement and estimation uncertainty involved.

(f)

Segmental analysis

The group’s chief operating decision-maker is the Executive Committee which operates as a general management committee under the
direct authority of the Board and operating segments are reported in a manner consistent with the internal reporting provided to the
Executive Committee.
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.

(g)

Going concern

The Consolidated Financial Satements 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 considereda 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, the group consolidates when it holds, directly or indirectly, the necessary voting rights topass resolutions by the governing body. In all other cases, the assessment of control is more complex and requires judgement of otherfactors, including having exposure to variability of returns, power to direct relevant activities and whether power is held as agent or
principal.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201967

Notes on the Consolidated Financial Statements

Business combinations are accounted for using the acquisition method. The amount of non-controlling interest is measured either at fairvalue or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets. This election is made for eachbusiness combination.
The Bank’s investments in subsidiaries are stated at cost less impairment losses.

Goodwill
Goodwill is allocated to cash-generating units (‘CGU’) for the purpose of impairment testing, which is undertaken at the lowest level atwhich goodwill is monitored for internal management purposes. Impairment testing is performed at least annually, or whenever there isan indication of impairment, by comparing the recoverable amount of a CGU with its carrying amount.

Interests in associates
The group classifies investments in entities over which it has significant influence, and that are neither subsidiaries nor joint
arrangements, as associates.
Investments in associates are recognised using the equity method. The attributable share of the results and reserves of associates areincluded in the consolidated financial statements of the group 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 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 associates is not tested separately for impairment but is assessed as part of thecarrying amount of the investment.

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

Estimates

•

•

(b)

Management’s best estimate of BoCom’s earnings are based on management’s
explicit forecasts over the short to medium term and the capital maintenancecharge which is management’s forecast of the earnings that need to be withheld inorder for BoCom to meet regulatory requirements over the forecast period, both ofwhich are subject to uncertain factors
Key assumptions used in estimating BoCom’s value in use, the sensitivity of thevalue in use calculations to different assumptions and a sensitivity analysis thatshows 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 14

Income and expenses

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 arerecognised in ‘Interest income’ and ‘Interest expense’ in the income statement using the effective interest method. However, as an
exception to this, interest on debt instruments issued by the group for funding purposes that are designated under the fair value option to
reduce accounting mismatch and on derivatives managed in conjunction with those debt instruments is included in interest expense.
Interest on credit impaired financial assets is recognised using the rate of interest used to discount the future cash flows for the purposeof measuring the impairment loss.
Non-interest income and expense
The group generates fee income from services provided at a fixed price over time, such as account service and card fees, or when thegroup 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 bevariable depending on the size of the customer portfolio and the group’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 asignificant financing component.
The group acts as principal in the majority of contracts with customers, with the exception of broking services. For most brokerage trades
the group acts as agent in the transaction and recognises broking income net of fees payable to other parties in the arrangement.
The group recognises fees earned on transaction-based arrangements at a point in time when we have fully provided the service to thecustomer. Where the contract requires services to be provided over time, income is recognised on a systematic basis over the life of theagreement.
Where the group offers a package of services that contains multiple non-distinct performance obligations, such as those included inaccount 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 allocatedto each performance obligation based on the estimated stand-alone selling prices.
Dividend income is recognised when the right to receive payment is established. This is the ex-dividend date for listed equity securities,
and usually the date when shareholders approve the dividend for unlisted equity securities.
Net income/(expense) from financial instruments measured at fair value through profit or loss includes the following:• ‘Net income from financial instruments held for trading or managed on a fair value basis’. This comprises net trading income, which
includes all gains and losses from changes in the fair value of financial assets and financial liabilities held for trading and otherfinancial instruments managed on a fair value basis, together with the related interest income, expense and dividends, excluding theeffect of changes in the credit risk of liabilities managed on a fair value basis. It also includes all gains and losses from changes in thefair value of derivatives that are managed in conjunction with financial assets and liabilities measured at fair value through profit or
loss.
68

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019• ‘Net income/(expense) from assets and liabilities of insurance businesses, including related derivatives, measured at fair value throughprofit or loss’. This includes interest income, interest expense and dividend income in respect of financial assets and liabilities
measured at fair value through profit or loss; and those derivatives managed in conjunction with the above that can be separately
identifiable from other trading derivatives.
• ‘Changes in fair value of designated debt instruments and related derivatives’. Interest paid on debt instruments and interest cash
flows on related derivatives is presented in interest expense where doing so reduces an accounting mismatch.
• ‘Changes in fair value of other financial instruments mandatorily measured at fair value through profit or loss’. This includes interest
on instruments that fail the solely payments of principal and interest ('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 totransfer a liability in an orderly transaction between market participants at the measurement date. The fair value of a financial instrument
on initial recognition is generally its transaction price (that is, the fair value of the consideration given or received). However, if there is adifference 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, the group recognises the difference as a trading gainor 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 thegroup enters into an offsetting transaction.
The fair value of financial instruments is generally measured on an individual basis. However, in cases where the group manages a groupof financial assets and liabilities according to its net market or credit risk exposure, the fair value of the group of financial instruments ismeasured on a net basis but the underlying financial assets and liabilities are presented separately in the Consolidated Financial
Statements, unless they satisfy the HKFRSs 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:
Judgements

Estimates

•

•

•

(d)

An instrument in its entirety is classified as valued using significant unobservable
inputs if, in the opinion of management, a significant proportion of the
instrument’s inception profit or greater than 5% of the instrument’s valuation isdriven by unobservable inputs‘Unobservable’ in this context means that there is little or no current market data
available from which to determine the price at which an arm’s length transaction
would be likely to occur. It generally does not mean that there is no data available
at all upon which to base a determination of fair value (consensus pricing data
may, for example, be used)

Details on the group’s level 3 financial instruments are set out innote 34

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.
The group accounts for regular way amortised cost financial instruments using trade date accounting. The carrying value of thesefinancial 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 andrecognised over the life of the loan through the recognition of interest income.
The group may commit to underwriting loans on fixed contractual terms for specified periods of time. When the loan arising from thelending commitment is expected to be held for trading, the commitment to lend is recorded as a derivative. When the group intends tohold 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 thebalance 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 purchaseand 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 (‘FVOCI’)

Financial assets held for a business model that is achieved by both collecting contractual cash flows and selling and which containcontractual terms that give rise on specified dates to cash flows that are solely payments of principal and interest are measured at FVOCI.
These comprise primarily debt securities. They are recognised on the trade date when the group enters into contractual arrangements topurchase and are normally derecognised when they are either sold or redeemed. They are subsequently remeasured at fair value andchanges therein (except for those relating to impairment, interest income and foreign currency exchange gains and losses) arerecognised in other comprehensive income until the assets are sold. Upon disposal, the cumulative gains or losses in othercomprehensive 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.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201969

Notes on the Consolidated Financial Statements(f)Equity securities measured at fair value with fair value movements presented in OCI

The equity securities for which fair value movements are shown in OCI are business facilitation and other similar investments where thegroup 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. Dividend income 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;• when a group of financial assets and liabilities or a group of financial liabilities is managed and its performance is evaluated on a fairvalue basis, in accordance with a documented risk management or investment strategy; and• where the financial liability contains one or more non-closely related embedded derivatives.
Designated financial assets are recognised when the group 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 the group 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 andliabilities of insurance businesses, including related derivatives, measured at fair value through profit or loss’ except for the effect ofchanges in the liabilities' credit risk which is presented in OCI, unless that treatment would create or enlarge an accounting mismatch inprofit or loss.
Under the above criterion, the main classes of financial instruments designated by the group are:• Debt instruments for funding purposes that are designated to reduce an accounting mismatch.
The interest and/or foreign exchange exposure on certain fixed rate debt securities issued has been matched with the interest and/or
foreign exchange exposure on certain swaps as part of a documented risk management strategy.
• Financial assets and financial liabilities under unit-linked and non-linked investment contracts.
A contract under which the group 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 fairvalue of the assets held in the linked funds. If no fair value designation was made for the related assets, at least some of the assets would
otherwise be measured at either fair value through other comprehensive income or amortised cost. The related financial assets andliabilities are managed and reported to management on a fair value basis. Designation at fair value of the financial assets and related
liabilities allows changes in fair values to be recorded in the income statement and presented in the same line.
• Financial liabilities which contain both deposit and derivative components: These financial liabilities are managed and theirperformance evaluated on a fair value basis.

(h)Derivatives

Derivatives are financial instruments that derive their value from the price of underlying items such as equities, interest rates or otherindices. Derivatives are recognised initially and are subsequently measured at fair value, with changes in fair value generally recorded in
the income statement. 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 the group 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 held for risk management purposes, they are designated in hedge accounting relationships where the required
criteria for documentation and hedge effectiveness are met. The group enters into 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 berecognised 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 arecalculated 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 portionof 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 inwhich the hedged item affects profit or loss. In hedges of forecast transactions that result in recognition of a non-financial asset or
liability, previous gains and losses recognised in other comprehensive income are included in the initial measurement of the asset or
liability. When a hedge relationship is discontinued, or partially discontinued, any cumulative gain or loss recognised in othercomprehensive 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 isimmediately reclassified to the income statement.

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The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

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 notapplied.

(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 repurchaseagreements, other financial assets held at amortised cost, debt instruments measured at FVOCI, and certain loan commitments andfinancial 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 12month ECL is recognised are considered to be ‘stage 1’; financial assets that are considered to have experienced a significant increase incredit risk are in ‘stage 2’; and financial assets for which there is objective evidence of impairment so are considered to be in default orotherwise 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)
The group determines that a financial instrument is credit-impaired and in stage 3 by considering relevant objective evidence, primarily
whether:• contractual payments of either principal or interest are past due for more than 90 days;• there are other indications that the borrower is unlikely to pay such as when a concession has been granted to the borrower for
economic or legal reasons relating to the borrower’s financial condition; and• the loan is otherwise considered to be in default.
If such unlikeliness to pay is not identified at an earlier stage, it is deemed to occur when an exposure is 90 days past due, even where
regulatory rules permit default to be defined based on 180 days past due. Therefore, the definitions of credit-impaired and default arealigned 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 asignificant reduction in the risk of non-payment of future cash flows and retain the designation of renegotiated until maturity orderecognition.
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 the group’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 atmarket rates and no payment-related concession has been provided.

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 byconsidering 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 accountreasonable 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, andthe geographical region. Therefore, it is not possible to provide a single set of criteria that will determine what is considered to be asignificant increase in credit risk and these criteria will differ for different types of lending, particularly between retail and wholesale.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201971

Notes on the Consolidated Financial Statements

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, andincluded 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 andcredit 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 ofsignificance varies depending on the credit quality at origination as follows:
Origination CRR

Significance trigger – PD to increase by

0.1–1.2
2.1–3.3

15bps
30bps

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

Origination CRR

Additional significance criteria – Number of CRR grade notches deterioration
required to identify as significant credit deterioration (stage 2) (> or equal to)

0.1
1.1–4.2
4.3–5.1
5.2–7.1
7.2–8.2
8.3

5 notches
4 notches
3 notches
2 notches
1 notch0 notchFurther information about the 23-grade scale used for CRR can be found on page 23.
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 meetits 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 havebeen 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 instrumentsthat remain in stage 1.

Purchased or originated credit-impaired (‘POCI’)
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 theamount 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 aretransferred 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-paymentof future cash flows, observed over a minimum one-year period and there are no other indicators of impairment. For loans that areassessed for impairment on a portfolio basis, the evidence typically comprises a history of payment performance against the original orrevised terms, as appropriate to the circumstances. For loans that are assessed for impairment on an individual basis, all available
evidence is assessed on a case-by-case basis.

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

72

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019In general, the group 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.
The group leverages the Basel II IRB framework where possible, with recalibration to meet the differing HKFRS 9 requirements as set out
in the following table:
Model

Regulatory capitalPD• Through the cycle (represents long-run average PD throughout a • Point in time (based on current conditions, adjusted to take intofull economic cycle)
account estimates of future conditions that will impact PD)• The definition of default includes a backstop of 90+ days past
• Default backstop of 90+ days past due for all portfolios
due

EAD

• Cannot be lower than current balance• Amortisation captured for term products

LGD• Downturn LGD (consistent losses expected to be sufferedduring a severe but plausible economic downturn)• Regulatory floors may apply to mitigate risk of underestimating
downturn LGD due to lack of historical data
• Discounted using cost of capital• All collection costs included• Expected LGD (based on estimate of loss given default including
the expected impact of future economic conditions such aschanges in value of collateral)• No floors• Discounted using the original effective interest rate of the loan
• Only costs associated with obtaining/selling collateral included• Discounted back from point of default to balance sheet dateOther

HKFRS 9While 12-month PDs are re-calibrated from Basel 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 thatthe 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 tothe economic scenarios applied more generally by the group and the judgement of the credit risk officer in relation to the likelihood of theworkout strategy succeeding or receivership being required. For less significant cases, the effect of different economic scenarios andwork-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 the group 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 the group’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 thegroup 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 theloan 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 isrecognised as a provision.

Forward-looking economic inputs
The group applies multiple forward-looking global economic scenarios determined with reference to external forecast distributions
representative of our view of forecast economic conditions. This approach is considered sufficient to calculate unbiased expected loss inmost economic environments. In certain economic environments, additional analysis may be necessary and may result in additional
scenarios or adjustments, to reflect a range of possible economic outcomes sufficient for an unbiased estimate. The detailed
methodology is disclosed in ‘Measurement uncertainty and sensitivity analysis of ECL estimates’ on page 27.

Critical accounting estimates and judgements
The calculation of the group’s ECL under HKFRS 9 requires the group to make a number of judgements, assumptions and estimates. The most significant
are set out below:
Judgements

•
•
•

•

Estimates

Defining what is considered to be a significant increase in credit risk•
Determining the lifetime and point of initial recognition of overdrafts and credit cards
Selecting and calibrating the PD, LGD and EAD models, which support the calculations,
including making reasonable and supportable judgements about how models react to current
and future economic conditions
Selecting model inputs and economic forecasts, including determining whether sufficientand appropriately weighted economic forecasts are incorporated to calculate unbiased
expected loss

The sections marked as audited on pages 27 to 30,‘Measurement uncertainty and sensitivity analysis of
ECL estimates’ set out the assumptions used indetermining ECL and provide an indication of thesensitivity of the result to the application of different
weightings being applied to different economic
assumptions

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201973

Notes on the Consolidated Financial Statements(j)Insurance contracts

A contract is classified as an insurance contract where the group accepts significant insurance risk from another party by agreeing tocompensate 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, the group issues investment contracts withdiscretionary participation features ('DPF') which are also accounted for as insurance contracts as required by HKFRS 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 areaccounted 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 byreference 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 andmanagement’s expectation of the future performance of the assets backing the contracts, as well as other experience factors such asmortality, 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
HKFRS 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 performanceof the investment portfolio, the corresponding increase in the liabilities is recognised in either the income statement or othercomprehensive income, following the treatment of the unrealised gains on the relevant assets. In the case of net unrealised losses, adeferred participating asset is recognised only to the extent that its recoverability is highly probable. Movements in the liabilities arisingfrom realised gains and losses on relevant assets are recognised in the income statement.

Present value of in-force long-term insurance business
The group recognises the value placed on insurance contracts and investment contracts with DPF, which are classified as long-term andin-force at the balance sheet date, as an asset. The PVIF asset is presented gross of attributable tax in the balance sheet and movementsin the PVIF asset are included in ‘Other operating income’ on a gross of tax basis.

Critical accounting estimates and judgements
The valuation of the PVIF is dependent on economic assumptions (e.g. future investment returns) and non-economic assumptions (e.g. related topolicyholder behaviour or demographics
Judgements•(k)

Estimates

The PVIF asset represents the value of the equity holders’ interest in the issuing insurance•companies’ profits expected to emerge from these contracts written at the balance sheet
date. It 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 offinancial options and guarantees.

The assumptions are reassessed at each reporting
date and changes in the estimates which affect thevalue of PVIF are reflected in the income statement.
More information is included in note 15.

Property

Land and buildings
Land and buildings held for own use are carried at their revalued amount, being the fair value at the date of the revaluation less any
subsequent accumulated depreciation and impairment losses.
Revaluations are performed by professional qualified valuers, on a market basis, with sufficient regularity to ensure that the net carrying
amount does not differ materially from the fair value. Surpluses arising on revaluation are credited firstly to the income statement, to theextent of any deficits arising on revaluation previously charged to the income statement in respect of the same land and buildings, andare thereafter taken to the ‘Property revaluation reserve’. Deficits arising on revaluation are first set off against any previous revaluation
surpluses included in the ‘Property revaluation reserve’ in respect of the same land and buildings, and are thereafter recognised in theincome statement.
Leasehold land and buildings are depreciated over the shorter of the unexpired terms of the leases or the remaining useful lives.

74

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

The Government of Hong Kong owns all the land in Hong Kong and permits its use under leasehold arrangements. Similar arrangements
exist in mainland China. The group accounts for its interests in own use leasehold land and land use rights in accordance with HKFRS 16
but discloses these as owned assets when the right of use are considered sufficient to constitute control.

Investment properties
The group holds certain properties as investments to earn rentals or for capital appreciation, or both, and those investment properties areincluded on balance sheet at fair value with changes in fair value being recognised in the income statement.

(l)

Employee compensation and benefits

Post-employment benefit plans
The group operates a number of pension schemes including defined benefit and 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 mainlycomprises 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 excludinginterest 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 infuture contributions to the plan.

(m)

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 therelated 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 ofprevious years. The group 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 theamounts 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.

(n)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 orconstructive obligation that has arisen as a result of past events and for which a reliable estimate can be made.

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

Estimates•••

Determining whether a present obligation exists. Professional
advice is taken on the assessment of litigation, property(including onerous contracts) and similar obligations.
Provisions for legal proceedings and regulatory matters typicallyrequire a higher degree of judgement than other types ofprovisions. When matters are at an early stage, accounting
judgements can be difficult because of the high degree of
uncertainty associated with determining whether a present
obligation exists, and estimating the probability and amount of
any outflows that may arise. As matters progress, management
and legal advisers evaluate on an ongoing basis whether
provisions should be recognised, revising previous estimates asappropriate. At more advanced stages, it is typically easier tomake estimates around a better defined set of possible
outcomes.

•

Provisions for legal proceedings and regulatory matters remain very sensitive tothe assumptions used in the estimate. There could be a wider range of possible
outcomes for any pending legal proceedings, investigations or inquiries. As aresult, it is often not practicable to quantify a range of possible outcomes forindividual matters. It is also not practicable to meaningfully quantify ranges ofpotential outcomes in aggregate for these types of provisions because of thediverse nature and circumstances of such matters and the wide range of
uncertainties involved.
Provisions for customer remediation also require significant levels of estimation.
The amounts of provisions recognised depend on a number of different
assumptions, such as the volume of inbound complaints, the projected period of
inbound complaint volumes, the decay rate of complaint volumes, thepopulations 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 Consolidated Financial Statements but are disclosed unless theprobability 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, whichis generally the fee received or present value of the fee receivable.
The Bank has issued financial guarantees and similar contracts to other group entities. The group elects to account for certain guarantees
as insurance contracts in the Bank's 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.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201975

Notes on the Consolidated Financial Statements

2

Operating profit(a)

Net interest income

Net interest income includes:

Interest income recognised on impaired financial assets

2019

2018

HK$m

HK$m

309

276

Interest income recognised on financial assets measured at amortised cost

160,387

143,709

Interest income recognised on financial assets measured at FVOCI

30,974

26,412

Interest expense on financial instruments, excluding interest on financial liabilities held for trading or designated or otherwise
mandatorily measured at fair value(56,493)(41,259)(b)

Net fee income

Net fee income by global business
RetailBanking and
WealthManagement

Commercial
BankingGlobalBanking andMarkets

Global Private
Banking

Corporate
Centre1

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Account services

1,281

893

340

23

1

2,538

Funds under management

3,779

646

1,694

1,095

1

7,215

Cards

6,755

1,726

85

—

1

8,567

Credit facilities

223

1,693

1,367

9

1

3,293

Broking income

2,441

43

696

380

—

3,560

Imports/exports

—

2,590

690

—

—

3,280

6,318

158

—

674

—

7,150

Underwriting

2

2

1,557

—

(6)

1,555

Remittances

284

1,945

665

3

(14)

2,883

Global custody

657

51

2,936

98

—

3,742

Insurance agency commission

1,463

131

2

139

—

1,735

Other

1,758

2,145

5,294

761

(2,377)

7,581

Fee income

24,961

12,023

15,3263,182(2,393)53,099Fee expense(6,314)(2,063)(5,349)

(343)

2,475

(11,594)

Year ended 31 Dec 2019

18,647

9,960

9,977

2,839

82

41,505

Account services

1,434

979

337

55

3

2,808

Funds under management

4,122

724

1,749

910

1

7,506

Cards

6,552

1,788

74

—

—

8,414

Credit facilities

242

1,568

1,360

9

1

3,180

Broking income

3,397

73

702

507

—

4,679

Imports/exports

—

2,909

723

—

—

3,632

6,381

172

—

558

(4)

7,107

Underwriting

5

3

1,111

—

(7)

1,112

Remittances

333

2,183

625

3

(6)

3,138

Global custody

713

51

3,025

95

(18)

3,866

Insurance agency commission

1,510

142

4

94

(9)

1,741

Other

1,816

2,020

5,087

719

(2,240)7,402

Fee income

26,505

12,612

14,7972,950(2,279)54,585

Unit trusts

Unit trusts

Fee expense(5,418)(2,014)(5,003)

(300)

2,381

(10,354)

Year ended 31 Dec 201821,087

10,598

9,794

2,650

102

44,231

1

Includes inter-segment elimination.

Net fee income includes:
2019

2018

HK$m

HK$m

Fees earned on financial assets that are not at fair value through profit and loss (other than amounts included in determining theeffective interest rate)

11,400

11,583– fee income

16,324

16,368– fee expense(4,924)(4,785)

Fee earned on trust and other fiduciary activities

9,234

9,653

– fee income

10,421

10,787– fee expense(1,187)(1,134)76

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

(c)Net income from financial instruments measured at fair value through profit or loss
2019

2018

HK$m

HK$m

Net trading activities

42,81332,583

Other instruments managed on a fair value basis(6,425)(513)

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

36,38832,070Financial assets held to meet liabilities under insurance and investment contracts

16,245(6,104)

Liabilities to customers under investment contracts(1,988)543

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

Net income/(expense) arising on:

14,257(5,561)

Changes in fair value of designated debts issued and related derivatives1

(305)

(327)

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

118

(217)

50,45825,965

Year ended 31 Dec

1 The definition has been updated to include debt instruments which are issued for funding purposes and are designated under the fair value option
to reduce an accounting mismatch, previously reported as 'Net trading activities' under 'Net income from financial instruments held for trading
and managed on a fair value basis'. Comparatives have been re-presented to conform to the current year's presentation.

(d)Other operating income
2019

2018

HK$m

HK$m

12,546

4,629

154

639

Losses on disposal of property, plant and equipment and assets held for sale

(2)

(69)

Gains/(losses) on disposal of subsidiaries, associates and business portfolios

(14)

38

Rental income from investment properties

423

416

Movement in present value of in-force insurance business
Gains on investment properties

161

164

Other1

2,490

4,653

Year ended 31 Dec

15,758

10,470

Dividend income

1 In 2019, the group transferred shared services and operations to a separate service company, HSBC Global Services (Hong Kong) Limited('ServCo'), a fellow subsidiary which provides functional support services to the group. As a result of the transfer, costs incurred relating toservices provided to fellow group companies are reflected in the financial statements of ServCo instead of the group, and so are recoveries onthese costs.

There was a loss on disposal of loans and receivables of HK$3m in the year (2018: loss of HK$5m). There were no gains or losses on
disposal of financial liabilities measured at amortised cost in the year (2018: nil).

(e)Change in expected credit losses and other credit impairment charges
2019

2018

HK$m

HK$m

Loans and advances to banks and customers

5,420

4,611

– new allowances net of allowance releases

6,283

5,551

– recoveries of amounts previously written off

(863)

(940)

Loan commitments and guarantees

95

123

Other financial assets

157

(14)

Year ended 31 Dec

5,672

4,720

Change in expected credit losses as a percentage of average gross customer advances was 0.15% for 2019 (2018: 0.13%).

(f)

General and administrative expenses
2019

2018

HK$m

HK$m

3,246

8,208

794

4,134

– other premises and equipment expenses

2,452

4,074

Marketing and advertising expenses

2,815

2,940

Other administrative expenses1

38,70828,841

Year ended 31 Dec

44,76939,989Premises and equipment– rental expenses

1 In 2019, over 8,500 employees performing shared services and operations in Hong Kong were transferred from the group to ServCo as part ofrecovery and resolution planning to provide services to the group. The group recognises management charges for the services provided by
ServCo, which is reported under 'general administrative expenses'. For further details, please refer to note 33 'Related party transactions'.

Included in operating expenses were direct operating expenses of HK$34m (2018: HK$35m) arising from investment properties thatgenerated rental income in the year. Direct operating expenses arising from investment properties that did not generate rental income
amounted to HK$2m (2018: HK$3m).

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201977

Notes on the Consolidated Financial Statements(g)

Depreciation and impairment of property, plant and equipment
2019

2018

HK$m

HK$m

Owned property, plant and equipment

5,620

4,686

Other right-of-use assets1

2,610

N/A

Year ended 31 Dec

8,230

4,686

1 The impact on right-of-use assets has been recognised from 1 January 2019 following the adoption of HKFRS 16. Comparatives have not been
restated.

(h)Auditors’ remuneration

Auditors’ remuneration amounted to HK$125m (2018: HK$125m).

3

Insurance business

Net insurance premium Income
Non-linked
insurance

Unit-linked

Total

HK$m

HK$m

HK$m

Gross insurance premium income

69,7191,381

71,100

Reinsurers’ share of gross insurance premium income(10,798)(27)(10,825)

Year ended 31 Dec 201958,921

1,354

60,275Gross insurance premium income

63,462

1,586

65,048

Reinsurers’ share of gross insurance premium income(4,349)(21)(4,370)Year ended 31 Dec 201859,113

1,565

60,678Non-linked
insurance

Unit-linked

Total

HK$m

HK$m

HK$m

Gross claims and benefits paid and movement in liabilities to policyholders

84,921

5,910

90,831– claims, benefits and surrenders paid

26,9606,095

33,055– movement in liabilities

57,961(185)

57,776

Reinsurers’ share of claims and benefits paid and movement in liabilities(10,677)2(10,675)– claims, benefits and surrenders paid

(2,658)(107)(2,765)– movement in liabilities(8,019)109(7,910)Year ended 31 Dec 201974,244

5,912

80,156Gross claims and benefits paid and movement in liabilities to policyholders

65,002(3,080)61,922– claims, benefits and surrenders paid

27,086

7,598

34,684– movement in liabilities

37,916(10,678)

27,238

Reinsurers’ share of claims and benefits paid and movement in liabilities(4,155)72(4,083)– claims, benefits and surrenders paid

(1,930)(1,394)(3,324)– movement in liabilities(2,225)

1,466

(759)

Year ended 31 Dec 2018

60,847(3,008)57,839Net insurance claims and benefits paid and movement in liabilities to policyholders

78

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Liabilities under insurance contracts
2019

2018

Gross

Reinsurers’
share2Gross

Reinsurers’
share2

Net

HK$m

HK$m

HK$m

Net

HK$m

HK$m

HK$m

433,668(17,758)

N/A

N/A

415,910391,348(15,624)

375,724

N/A

(535)

—

At 1 Jan

433,668(535)(17,758)

415,910

390,813(15,624)

375,189

Claims and benefits paid
Increase/(decrease) in liabilities to policyholders(26,960)

2,658(24,302)(27,086)

1,930(25,156)

84,921(10,677)

74,24465,002(4,155)

Exchange differences and other movements1

60,847

2,552

(470)

2,082

4,939

91

5,030

494,181(26,247)

467,934

433,668(17,758)

415,910Non-linked insurance
At 31 Dec
Impact on transition to HKFRS 9

At 31 Dec
Unit-linked
At 1 Jan

34,921(34)

34,887

46,669(110)

46,559Claims and benefits paid

(6,095)107(5,988)(7,598)1,394(6,204)

Increase/(decrease) in liabilities to policyholders

5,910

2

5,912

(3,080)72(3,008)Exchange differences and other movements1

(157)

(110)

(267)

(1,070)(1,390)(2,460)At 31 Dec

34,579(35)

34,54434,921(34)

34,887

Total liabilities to policyholders

528,760(26,282)

502,478

468,589(17,792)

450,797

1 'Exchange differences and other movements’ includes movements in liabilities arising from net unrealised investment gains recognised in othercomprehensive income.
2 Amounts recoverable from reinsurance of liabilities under insurance contracts are included in the consolidated balance sheet in ‘Prepayment,
accrued income and other assets’.

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, thedeclaration of bonuses and other amounts attributable to policyholders.

4

Employee compensation and benefits
2019

2018

HK$m

HK$m

Wages and salaries1

34,67436,972Social security costs

1,264

1,249

Post-employment benefits

2,110

2,572

– defined contribution pension plans

1,516

1,804

– defined benefit pension plans
Year ended 31 Dec2

594

768

38,04840,793

1 'Wages and salaries’ includes the effect of share-based payments arrangements of HK$882m (2018: HK$968m).
2 In 2019, over 8,500 employees performing shared services and operations in Hong Kong were transferred from the group to ServCo as part ofrecovery and resolution planning to provide services to the group. The group recognises management charges for the services provided by
ServCo, which is reported under 'general administrative expenses'. For further details, please refer to note 33 'Related party transactions'.

Post-employment benefit plans
The group operates a number of post-employment benefit plans for its employees. ‘Pension risk management’ in the Risk section
contains details of the policies and practices associated with these benefit plans. Some of these plans are defined benefit plans, of which
the largest plan is The HSBC Group Hong Kong Local Staff Retirement Benefit Scheme (the 'Principal Plan’).
The group's balance sheet includes the net surplus or deficit, being the difference between the fair value of plan assets and thediscounted value of scheme liabilities at the balance sheet date for each plan. Surpluses are only recognised to the extent that they arerecoverable through reduced contributions in the future or through potential future refunds from the schemes. In assessing whether asurplus is recoverable, the group has considered its current right to obtain a future refund or a reduction in future contributions.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201979

Notes on the Consolidated Financial Statements

Defined benefit pension plans
Net asset/(liability) under defined benefit pension plans
Fair value ofplan assets

Present value of
defined benefit
obligations

Net defined
benefit liability

HK$m

HK$m

HK$m

13,856(17,197)(3,341)Service cost

—

(511)

(511)

– current service cost

—

(511)

(511)

Net interest income/(expense) on the net defined benefit asset/(liability)

206

(274)

(68)

Re-measurement effects recognised in other comprehensive income

927

(682)

245

– return on plan assets (excluding interest income)

927

—

927

—

(682)

(682)
391

At 1 Jan 2019– actuarial losses
Contributions by the group391—

Benefits paid

(1,290)1,376

86

Exchange differences and other movements1(3,788)

4,440

652

At 31 Dec 201910,302(12,848)(2,546)Retirement benefit liabilities recognised on the balance sheet(2,595)Retirement benefit assets recognised on the balance sheet (within ‘Prepayment, accrued income and otherassets’)At 1 Jan 201849
15,167(17,308)(2,141)Service cost

—

(697)

(697)

– current service cost

—

(684)

(684)

– past service cost and gains/(losses) from settlements

—

(13)

(13)

Net interest income/(expense) on the net defined benefit asset/(liability)

289

(338)

(49)

Re-measurement effects recognised in other comprehensive income

(692)

(399)

(1,091)– return on plan assets (excluding interest income)

(692)

—

(692)

—

(399)

(399)

576

—

576

(1,404)

1,471

67

(80)

74

(6)

13,856(17,197)(3,341)– actuarial losses
Contributions by the group
Benefits paid
Exchange differences and other movements1
At 31 Dec 2018
Retirement benefit liabilities recognised on the balance sheet(3,369)Retirement benefit assets recognised on the balance sheet (within ‘Prepayment, accrued income and otherassets’)28

1 Other movements in 2019 included the impact from transfer of employees from the group to HSBC Global Services (Hong Kong) Limited (the'ServCo'), which is a fellow subsidiary of the Group.

Fair value of plan assets by asset classes
At 31 Dec 2019

At 31 Dec 2018

Value

Quoted market
price in active
marketThereof HSBC

Value

Quoted market
price in active
marketThereof HSBC

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Fair value of plan assets

10,302

10,302

177

13,856

13,856454– equities

3,076

3,076

—

3,519

3,519

—

– bonds

6,034

6,034

—

7,380

7,380

—

– other1

1,192

1,192

177

2,957

2,957

454

1 Other mainly consists of alternative investments (previously included within equities and bonds) and cash and cash deposits. Comparatives havebeen re-presented to conform to current year's presentation.

80

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

The Principal Plan
In Hong Kong, the HSBC Group Hong Kong Local Staff Retirement Benefit Scheme (‘LSRBS’), the Principal Plan, covers employees of the
Bank and HSBC Global Services (Hong Kong) Limited (the 'ServCo'), which is a fellow subsidiary of the Group set up in Hong Kong aspart of the recovery and resolution planning to provide functional support services to the group, as well as certain other local employeesof the Group. The Principal Plan comprises a funded defined benefit scheme (which provides a lump sum benefit on retirement and is
now closed to new members) and a defined contribution scheme. The latter was established on 1 January 1999 for new employees, andthe group has been providing defined contribution plans to all new employees. Since the defined benefit scheme of the Principal Plan is a
final salary lump sum scheme, its exposure to longevity risk and interest rate risk is limited compared to a scheme that provides annuity
payments.
The Principal Plan is a funded plan with assets which are held in trust funds separate from the group. The investment strategy of thedefined benefit scheme of the Principal Plan is to hold the majority of assets in fixed income investments, with a smaller portion in
equities. The target asset allocation for the portfolio has been updated in December 2019 to: Fixed income investments 75% and Equity
25% following an update to the investment strategy to de-risk the investment portfolio. Each investment manager has been assigned abenchmark applicable to their respective asset class. The actuarial funding valuation of the Principal Plan is conducted at least on atriennial basis in accordance with the local practice and regulations. The actuarial assumptions used to conduct the actuarial funding
valuation of the Principal Plan vary according to the economic conditions.
The trustee, which is a subsidiary of the Bank, assumes the overall responsibility for the Principal Plan and the group has established amanagement committee and a number of sub-committees to broaden the governance and manage the concomitant issues.
During 2019, over 1,400 employees covered under the defined benefit scheme of the Principal Plan were transferred from the group to
ServCo as part of the recovery and resolution planning. There were no changes to employment terms and conditions or retirement
benefits as a result of these transfers. Both the group and ServCo participate in the Principal Plan that shares risks between the entities
which are under common control of the Group. As agreed between the group and ServCo, the net defined benefit cost of the defined
benefit scheme of the Principal Plan shall be charged separately. Details on the defined benefit scheme of the Principal Plan are disclosed
below.
Net asset/(liability) under the defined benefit scheme of the Principal Plan
Included within HBAP

Fair valueof planassetsPresent
value ofdefinedbenefitobligations

Included within ServCoNet
definedbenefitliability

Fair valueof planassetsPresent
value ofdefinedbenefitobligationsNet
definedbenefitliability

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

8,402

(9,749)(1,347)

478

(618)

(140)

Service cost

—

(194)

(194)

—

(182)

(182)

– current service cost

—

(194)

(194)

—

(182)

(182)

Net interest income/(expense) on the net defined benefit asset/(liability)

68

(80)

(12)

63

(73)

(10)

Re-measurement effects recognised in other comprehensive income

390

(255)

135

416

(168)

248

– return on plan assets (excluding interest income)

390

—

390

416

—

416

—

(255)

(255)

—

(168)

(168)
184

At 1 Jan 2019– actuarial losses
Contributions by the group

198

—

198

184

—

Benefits paid

(637)

637

—

(460)

460

—

Exchange differences and other movements1(3,767)

4,389

622

3,764

(4,379)(615)

At 31 Dec 2019

4,654

(5,252)

(598)

4,445

(4,960)(515)

Retirement benefit liabilities recognised on the balance sheet
At 1 Jan 2018

(598)

(515)

9,094

(10,096)(1,002)

510

(640)

(130)

Service cost

—

(372)

(372)

—

(25)

(25)

– current service cost

—

(372)

(372)

—

(25)

(25)

Net interest income/ (expense) on the net defined benefit asset/(liability)

153

(167)

(14)

9

(11)

(2)

Re-measurement effects recognised in other comprehensive income

(386)

70

(316)

(22)

17

(5)

– return on plan assets (excluding interest income)

(386)

—

(386)

(22)

—

(22)

– actuarial gains

—

70

70

—

17

17

Contributions by the group

373

—

373

23

—

23

Benefits paid

(832)

832

—

(42)

42

—

—

(16)

(16)

—

(1)

(1)

8,402

(9,749)(1,347)

478

(618)

(140)

Exchange differences and other movements
At 31 Dec 2018
Retirement benefit liabilities recognised on the balance sheet(1,347)(140)

1 Other movements in 2019 included the impact from transfer of employees from the group to ServCo.

The group expects to make HK$402m of contributions to the defined benefit scheme of the Principal Plan during 2020, which isdetermined separately for the group and ServCo by reference to the actuarial funding valuation carried out by the Principal Plan's local
actuary.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201981

Notes on the Consolidated Financial Statements

Benefits expected to be paid from the defined benefit scheme of the Principal Plan over each of the next five years, and in aggregate forthe five years thereafter, are as follows:
Benefits expected to be paid from the defined benefit scheme of the Principal Plan1
2020

2021

2022

2023

2024

2025-2029

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

– HBAP

377

650

545

507

438

1,926

– ServCo

332

475

546

366

411

1,987

As reported by:

1 The duration of the defined benefit obligation is seven years for the Principal Plan under the disclosure assumptions adopted (2018: seven years).

Fair value of plan assets of the defined benefit scheme of the Principal Plan by asset classes
At 31 Dec 2019

At 31 Dec 2018

Value

Quoted market
price in active
marketThereof HSBC

Value

Quoted market
price in active
marketThereof HSBC

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Fair value of plan assets

9,099

9,099

66

8,880

8,880

348

– equities

2,228

2,228

—

2,234

2,234

—

– bonds

5,433

5,433

—

4,228

4,228

—

– other1

1,438

1,438

66

2,418

2,418

348

1 Other mainly consists of alternative investments and cash and cash deposits.

The Principal Plan’s key actuarial financial assumptions
The group determines the discount rate to be applied to the defined benefit scheme's obligations in consultation with the Principal
Plan’s local actuary, on the basis of the current average yields of Hong Kong Government bonds and Hong Kong Exchange Fund Notes,
with maturities consistent with that of the defined benefit obligations.
The key actuarial assumptions used to calculate the group’s obligations for the defined benefit scheme of the Principal Plan for the year,
and used as the basis for measuring the expenses were as follows:
Key actuarial assumptions for the defined benefit scheme of the Principal Plan
Discount rate

Rate of pay
increase% p.a.

% p.a.

At 31 Dec 2019

1.75

3.00

HKLT 20181

At 31 Dec 2018

1.95

3.00

HKLT 20172

Mortality table

1 HKLT 2018 – Hong Kong Life Tables 2018.
2 HKLT 2017 – Hong Kong Life Tables 2017.

Actuarial assumption sensitivities
The discount rate and rate of pay increase are sensitive to changes in market conditions arising during the reporting period. The
following table shows the financial impact of assumption changes on the defined benefit scheme of the Principal Plan at year end:
The effect of changes in key assumptions on the defined benefit scheme of the Principal Plan
Impact on HSBC Group Hong Kong Local Staff Retirement Benefit
Scheme obligation
Financial impact of increase

Financial impact of decrease

2019

2018

2019

2018

HK$m

HK$m

HK$m

HK$m

Discount rate – increase/decrease of 0.25%

(173)

(179)

178

185

Pay – increase/decrease of 0.25%

183

189

(178)

(184)

Directors’ emoluments
The aggregate emoluments of the Directors of the Bank disclosed pursuant to section 4 of the Companies (Disclosure of Information
about Benefits of Directors) Regulation were HK$110m (2018: HK$115m). This comprises fees of HK$11m (2018: HK$10m) and other
emoluments of HK$99m (2018: HK$105m) which includes contributions to pension schemes of HK$1m (2018: HK$1m). Non-cash
benefits which are included in other emoluments mainly relate to share-based payment awards, and the provision of housing andfurnishing. Details on loans to directors are set out in note 33.

82

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

5

Tax

The Bank and its subsidiaries in Hong Kong have provided for Hong Kong profits tax at the rate of 16.5% (2018: 16.5%) on the profits forthe year assessable in Hong Kong. Overseas branches and subsidiaries have similarly provided for tax in the countries in which they
operate at the appropriate rates of tax in force in 2019. Deferred taxation is provided for in accordance with the group’s accounting policy
in note 1.2(m).
Tax expense
2019

2018

HK$m

HK$m

Current tax

19,461

20,413– Hong Kong taxation – on current year profit

11,05812,155– Hong Kong taxation – adjustments in respect of prior years– overseas taxation – on current year profit

(7)

(11)

8,813

8,471

– overseas taxation – adjustments in respect of prior years

(403)

(202)

Deferred tax

1,932

2,054

– origination and reversal of temporary differences

1,975

1,938

– effect of changes in tax rates—

62– adjustments in respect of prior years

(43)

54

21,393

22,467

Year ended 31 Dec

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 applicable tax
rates in the countries concerned as follows:
Reconciliation between taxation charge and accounting profit at applicable tax rates
2019

2018

HK$m

HK$m

Profit before tax

136,433

134,583

Notional tax on profit before tax, calculated at the rates applicable to profits in the countries concerned

25,85525,232

Effects of profits in associates and joint ventures(2,676)(2,683)

Non-taxable income and gains(3,969)(3,412)

Local taxes and overseas withholding taxes

2,503

1,470

Permanent disallowables

606

1,132

Others(926)

728

21,393

22,467

Year ended 31 Dec

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201983

Notes on the Consolidated Financial Statements

Movements of deferred tax assets and liabilities

At 31 Dec 2018
Impact on transition to HKFRS 16
At 1 Jan 2019
Exchange and other adjustments
Charge/(credit) to income statement
Charge/(credit) to other comprehensive
incomeAt 31 Dec 2019

Expenseprovisions

Impairment
allowance on
financial
instruments

Revaluationof properties

Other

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

(472)

(8,057)

1,419

1,314

(13,673)(2,729)(22,198)

—

—

—

—

(2,664)—(2,664)(472)(8,057)

1,419

1,314

(16,337)(2,729)(24,862)

Accelerated
capitalallowances

Insurancebusiness

HK$m

(1)

—

7

(107)

25

118

42

324

(2,083)

(138)

271

603

(909)

(1,932)

—

—

2

—

(753)

(207)

(958)

(149)

(10,140)

1,290

1,478

(16,462)(3,727)(27,710)

Assets1

183

—

1,290

1,478

—

2,280

5,231

Liabilities1(332)(10,140)——(16,462)(6,007)(32,941)

At 31 Dec 2017

(658)

(7,417)

1,296

491

(13,667)(2,281)(22,236)

(2)

103

(2)

873

—

1,321

2,293

(660)

(7,314)

1,294

1,364

(13,667)(960)(19,943)

Impact on transition to HKFRS 9
At 1 Jan 2018
Exchange and other adjustments
Charge/(credit) to income statement
Charge/(credit) to other comprehensive
incomeAt 31 Dec 2018

3

27

(60)

117

1,484

51

1,622

185

(770)

185

(167)

310

(1,797)(2,054)

—

—

—

—

(1,800)(23)(1,823)(472)(8,057)

1,419

1,314

(13,673)(2,729)(22,198)

Assets1

111

—

1,419

1,314

—

1,870

4,714

Liabilities1(583)(8,057)——(13,673)(4,599)(26,912)

1 After netting off balances within countries, the balances as disclosed in the Consolidated Financial Statements are as follows: deferred tax assets
HK$2,179m (2018: HK$2,315m); and deferred tax liabilities HK$29,889m (2018: HK$24,513m).

The amount of unused tax losses for which no deferred tax asset is recognised in the balance sheet is HK$3,497m (2018: HK$3,626m). Of
this amount, HK$1,939m (2018: HK$1,950m) has no expiry date and the remaining will expire within 10 years.
Deferred tax of HK$3,197m (2018: HK$2,261m) has been provided in respect of distributable reserves or post-acquisition reserves ofassociates that, on distribution or sale, would attract withholding tax.
Deferred tax is not recognised in respect of the group‘s investments in subsidiaries and branches where remittance or other realisation is
not probable, and for those associates and interests in joint ventures where it has been determined that no additional tax will arise.

6

Dividends

Dividends to shareholders of the parent company
2019

2018

HK$ per share

HK$m

HK$ per share

HK$m

0.47

21,9580.36

16,559– first interim dividend paid

0.32

14,9630.22

10,000– second interim dividend paid

0.32

14,9630.22

10,000– third interim dividend paid

0.32

14,9630.22

10,000

Total

1.43

66,8471.02

46,559Dividends paid on ordinary shares
In respect of previous year:– fourth interim dividend
In respect of current year:

Distributions on other equity instruments

1,522

881

Dividends to shareholders

68,36947,440The Directors have declared a fourth interim dividend in respect of the financial year ended 31 December 2019 of HK$0.58 per ordinary
share (HK$27,026m) (2018: HK$0.47 per ordinary share (HK$21,958m)).
Total coupons on capital securities classified as equity
2019
HK$m

2018
HK$m

US$1,900m Floating rate perpetual subordinated loans (interest rate at one year US dollar LIBOR plus 3.84%)1

497

881

US$1,400m Floating rate perpetual subordinated loans (interest rate at three months US dollar LIBOR plus 3.51%)1

373—

US$600m

Floating rate perpetual subordinated loan (interest rate at three months US dollar LIBOR plus 3.62%)1

178—

US$700m

Floating rate perpetual subordinated loan (interest rate at three months US dollar LIBOR plus 4.98%)1

214—

US$900m

Fixed rate perpetual subordinated loan (interest rate fixed at 6.51%)2

150—

US$900m

Fixed rate perpetual subordinated loan (interest rate fixed at 6.03%)2

110

—

1,522

881

Total

1
2

84

These subordinated loans were early repaid in the first half of 2019 and distributions were made on repayment.
These subordinated loans were issued in May and June 2019.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

7

Trading assets
2019

2018

HK$m

HK$m

Treasury and other eligible bills

131,967

140,050

Debt securities

281,555

283,506

Equity securities

177,463

119,475

Other1

31,77615,807

At 31 Dec

622,761

558,838

1 'Other' includes reverse repos, stock borrowing and other accounts with banks and customers.

8

Derivatives

Notional contract amounts and fair values of derivatives by product contract type
Notional contract amount

Fair value – Assets

Fair value – Liabilities

Trading

Hedging

Trading

Hedging

Total

Trading

Hedging

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Foreign Exchange

20,494,866

75,324150,019800

150,819

164,831279

165,110

Interest rate

30,656,367

342,609236,110

3,436

239,546

226,951

3,495

230,446

Equity657,760—

13,666—

13,666

17,751—

17,751Credit664,590

—

6,500

—

6,500

7,170

—

7,170

Commodity and other

140,553

—

2,983

—

2,983

4,626

—

4,626

52,614,136

417,933

409,278

4,236

413,514421,3293,774

425,103

Gross total
Offset(132,872)(132,872)

At 31 Dec 2019280,642

292,231

Foreign Exchange

21,492,856

91,274

187,746909

188,655

186,776

1,529

188,305

Interest rate

32,926,700

365,130

196,720

2,924

199,644

197,904

2,790

200,694

Equity574,411—

17,302—

17,302

18,619—18,619Credit926,082

—

5,967

—

5,967

5,904

—

5,904

Commodity and other112,386

—

1,710

—

1,710

2,440

—

2,440

56,032,435

456,404

409,445

3,833

413,278

411,6434,319

415,962

Gross total
Offset(120,409)(120,409)

At 31 Dec 2018292,869

295,553

Use of derivatives
The group transacts derivatives for three primary purposes: to create risk management solutions for clients, to manage the portfolio risk
arising from client business, and to manage and hedge the group’s own risks. Derivatives (except for derivatives which are designated as
effective hedging instruments) are held for trading. Within the held for trading classification are two types of derivative instruments:
those used in sales and trading activities, and those used for risk management purposes but which for various reasons do not meet thequalifying criteria for hedge accounting. The second category includes derivatives managed in conjunction with financial instruments
designated at fair value. These activities are described more fully below.
The group’s derivative activities give rise to significant open positions in portfolios of derivatives. These positions are managed constantly
to ensure that they remain within acceptable risk levels. When entering into derivative transactions, the group employs the same credit
risk management framework to assess and approve potential credit exposures that it uses for traditional lending.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201985

Notes on the Consolidated Financial Statements

Trading derivatives
Most of the group’s derivative transactions relate to sales and trading activities. Sales activities include the structuring and marketing ofderivative 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 ofgenerating revenues based on spread and volume. Risk management activity is undertaken to manage the risk arising from clienttransactions, with the principal purpose of retaining client margin. Other derivatives classified as held for trading include non-qualifying
hedging derivatives.

Derivatives valued using models with unobservable inputs
Any initial gain or loss on financial instruments where the valuation is dependent on unobservable parameters is deferred over the life of
the contract or until the instrument is redeemed, transferred or sold or the fair value becomes observable. All derivatives that are part ofqualifying hedging relationships have valuations based on observable market parameters.
The aggregate unobservable inception profit yet to be recognised in the income statement is immaterial.

Hedge accounting derivatives
The group applies hedge accounting to manage the following risks: interest rate, foreign exchange and net investment in foreign
operations. The group uses derivatives (principally interest rate and currency swaps) for hedging purposes in the management of its own
asset and liability portfolios and structural positions. This enables the group to optimise the overall costs to the group of accessing debt
capital markets, and to mitigate the market risk which would otherwise arise from structural imbalances in the maturity and other profilesof its assets and liabilities. The accounting treatment of hedging transactions varies according to the nature of the instrument hedged
and the type of hedging transaction. Derivatives may qualify as hedges for accounting purposes if they are fair value hedges, cash flow
hedges, or hedges of net investments in foreign operations.

Fair value hedges
The group enters into to fixed-for-floating-interest-rate swaps to manage the exposure to changes in fair value due to movements inmarket interest rates on certain fixed rate financial instruments which are not measured at fair value through profit or loss, including debt
securities held and issued.
Sources of hedge ineffectiveness may arise from basis risk including but not limited to the discount rates used for calculating the fairvalue 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, the group manages interest rate risk in a dynamic risk management strategy. The assets in scope of thisstrategy are high quality fixed-rate debt securities, which may be sold to meet liquidity and funding requirements.
The interest rate risk of the group's fixed rate debt securities issued is managed in a non-dynamic risk management strategy.

Cash flow hedges
The group’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.
The group applies macro cash flow hedging for interest-rate risk exposures on portfolios of replenishing current and forecasted issuancesof 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 thebasis 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 andineffectiveness. Macro cash flow hedges are considered to be dynamic hedges.
The group also hedges the variability in future cash-flows on foreign-denominated financial assets and liabilities arising due to changes inforeign exchange market rates with cross-currency swaps; these are considered non-dynamic hedges.

Interest rate benchmark reform: Amendments to HKFRS 9 and HKAS 39 ‘Financial Instruments’
Following the request received by the Financial Stability Board from the G20, a fundamental review and reform of the major interest ratebenchmarks is under way across the world's largest financial markets. This reform was not contemplated when HKAS 39 was published,
and consequently, the International Accounting Standards Board has published a set of temporary exceptions from applying specifichedge accounting requirements to provide clarification on how the standard should be applied in these circumstances.
Amendments to HKFRS 9 and HKAS 39 were issued in November 2019 and modify specific hedge accounting requirements. Under these
temporary exceptions, Inter-Bank Offered Rates (‘IBORs’) are assumed to continue unaltered for the purposes of hedge accounting until
such time as the uncertainty is resolved.
The application of this set of temporary exceptions is mandatory for accounting periods starting on or after 1 January 2020, but early
adoption is permitted and the group has elected to apply these exceptions for the year ended 31 December 2019. Significant judgement
will be required in determining when uncertainty is expected to be resolved and therefore when the temporary exceptions will cease to
apply. However, at 31 December 2019, the uncertainty continued to exist and so the temporary exceptions apply to all of the group’s
hedge accounting relationships that reference benchmarks subject to reform or replacement.
The group has cash flow and fair value hedge accounting relationships that are exposed to different IBORs, predominantly US dollar
Libor. Derivatives, loans, bonds, and other financial instruments designated in relationships referencing these benchmarks will transition
to new risk-free rates (‘RFRs’) in different ways and at different times. External progress on the transition to RFRs is being monitored,with the objective of ensuring a smooth transition for the group’s hedge accounting relationships. The specific issues arising will varywith the details of each hedging relationship, but may arise due to the transition of existing products included in the designation, achange in expected volumes of products to be issued, a change in contractual terms of new products issued, or a combination of thesefactors. Some hedges may need to be de-designated and new relationships entered into, while others may survive the market-wide
benchmarks reform.

86

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

The hedge accounting relationships that are affected by the adoption of the temporary exceptions hedge items presented in the balance
sheet as 'Financial investments', 'Loans and advances to customers', 'Debt securities in issue', and 'Deposits by banks'.
At 31 December 2019, HK$252,443 million of the notional amounts of interest rate derivatives designated in hedge accounting
relationships represent the extent of the risk exposure managed by the group that is directly affected by market-wide benchmarks reform
and impacted by the temporary exceptions. The group has also designated hedge accounting relationships which involve cross currency
swaps, although the amount is not significant.
The notional contract amounts of interest rate 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.
Risks and governance regarding the impact of the market-wide benchmarks reform is set out in the Risk section of the Annual Report andAccounts 2019.

9

Financial assets designated and otherwise mandatorily measured at fair value through profit
or loss
2019

2018

Designated atfair value

Mandatorily
measured atfair value

Total

HK$m

HK$m

HK$m

Treasury and other eligible bills

Designated atfair value

Mandatorily
measured atfair value

Total

HK$m

HK$m

HK$m

—

234

234

107

220

327

Debt securities

13,350

6,733

20,083

13,3806,134

19,514Equity securities—

120,047

120,047—

99,836

99,836

Other1—

13,147

13,147—

13,182

13,182

13,350140,161

153,511

13,487

119,372

132,859

At 31 Dec

1 ‘Other’ primarily includes loans and advance to banks and customers.

10

Loans and advances to customers

Gross loans and advances to customers
Expected credit loss allowances
At 31 Dec

2019

2018

HK$m

HK$m

3,738,269

3,545,258(17,394)(16,556)

3,720,875

3,528,702

The following table provides an analysis of gross loans and advances to customers by industry sector based on the Statistical
Classification of economic activities in the European Community (‘NACE’).
Analysis of gross loans and advances to customers
2019

2018

HK$m

HK$m

Residential mortgages

1,027,087

937,666

Credit card advances

94,582

93,200

Other personal

281,087

236,133

Total personal

1,402,756

1,266,999

Real estate

666,380

626,120

Wholesale and retail trade418,669

433,734

Manufacturing

418,822424,813

Transportation and storage

86,912

95,773

Other494,416

484,186

2,085,199

2,064,626

Total corporate and commercial
Non-bank financial institutions

250,314

213,633

3,738,269

3,545,258

Hong Kong

2,399,867

2,282,909

Rest of Asia Pacific

1,338,402

1,262,349

At 31 Dec
By geography1

1 The geographical information shown above is classified by the location of the principal operations of the subsidiary or the branch responsible foradvancing the funds.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201987

Notes on the Consolidated Financial Statements

Finance lease receivables and hire purchase contracts
The group leases a variety of assets to third parties under finance leases. At the end of lease terms, assets may be sold to third parties orleased for further terms. Rentals are calculated to recover the cost of assets less their residual value, and earn finance income. Loans andadvances to customers include receivables under finance leases and hire purchase contracts having the characteristics of finance leases.
Net investment in finance leases and hire purchase contracts
2019

2018

Total future
minimum
payments

Unearnedfinance
incomePresent value

Total future
minimum
payments

Unearnedfinance
income

HK$m

HK$m

Present value

HK$m

HK$m

HK$m

HK$m

3,214
N/A

(639)

2,575

2,990

(640)

2,350

N/A

N/A

8,622

(2,097)– one to two years

6,525

2,955

(572)

2,383

N/A

N/A

N/A

– two to three years

2,593

(529)

2,064

N/A

N/A

N/A

– three to four years

2,204

(496)

1,708

N/A

N/A

N/A

– four to five years

1,936

(464)

1,472

N/A

N/A

N/A

– after five years

23,195(3,567)

19,62823,346(3,819)19,52736,097(6,267)

29,83034,958(6,556)28,402

Amounts receivable– within one year
– after one year but within five years

Expected credit loss allowances
At 31 Dec

11

(175)

(117)

29,65528,285

Financial investments

Financial investments measured at fair value through other comprehensive income

2019

2018

HK$m

HK$m

1,465,998

1,503,625– treasury and other eligible bills

606,738

660,871– debt securities

850,623

836,896– equity securities

8,637

5,858

434,300

367,401

Debt instruments measured at amortised cost– treasury and other eligible bills– debt securities
At 31 Dec

5,049

3,624

429,251

363,777

1,900,298

1,871,026

Equity instruments measured at fair value through other comprehensive income
2019

2018

Fair value

Dividends
recognised

Fair value

Dividends
recognised

Type of equity instruments

HK$m

HK$m

HK$m

HK$m

Business facilitation

7,906

141

5,137

155

Investments required by central institutions

376

7

356

3

Others

355

5

365

5

8,637

153

5,858

163

At 31 Dec

88

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

12

Assets pledged, assets transferred and collateral received

Assets pledged
Financial assets pledged to secure liabilities

Treasury bills and other eligible securities
Loans and advances to banks

2019

2018

HK$m

HK$m

88,36566,706228

893

Loans and advances to customers

12,806

15,813

Debt securities

76,01965,784Equity securities

11,648

3,894

Other

52,47342,598Assets pledged at 31 Dec

241,539

195,688

Amount of liabilities secured

208,436

162,036

The table above shows assets where a charge has been granted to secure liabilities on a legal and contractual basis. These transactions
are conducted under terms that are usual and customary to collateralised transactions including sale and repurchase agreements,
securities lending, derivative margining, and include assets pledged to cover short positions and to facilitate settlement processes withclearing houses.
Hong Kong currency notes in circulation are secured by the deposit of funds in respect of which the Hong Kong Government certificatesof indebtedness are held.
Financial assets pledged as collateral which the counterparty has the right to sell or repledge was HK$63,194m (2018: HK$54,953m).

Assets transferred
Transferred financial assets not qualifying for full derecognition and associated financial liabilities
2019

2018

Carrying amount of:Carrying amount of:TransferredassetsRepurchase agreements
Securities lending agreements

Associatedliabilities

Transferredassets

Associatedliabilities

HK$m

HK$m

HK$m

HK$m

98,92994,29670,492

59,11815,270

114

6,702

870

114,199

94,41077,19459,988The financial assets shown above include amounts transferred to third parties that do not qualify for derecognition, notably debt
securities held by counterparties as collateral under repurchase agreements and equity securities lent under securities lending
agreements. As the substance of these transactions is secured borrowings, the collateral assets continue to be recognised in full and therelated liabilities, reflecting the group’s obligation to repurchase the transferred assets for a fixed price at a future date, are also
recognised on the balance sheet. As a result of these transactions, the group is unable to use, sell or pledge the transferred assets for theduration of the transactions. The group remains exposed to interest rate risk, credit risk and market risk on these pledged instruments.
The counterparty’s recourse is not limited to the transferred assets.

Collateral received
Assets accepted as collateral relate primarily to standard securities lending, reverse repurchase agreements and derivative margining.
These transactions are conducted under terms that are usual and customary to standard securities lending, reverse repurchaseagreements and derivative margining.
Fair value of collateral accepted as security for assets
2019

2018

HK$m

HK$m

Fair value of collateral permitted to sell or repledge in the absence of default

556,634

512,242Fair value of collateral actually sold or repledged

95,154

112,832

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201989

Notes on the Consolidated Financial Statements

13

Investments in subsidiaries

Main subsidiaries of the Bank

Hang Seng Bank Limited

Place of incorporation

Principal activity

The group’s interest inissued share capital/
registered or charter capitalHong Kong

Banking

62.14%

People's Republic of China

Banking

100%

HSBC Bank Malaysia Berhad

Malaysia

Banking

100%

HSBC Bank Australia Limited1

Australia

Banking

100%

HSBC Bank (Taiwan) Limited1

TaiwanBanking

100%

Singapore

Banking

100%

BermudaRetirement benefits andlife insurance

100%

HSBC Bank (China) Company Limited

HSBC Bank (Singapore) Limited
HSBC Life (International) Limited1

1 Held indirectly.

All the above subsidiaries are included in the group’s consolidated financial statements. All these subsidiaries make their financial
statements up to 31 December.
The principal places of business are the same as the places of incorporation except for HSBC Life (International) Limited which operates
mainly in Hong Kong.
The proportion of voting rights held is the same as the proportion of ownership interest held.
The main subsidiaries are regulated banking and insurance entities in the Asia-Pacific region and, as such, are required to maintaincertain minimum levels of capital and liquid assets to support their operations. The effect of these regulatory requirements is to limit theextent to which the subsidiaries may transfer funds to the Bank in the form of repayment of shareholder loans or cash dividends.
Subsidiary with significant non-controlling interest
2019

2018

37.86%

37.86%HK$m

HK$m

Hang Seng Bank Limited
Proportion of ownership interests and voting rights held by non-controlling interests
Profit attributable to non-controlling interests

9,386

9,144

Accumulated non-controlling interests of the subsidiary

63,36358,750

Dividends paid to non-controlling interests

5,646

5,066

– total assets

1,676,721

1,571,297– total liabilities

1,497,804

1,409,190– net operating income before change in expected credit losses and other credit impairment charges

43,54941,493– profit for the year

24,822

24,188– other comprehensive income for the year

2,376

400

– total comprehensive income for the year

27,19824,588

Summarised financial information (before intra-group eliminations):

14

Interests in associates and joint ventures

Associates

Share of net assets
Goodwill

2019

2018

HK$m

HK$m

148,154

139,052

3,787

3,857

Impairment

(24)

(24)

At 31 Dec

151,917

142,885

The above balance represented the group’s interests in associates.

Principal associate
Place of incorporation

Bank of Communications Co., Limited

People’s Republic of China

The group’s interest in issued sharecapital19.03%

Bank of Communications Co., Ltd. is listed on recognised stock exchanges. The fair value represents valuation based on the quoted
market price of the shares held (Level 1 in the fair value hierarchy) and amounted to HK$78,311m at 31 December 2019(2018: HK$86,086m).

90

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Bank of Communications Co., Limited (‘BoCom’)
The group’s investment in BoCom is classified as an associate. Significant influence in BoCom was established via representation on
BoCom’s Board of Directors and participation in a Technical Cooperation and Exchange Programme (‘TCEP’). Under the TCEP, a numberof HSBC staff have been seconded to assist in the maintenance of BoCom’s financial and operating policies. Investments in associates
are recognised using the equity method of accounting in accordance with HKAS 28 whereby the investment is initially recognised at costand adjusted thereafter for the post-acquisition change in the group’s share of BoCom’s net assets. An impairment test is required if
there is any indication of impairment.

Impairment testing
At 31 December 2019, the fair value of the group’s investment in BoCom had been below the carrying amount for approximately
eight years. As a result, the group performed an impairment test on the carrying amount, which confirmed that there was no impairment
at 31 December 2019 as the recoverable amount as determined by a value-in-use (‘VIU’) calculation was higher than the carrying value.
At
31 Dec 2019BoCom

31 Dec 2018

VIU

Carrying
value

Fair
value

VIU

Carrying
value

Fair
value

HK$bn

HK$bn

HK$bn

HK$bn

HK$bn

HK$bn

167.8

148.4

78.3

141.3

139.6

86.1

In future periods, the VIU may increase or decrease depending on the effect of changes to model inputs. The main model inputs aredescribed below and are based on factors observed at period-end. The factors that could result in a change in the VIU and an impairment
include a short-term under-performance by BoCom, a change in regulatory capital requirements, or an increase in uncertainty regarding
the future performance of BoCom resulting in a downgrade of the future asset growth or profitability. An increase in the discount rate asa result of an increase in the risk premium or risk-free rates could also result in a reduction of VIU and an impairment. At the point where
the carrying value exceeds the VIU, impairment would be recognised.
If the group did not have significant influence in BoCom, the investment would be carried at fair value rather than the current carrying
value.

Basis of recoverable amountThe impairment test was performed by comparing the recoverable amount of BoCom, determined by a VIU calculation, with its carrying
amount. The VIU calculation uses discounted cash flow projections based on management’s best estimates of future earnings available
to ordinary shareholders prepared in accordance with HKAS 36. Significant management judgement is required in arriving at the best
estimate. There are two main components to the VIU calculation. The first component is management’s best estimate of BoCom’s
earnings which is based on explicit forecasts over the short to medium term. This results in forecast earnings growth that is lower thanrecent historical actual growth and also reflects the uncertainty arising from the current economic outlook. Earnings beyond the short tomedium term are then extrapolated in perpetuity using a long-term growth rate to derive a terminal value, which comprises the majorityof the VIU. The second component is the capital maintenance charge (‘CMC’) which is management’s forecast of the earnings that need
to be withheld in order for BoCom to meet regulatory capital requirements over the forecast period (i.e. CMC is deducted when arriving at
management’s estimate of future earnings available to ordinary shareholders). The principal inputs to the CMC calculation include
estimates of asset growth, the ratio of risk-weighted assets to total assets, and the expected minimum regulatory capital requirements.
An increase in the CMC as a result of a change to these principal inputs would reduce VIU. Additionally, management considers otherfactors (including qualitative factors) to ensure that the inputs to the VIU calculation remain appropriate.

Key assumptions in value-in-use calculation
We used a number of assumptions in our VIU calculation, in accordance with the requirements of HKAS 36:• Long-term profit growth rate: 3% (2018: 3%) for periods after 2023, which does not exceed forecast GDP growth in mainland China
and is consistent with forecasts by external analysts.
• Long-term asset growth rate: 3% (2018: 3%) for periods after 2023, which is the rate that assets are expected to grow to achieve longterm profit growth of 3%.
• Discount rate: 11.24% (2018: 11.82%) which is based on a Capital Asset Pricing Model (‘CAPM’) calculation for BoCom, using market
data. Management also compares the rate derived from the CAPM with discount rates from external sources. The discount rate used
is within the range of 10.0% to 15.0% (2018: 10.4% to 15.0%) indicated by external sources.
• Expected credit losses as a percentage of customer advances: 0.95% (2018: ranges from 0.73% to 0.79%) in the short to medium
term and reflect increases due to the US-China trade tensions and BoCom's actual results. For periods after 2023, the ratio is 0.76%(2018: 0.70%). This ratio was increased to provide greater weighting to the most recent data points and analyst forecasts.
• Risk-weighted assets as a percentage of total assets: 61% (2018: 62%) for all forecast periods. This is consistent with BoCom’s actual
results and slightly higher than the forecasts disclosed by external analysts.
• Cost–income ratio: ranges from 37.1% to 38.8% (2018: 38.7% to 39.0%) in the short to medium term. This is slightly above BoCom's
actual results in recent years and within the range of forecasts disclosed by external analysts.
• Effective tax rate: ranges from 12.0% to 17.0% (2018: 13.8% to 22.3%) in the short to medium term reflecting BoCom's actual results
and an expected increase towards the long-term assumption. For periods after 2023, the rate is 22.5% (2018: 22.5%) which is slightly
higher than the historical average.
• Capital requirements: Capital adequacy ratio: 11.5% (2018: 11.5%) and Tier 1 capital adequacy ratio: 9.5% (2018: 9.5%), based on theminimum regulatory requirements.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201991

Notes on the Consolidated Financial Statements

The following table shows the change to each key assumption in the VIU calculation that on its own would reduce the headroom to nil:
Key assumption

Changes to key assumption to reduce headroom to nil

•
•
•
•
•
•
•
•
•

•
•
•
•
•
•
•
•
•

Long-term profit growth rateLong-term asset growth rate
Discount rate
Expected credit losses as a percentage of customer advances
Risk-weighted assets as a percentage of total assets
Cost-income ratio
Long-term effective tax rate
Capital requirements – capital adequacy ratio
Capital requirements – tier 1 capital adequacy ratio

Decrease by 96 basis points
Increase by 78 basis points
Increase by 118 basis points
Increase by 15 basis points
Increase by 607 basis points
Increase by 363 basis points
Increase by 875 basis points
Increase by 114 basis points
Increase by 187 basis points

The following table further illustrates the impact on VIU of reasonably possible changes to key assumptions. This reflects the sensitivityof the VIU to each key assumption on its own and it is possible that more than one favourable and/or unfavourable change may occur atthe same time. The selected rates of reasonably possible changes to key assumptions are largely based on external analysts’ forecasts
which can change period to period.
Favourable changebps

Unfavourable change

Increase in
VIU

VIU

HK$bn

HK$bn

Decrease in
VIU

VIU

bps

HK$bn

HK$bn

At 31 December 2019
Long-term profit growth rate

—

—

167.8

-50

(10.6)

157.2

Long-term asset growth rate

-50

10.6

178.4

—

—

167.8

Discount rate

-54

10.9

178.7

+56

(9.9)

157.9

2019 to 2023:
902024 onwards:
70

7.5

175.3

2019 to 2023:
1082024 onwards:
81

(9.4)

158.4

Risk-weighted assets as a percentage of total assets

-96

2.9

170.7

+12

(0.4)

167.4

Cost-income ratio

-175

7.7

175.5

+95

(9.4)

158.4

Long-term effective tax rate

-352

7.8

175.6

+250

(5.6)

162.2

Earnings in short to medium term - compound annual growth rate1

+107

3.8

171.6

-346

(18.9)

148.9

Capital requirements – capital adequacy ratio

—

—

167.8

+337

(64.1)

103.7

Capital requirements – tier 1 capital adequacy ratio

—

—

167.8

+322

(47.2)

120.6

Long-term profit growth rate

+100

20.2

161.5

-10

(1.7)

139.6

Long-term asset growth rate

-10

2.0

143.3

+100

(21.7)

119.6

Discount rate

-142

25.4

166.7

+28

(4.0)

137.3

Expected credit losses as a percentage of customer advances

At 31 December 20182018 to 2022:
70
2023 onwards:
65

7.0

148.3

2018 to 2022:
83
2023 onwards:
77

(7.9)

133.4

Risk-weighted assets as a percentage of total assets

-140

4.1

145.4

+80

(2.3)

139.0

Cost-income ratio

-160

8.8

150.1

+200

(10.9)

130.4

Long-term effective tax rate

-280

5.3

146.6

+250

(4.6)

136.7

Earnings in short to medium term - compound annual growth rate1,2

+204

8.1

149.4

-366

(14.2)

127.1

Capital requirements – capital adequacy ratio

—

—

141.3

+258

(39.4)

101.9

Capital requirements – tier 1 capital adequacy ratio

—

—

141.3

+243

(25.2)

116.1

Expected credit losses as a percentage of customer advances

1 Based on management's explicit forecasts over the short to medium term.
2 Comparatives on 31 December 2018 have been updated to align with the 2019 approach to describe the impact of the change in isolation.

Considering the interrelationship of the changes set out in the table above, management estimates that the reasonably possible range of
VIU is HK$144.3bn to HK$177.2bn (2018: HK$121.4bn to HK$153.5bn). The range is based on the favourable/unfavourable change in theearnings in the short to medium term and long-term expected credit losses as a percentage of customer advances as set out in the table
above. All other long-term assumptions, the discount rate and the basis of the CMC have been kept unchanged when determining thereasonably possible range of the VIU.

Selected financial information of BoCom
The statutory accounting reference date of BoCom is 31 December. For the year ended 31 December 2019, the group included theassociate’s results on the basis of financial statements made up for the 12 months to 30 September 2019, but taking into account thefinancial effect of significant transactions or events in the period from 1 October 2019 to 31 December 2019.

92

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Selected balance sheet information of BoComAt 30 Sep
2019

2018

HK$m

HK$m

Cash and balances at central banks

874,238

982,268

Loans and advances to banks and other financial institutions

841,420806,561

Loans and advances to customers

5,689,981

5,380,339

Other financial assets

3,394,004

3,196,602

Other assets

315,310

332,795

Total assets

11,114,953

10,698,565

Deposits by banks and other financial institutions

2,262,654

2,384,086

Customer accounts

6,765,782

6,497,116

Other financial liabilities

1,026,377

743,278

Other liabilities

179,723

284,560

Total liabilities

10,234,536

9,909,040

880,417789,525

Total equity1

1 Due to the adoption of HKFRS 16, the equity balance of BoCom as at 1 January 2019 was reduced by HK$709m.

Reconciliation of BoCom’s net assets to carrying amount in the group’s consolidated financial statements
At 30 Sep

The group’s share of ordinary shareholders' equity
Goodwill
Carrying amount

2019

2018

HK$m

HK$m

144,727

135,871

3,687

3,753

148,414

139,624

Selected income statement information of BoCom
For the 12 months ended 30 Sep
2019

2018

HK$m

HK$m

Net interest income

161,079

151,223

Net fee and commission income

50,233

48,949Change in expected credit losses(58,603)(43,907)

Depreciation and amortisation(15,152)(6,012)

Tax expense(12,822)(12,178)– profit for the year

87,556

87,122– other comprehensive income

2,470

1,490

Total comprehensive income

90,026

88,612

Dividends received from BoCom

4,810

4,792

At 31 December 2019, the group's share of associates' contingent liabilities was HK$305,291m (2018: HK$319,469m).

15

Goodwill and intangible assets

Goodwill and intangible assets include goodwill arising on business combinations, the present value of in-force long-term insurance
business, and other intangible assets.
2019

2018

HK$m

HK$m

Goodwill

6,315

5,932

Present value of in-force long-term insurance business

61,07548,522Other intangible assets1

14,253

10,650At 31 Dec

81,643

65,104

1 Included within other intangible assets is internally generated software with a net carrying value of HK$11,851m (2018: HK$8,010m). During theyear, capitalisation of internally generated software was HK$6,219m (2018: HK$4,499m) and amortisation was HK$2,264m (2018: HK$1,566m).

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201993

Notes on the Consolidated Financial Statements

The present value of in-force long-term insurance business
When calculating the present value of in-force long term ('PVIF') insurance business, expected cash flows are projected after adjusting fora variety of assumptions made by each insurance operation to reflect local market conditions and management’s judgement of future
trends, and uncertainty in the underlying assumptions is reflected by applying margins (as opposed to a cost of capital methodology).
Variations in actual experience and changes to assumptions can contribute to volatility in the results of the insurance business.
Actuarial Control Committees of each key insurance entity meet on a quarterly basis to review and approve PVIF assumptions. Allchanges to non-economic assumptions, economic assumptions that are not observable and model methodology must be approved by
the Actuarial Control Committee.
Movements in PVIFAs at 31 Dec
Impact on transition to HKFRS 9

2019

2018

HK$m

HK$m

48,522

44,621

N/A(616)

At 1 Jan

48,52244,005

Changes in PVIF of long-term insurance business

12,546

4,629– value of new business written during the year

8,779

8,138

– expected return1(5,531)(4,650)– assumption changes and experience variances (see below)

9,386

1,153

– other adjustments
Exchange differences and otherAt 31 Dec

(88)

(12)

7

(112)

61,07548,522

1 ‘Expected return’ represents the unwinding of the discount rate and reversal of expected cash flows for the period.

Assumption changes and experience variances
Included within this line item are:• HK$8,829m (2018: HK$(439)m), directly offsetting regulatory-driven changes to the valuation of liabilities under insurance contracts.
• HK$282m (2018: HK$3,566m), reflecting the future expected sharing of returns with policyholders on contracts with discretionary
participation features (‘DPF’), to the extent this sharing is not already included in liabilities under insurance contracts.
• HK$275m (2018: HK$(1,974)m), driven by other assumptions changes and experience variances.

Key assumptions used in the computation of PVIF for the main life insurance operations
Economic assumptions are set in a way that is consistent with observable market values. The valuation of PVIF is sensitive to observed
market movements. The following are the key long-term assumptions used in the computation of PVIF for Hong Kong insurance entities,
being the main life insurance operations:
2019

2018

%

%

Weighted average risk free rate

1.84

2.29

Weighted average risk discount rate

5.44

5.90

Expense inflation

3.00

3.00

Sensitivity to changes in economic assumptions
The group sets the risk discount rate applied to the PVIF calculation by starting from a risk-free rate curve and adding explicit allowances
for risks not reflected in the best-estimate cash flow modelling. Where the insurance operations provide options and guarantees topolicyholders, the cost of these options and guarantees is an explicit reduction to PVIF, unless it is already allowed for as an explicit
addition to the technical provisions required by regulators. See page 49 for further details of these guarantees and the impact of changes
in economic assumptions on our insurance manufacturing subsidiaries.

Sensitivity to changes in non-economic assumptions
Policyholder liabilities and PVIF are determined by reference to non-economic assumptions, including mortality and/or morbidity, lapse
rates and expense rates. See page 50 for further details on the impact of changes in non-economic assumptions on our insurance
manufacturing operations.

94

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

16

Property, plant and equipment

Owned property, plant and equipment1

2019

2018

HK$m

HK$m

128,603

112,080

Other right-of-use assets2
At 31 Dec

9,327

N/A

137,930

112,0801

Included leasehold land and buildings of HK$119,264m for which the rights of use are considered sufficient to constitute control. They are
therefore presented as owned assets.
2 The group adopted the requirements of HKFRS 16 on 1 January 2019 and recognised lease liabilities and the associated right-of-use assets inrelation to leases which had previously been classified as ‘operating leases’ in accordance with HKAS 17 ’Leases’.

Movement in owned property, plant and equipment
2019

2018

Land andbuildings

Investment
properties

Total

Land andbuildings

Investment
properties

Equipment

HK$m

HK$m

HK$m

Equipment

Total

HK$m

HK$m

HK$m

HK$m

HK$m

At 31 Dec of prior year

94,037

12,875

Impact on transition to HKFRS 16

16,284—22,728

129,640

97,61912,617

22,617

132,853—

16,284

N/A

N/A

N/A

At 1 Jan110,321

12,875

N/A

22,728145,924

97,61912,617

22,617

132,853

Cost or valuation

Exchange and other adjustments

(119)

(12)

(152)

(283)

(497)

1

(342)

(838)

Additions

1,034

447

1,853

3,334

271

278

1,097

1,646

Disposals

(2)

—

(903)

(905)

(361)

—

(644)

(1,005)

Transfers1——(6,604)(6,604)(11,126)(464)—(11,590)

Elimination of accumulated depreciation onrevalued land and buildings(4,306)——(4,306)(2,613)——(2,613)

Surplus on revaluation

4,426

154

—

4,580

10,626639—

11,265

Reclassifications

119

(129)

—

(10)

118

(196)

—

(78)

111,473

13,335

16,922

141,730

94,037

12,87522,728

129,640

At 1 Jan

73—

17,487

17,560210—

16,307

16,517

Exchange and other adjustments

6

—

(56)

(50)

(2)

—

(251)

(253)

4,312

—

1,308

5,620

2,643

—

2,043

4,686

Disposals

(1)

—

(874)

(875)

(165)

—

(612)

(777)

Transfers1——(4,822)(4,822)

N/A

N/A

N/A

N/A

(4,306)——(4,306)(2,613)——(2,613)84—

13,043

13,12773—

17,487

17,560111,389

13,335

3,879

128,603

93,964

12,875

5,241

112,080

At 31 Dec
Accumulated depreciation

Charge for the year

Elimination of accumulated depreciation onrevalued land and buildings
At 31 Dec
Net book value at 31 Dec

1 In both 2018 and 2019, certain properties and equipment have been transferred to a fellow subsidiary as part of the Recovery and Resolution Plan
as set out in the Report of the Directors. The balance represented the carrying value of these properties on the date of transfer.

The carrying amount of land and buildings, had they been stated at cost less accumulated depreciation, would have been as follows:

Cost less accumulated depreciation

2019

2018

HK$m

HK$m

16,895

16,281

Valuation of land and buildings and investment properties
The group’s land and buildings and investment properties were revalued as at 31 December 2019. The basis of valuation for land andbuildings and investment properties was open market value. The resultant values are Level 3 in the fair value hierarchy. The fair values forland and buildings are determined by using a direct comparison approach which values the properties in their respective existing states
and uses, assuming sale with immediate vacant possession and by making reference to comparable sales evidence. The valuations take
into account the characteristics of the properties (unobservable inputs) which include the location, size, shape, view, floor level, year ofcompletion and other factors collectively. The premium or discount applied to the characteristics of the properties is within minus 20%
and plus 20%. In determining the open market value of investment properties, expected future cash flows have been discounted to theirpresent values. The net book value of ‘Land and buildings’ includes HK$7,859m (2018: HK$8,374m) in respect of properties which werevalued using the depreciated replacement cost method.
Valuation of land and buildings and investment properties in Hong Kong, Macau and mainland China were largely carried out by
Cushman & Wakefield Limited, who have recent experience in the location and type of properties and who are members of the Hong
Kong Institute of Surveyors. This represents 93% by value of the group’s properties subject to valuation. Other properties were valued bydifferent independent professionally qualified valuers.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201995

Notes on the Consolidated Financial Statements

17

Prepayments, accrued income and other assets
2019

2018

HK$m

HK$m

Prepayments and accrued income

28,32627,897

Bullion53,16350,058

Acceptances and endorsements

47,30244,401

Reinsurers’ share of liabilities under insurance contracts (note 3)

26,282

17,792Current tax assets

1,521

1,517

Settlement accounts

27,28923,683

Cash collateral and margin receivables

35,82430,378Other assets

28,551

34,223

At 31 Dec

248,258

229,949

Prepayments, accrued income and other assets included HK$165,497m (2018: HK$159,483m) of financial assets, the majority of whichwere measured at amortised cost.

18

Customer accounts

Customer accounts by country/territory

Hong Kong

2019

2018

HK$m

HK$m

3,894,175

3,797,807

Mainland China

376,390358,026

Singapore

378,303

331,479

Australia

180,637

161,726

India

116,330

111,297

Malaysia

113,907108,899

Taiwan114,250

106,537

Indonesia

36,861

29,843

Other

221,571

202,052

5,432,424

5,207,666

At 31 Dec

19

Trading liabilities
2019

2018

HK$m

HK$m

Deposits by banks1

159

1,162

Customer accounts1

1,150

773

Net short positions in securities

86,223

79,259At 31 Dec

87,532

81,194

1 ‘Deposits by banks’ and ‘Customer accounts’ include repos, stock lending and other amounts.

20

Financial liabilities designated at fair value
2019

2018

HK$m

HK$m

Deposits by banks and customer accounts

74,761

82,136

Debt securities in issue

48,50642,369Liabilities to customers under investment contracts

37,024

36,638At 31 Dec

160,291

161,143

The carrying amount of financial liabilities designated at fair value was HK$1,216m higher than the contractual amount at maturity(2018: HK$2,232m lower). The cumulative loss in fair value attributable to changes in credit risk was HK$6m loss (2018: HK$177m gain).

96

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

21

Debt securities in issue
2019

2018

HK$m

HK$m

Bonds and medium-term note

90,36575,980

Other debt securities in issue

65,074

24,625

Total debt securities in issue

155,439

100,605– financial liabilities designated at fair value (note 20)(48,506)(42,369)

At 31 Dec

106,933

58,236

Included within:

22

Accruals and deferred income, other liabilities and provisions
2019

2018

HK$m

HK$m

Accruals and deferred income

25,60026,932

Acceptances and endorsements

47,35544,438Settlement accounts

35,807

37,833

Cash collateral and margin payables

40,29936,613

Share-based payment liability to HSBC Holdings plc

1,417

1,923

Lease liabilities

9,291

N/A

Other liabilities

41,68747,521

Provisions for liabilities and charges
At 31 Dec

1,796

1,405

203,252

196,665

Accruals and deferred income, other liabilities and provisions included HK$195,122m (2018: HK$184,221m) of financial liabilities whichwere measured at amortised cost.
Movement in provisions
Restructuring
costs

Other

Total

HK$m

HK$m

HK$m

At 31 Dec 2018

74

640

714

Additions

563

383

946

Amounts utilised

(402)

(85)

(487)

Unused amounts reversed

(29)

(254)

(283)

2

128

130

208

812

1,020

Provisions (excluding contractual commitments)

Exchange and other movements
At 31 Dec 2019
Contractual commitments
At 31 Dec 2018

691

Net change in expected credit loss provision and other movements85

At 31 Dec 2019776

Total Provisions at 31 Dec 2019

1,796

At 31 Dec 2017

192

380

Additions

11

469

572
480

Amounts utilised

(97)

(91)

(188)

Unused amounts reversed

(120)

(37)

(83)

Exchange and other movements

5

(35)

(30)

At 31 Dec 2018

74

640

714

Contractual commitments1
At 31 Dec 2017

54

Impact on transition to HKFRS 9487

Net change in expected credit loss provision and other movements

150

At 31 Dec 2018

691

Total Provisions at 31 Dec 2018

1

1,405

The contractual commitments provision at 31 December 2017 represented HKAS 37 provisions on off-balance sheet loan commitments andguarantees, for which expected credit losses are provided following transition to HKFRS 9 on 1 January 2018.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201997

Notes on the Consolidated Financial Statements

23

Subordinated liabilities

Subordinated liabilities issued to third parties measured at amortised cost consist of undated primary capital notes and other loan capital
having an original term to maturity of five years or more. Subordinated liabilities issued to Group entities are not included in the below.

US$400m

Undated floating rate primary capital notes

MYR500m

Fixed rate (5.05%) subordinated bonds due 2027, callable from 20221

At 31 Dec

2019

2018

HK$m

HK$m

3,114

3,133

952

948

4,066

4,081

1 The interest rate on the MYR500m 5.05% callable subordinated bonds due 2027 will increase by 1% from November 2022.

24

Preference shares

Irredeemable preference shares, issued and fully paid
2019

2018

HK$m

HK$m

At 1 Jan

98

21,037

Converted / bought back during the year(96)

(20,975)

Exchange and other movements

(2)

36

At 31 Dec—

98

At the beginning of the year, there was INR870m (2018: INR870m) of authorised preference share capital, comprising 8.7m compulsorily
convertible preference shares (‘CCPS’) of INR100 each in the share capital of a subsidiary, HSBC InvestDirect Securities (India) Private
Limited (‘HSBC InvestDirect’). The CCPS were issued and fully paid in 2009 at a nominal value of INR100 each. During the year, all CCPS
were converted into fully paid equity shares of HSBC InvestDirect at par.

25

Share capital

2019

2018

HK$m

HK$m

Paid up share capital in HK$

116,103

116,103

Paid up share capital in US$1

56,232

56,232

At 31 Dec

172,335

172,335

Ordinary shares issued and fully paid2019

At 1 Jan
Redemption / bought back of preference shares
At 31 Dec

2018

HK$m

Number

HK$m

Number172,335

46,440,991,798

151,360

46,440,991,798——

20,975—

172,335

46,440,991,798

172,335

46,440,991,798

1 Paid up share capital in US$ represents preference shares which were redeemed or bought back via payment out of distributable profits and forwhich the amount was transferred from retained earnings to share capital in accordance with the requirements of the Companies Ordinance.

There were no new ordinary shares issued in 2019 (2018: nil). The holder of the ordinary shares is entitled to receive dividends as
declared from time to time, rank equally with regard to the Bank’s residual assets and are entitled to one vote per share at shareholder
meetings of the Bank.

98

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

26

Other equity instruments

Other equity instruments comprise additional tier 1 capital instruments in issue which are accounted for as equity.
2019

2018

HK$m

HK$m

US$1,000m Floating rate perpetual subordinated loan, callable from Dec 20191

—

7,756

US$900m

Floating rate perpetual subordinated loan, callable from Dec 20191

—

6,981

US$900m

Floating rate perpetual subordinated loan, callable from Nov 20231

—

7,048

US$500m

Floating rate perpetual subordinated loan, callable from Nov 20231

—

3,915

US$700m

Floating rate perpetual subordinated loan, callable from Dec 20231

—

5,481

US$600m

Floating rate perpetual subordinated loan, callable from Nov 20241

—

4,698

US$1,000m Fixed rate perpetual subordinated loan, callable from Mar 20252

7,834

—

US$900m

Fixed rate perpetual subordinated loan, callable from Sep 20263

7,063

—

US$700m

Fixed rate perpetual subordinated loan, callable from Mar 20254

5,467

—

US$500m

Fixed rate perpetual subordinated loan, callable from Mar 20254

3,905

—

US$600m

Fixed rate perpetual subordinated loan, callable from May 20275

4,685

—

US$900m

Fixed rate perpetual subordinated loan, callable from Sep 20246

7,044

—

US$1,100m Fixed rate perpetual subordinated loan, callable from Jun 20247

8,617

—

At 31 Dec

44,61535,879

1
2
3
4
5
6
7

These subordinated loans were early repaid in the first half of 2019
Interest rate fixed at 6.09%
Interest rate fixed at 6.51%
Interest rate fixed at 6.172%
Interest rate fixed at 5.91%
Interest rate fixed at 6.03%
Interest rate fixed at 6%

The additional tier 1 capital instruments are perpetual subordinated loans on which coupon payments may be cancelled at the sole
discretion of the Bank. The subordinated loans will be written down at the point of non-viability on the occurrence of a trigger event as
defined in the Banking (Capital) Rules. They rank higher than ordinary shares in the event of a wind-up.

27

Maturity analysis of assets and liabilities

The following table provides an analysis of consolidated total assets and liabilities by residual contractual maturity at the balance sheet
date. These balances are included in the maturity analysis as follows:• Trading assets and liabilities (including trading derivatives but excluding reverse repos, repos and debt securities in issue) are includedin the ‘Due not more than 1 month’ time bucket, because trading balances are typically held for short periods of time.
• Financial assets and liabilities with no contractual maturity (such as equity securities) are included in the ‘Due over 5 years’ timebucket. Undated or perpetual instruments are classified based on the contractual notice period which the counterparty of the
instrument is entitled to give. Where there is no contractual notice period, undated or perpetual contracts are included in the‘Due over 5 years’ time bucket.
• Non-financial assets and liabilities with no contractual maturity are included in the ‘Due over 5 years’ time bucket.
• Liabilities under insurance contracts are included in the ‘Due over 5 years’ time bucket. Liabilities under investment contracts
are classified in accordance with their contractual maturity. Undated investment contracts are included in the ‘Due over 5 years’ timebucket, however, such contracts are subject to surrender and transfer options by the policyholders.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201999

Notes on the Consolidated Financial Statements

Maturity analysis of assets and liabilities

Due not
more than1month

Due over 1
month butnot morethan 3monthsDue over 3
monthsbut not
more than
6 months

Due over 6
monthsbut not
more than
9 months

Due over 9monthsbut not
more than
1 yearDue over 1
year butnot morethan 2years

Due over 2
years butnot morethan 5years

Due over 5
years

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Cash and balances at central banks

202,746

—

—

—

—

—

—

—

202,746

Items in the course of collection from otherbanks

21,140

—

—

—

—

—

—

—

21,140Hong Kong Government certificates ofindebtedness

298,944

—

—

—

—

—

—

—

298,944

Trading assets

618,856

2,253

1,219

—

—

433

—

—

622,761

Derivatives

279,698

115

96

28

81

324

300

—

280,642

938

706

4,605

10,273

126,383

153,511422,333

Financial assets

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

8,883

393

1,330

Reverse repurchase agreements – nontrading

260,716

97,16832,322

6,856

11,772

9,624

3,875

—

Loans and advances to banks

180,357

46,56523,40919,174

15,50230,018

10,097

3,783

328,905

Loans and advances to customers

643,208356,953

285,049

144,180

141,465

404,131

795,421

950,468

3,720,875

Financial investments

201,596406,723

186,055

70,92289,852

197,506

310,398437,246

1,900,298

Amounts due from Group companies

79,091

3,043

1,318

79

—

—

3,911

190

87,632

Accrued income and other financial assets

108,167

30,046

15,491

3,935

1,947

1,265

572

4,074

165,497

2,903,402

943,259546,289

246,112261,325

647,906

1,134,847

1,522,144

8,205,284

—

—

—

—

—

—

—

456,430

456,430

2,903,402

943,259546,289

246,112261,325

647,906

1,134,847

1,978,574

8,661,714

Hong Kong currency notes in circulation

298,944

—

—

—

—

—

—

—

298,944

Items in the course of transmission to otherbanks

25,576

—

—

—

—

—

—

—

25,576

Repurchase agreements – non-trading

90,565

3,131

2,713

1,566

447

—

—

7,974

106,396

Financial assets at 31 Dec 2019Non-financial assets
Total assets at 31 Dec 2019
Financial liabilities

Deposits by banks

169,344

8,474

1,888

30

5

52

26

—

179,819

Customer accounts

4,657,422

467,294

190,460

45,68142,47918,38810,700—5,432,424

Trading liabilities

87,532

—

—

—

—

—

—

—

87,532Derivatives

290,808

113

15

41

73

339

662

180

292,231

Financial liabilities designated at fair value

38,52424,493

12,173

4,833

4,694

18,962

12,70343,909160,291

Debt securities in issue

5,113

31,76918,816

5,614

7,757

17,03817,6403,186

106,933

Amounts due to Group companies

88,10832,414

246

37

118

35

79,308110,808

311,074

Accruals and other financial liabilities

114,974

38,591

18,130

5,573

4,846

3,704

4,626

4,678

195,122

Subordinated liabilities1

—

—

—

—

—

—

—

4,066

4,066

Preference shares

—

—

—

—

—

—

—

—

—

5,866,910

606,279

244,441

63,37560,41958,518125,665

174,801

7,200,408

Total financial liabilities at 31 Dec 2019Non-financial liabilities
Total liabilities at 31 Dec 2019

100

—

—

—

—

—

—

—

582,025582,025

5,866,910

606,279

244,441

63,37560,41958,518125,665

756,826

7,782,433

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Maturity analysis of assets and liabilities (continued)
Due not
more than1month

Due over 1
month butnot morethan 3monthsDue over 3
months but
not morethan 6monthsDue over 6
months but
not morethan 9monthsDue over 2
years butnot morethan 5years

Due over 5
years

HK$m

HK$m

HK$m

HK$m

HK$m

Total

HK$m

HK$m

HK$m

HK$m

Cash and balances at central banks

205,660———

Items in the course of collection from other
banks

—

—

—

—

205,660

25,380——Hong Kong Government certificates ofindebtedness

—

—

—

—

—

25,380280,854—

Trading assets

554,886

1,359

—

—

—

—

—

—

280,854

1,723

—

—

870

—

—

Derivatives

291,51583

117

558,838

247

17

324

318

248

292,869

Due over 9
Due over 1
months but year but not
not more more than 2than 1 year
years

Financial assets

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

9,308

24

1,108

615

1,121

3,839

11,210105,634

132,859

Reverse repurchase agreements – non-trading

250,550

87,93915,059

4,326

7,771

37,682

3,000—

406,327

Loans and advances to banks

177,476

56,11817,86911,374

19,247

22,912

26,835

6,320

338,151

Loans and advances to customers

638,718

323,164

268,711

159,123

145,495

350,859

767,323875,3093,528,702

Financial investments

235,488409,356

185,205

84,22575,210218,508

297,627

365,407

1,871,026

Amounts due from Group companies

63,150

6,477

649

28

—

2

149

—

70,455

Accrued income and other financial assets

102,461

33,492

14,830

2,189

1,178

1,071

584

3,678

159,4832,835,446

918,012505,271

262,127

250,039

636,067

1,107,046

1,356,596

7,870,604

—

—

—

—

—

—

—

392,850

392,850

2,835,446

918,012505,271

262,127

250,039

636,067

1,107,046

1,749,446

8,263,454

Hong Kong currency notes in circulation

280,854

—

—

—

—

—

—

—

280,854

Items in the course of transmission to otherbanks

33,806

—

—

—

—

—

—

—

33,806

Repurchase agreements – non-trading

63,273

723

1,159

4,555

569

—

—

—

70,279Deposits by banks

154,915

2,415

3,923

2,018

1,260

53

80

—

164,664

Customer accounts

5,207,666

Financial assets at 31 Dec 2018
Non-financial assets
Total assets at 31 Dec 2018
Financial liabilities

4,547,352

342,264

150,739

72,992

61,66316,011

16,57075

Trading liabilities

81,194

—

—

—

—

—

—

—

81,194

Derivatives

294,112

304

157

250

207

209

314

—

295,553

Financial liabilities designated at fair value

22,52423,44721,021

7,873

10,014

18,541

18,31439,409161,143

Debt securities in issue

2,631

6,287

9,810

859

519

15,91319,053

3,164

58,236

Amounts due to Group companies

120,904

93,361

1,299

50

27

15

77,508103,323

396,487

Accruals and other financial liabilities

115,539

40,894

16,241

3,542

4,423

1,718

1,154

710

184,221Subordinated liabilities1

—

—

—

—

—

—

948

3,133

4,081

Preference shares

—

—

—

—

—

—

—

98

98

5,717,104

509,695

204,349

92,13978,682

52,460133,941

149,912

6,938,282

Financial liabilities at 31 Dec 2018
Non-financial liabilities
Total liabilities at 31 Dec 2018

—

—

—

—

—

—

—

512,252

512,252

5,717,104

509,695

204,349

92,13978,682

52,460133,941

662,164

7,450,534

1 The maturity for subordinated liabilities is based on the earliest date on which the group is required to pay, i.e. the callable date.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019101

Notes on the Consolidated Financial Statements

28 Analysis of cash flows payable under financial liabilities by remaining contractual
maturities

Due not morethan 1 monthDue over 1
month butnot morethan 3monthsDue between
3 and
12 months

Due between
1 and 5 years

Due after
5 years

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Hong Kong currency notes in circulation

298,944

—

—

—

—

298,944

Items in the course of transmission to other banks

25,576————25,576

Repurchase agreements – non-trading

90,675

3,131

4,857

—

8,068

106,731

At 31 Dec 2019

Deposits by banks

169,744

8,474

1,960

84

—

180,262

Customer accounts

4,664,306

467,294

283,081

31,564—

5,446,245

Trading liabilities

87,532————87,532Derivatives

290,016

113

2

846

180

291,157

Financial liabilities designated at fair value

39,63624,493

22,58932,87344,188

163,779

Debt securities in issue

5,418

31,76933,53836,214

3,892

110,831

Amounts due to Group companies

98,361

32,414

5,344

100,805

126,697363,621

Other financial liabilities

109,482

38,591

25,715

8,313

4,756

186,857

Subordinated liabilities

29

—

86

457

5,789

6,361

5,879,719

606,279

377,172

211,156

193,570

7,267,896

2,750,332

—

—

—

—

2,750,332

49,199————49,1998,679,250

606,279

377,172

211,156

193,570

10,067,427

86%

6%

4%

2%

2%

Hong Kong currency notes in circulation

280,854

—

—

—

—

280,854

Items in the course of transmission to other banks

33,806————33,806

Repurchase agreements – non-trading

63,360

723

6,464

—

—

70,547

Deposits by banks

155,763

2,415

7,221

137

—

165,536

Customer accounts

5,217,864

Loan and other credit-related commitments
Financial guarantees
Proportion of cash flows payable in period
At 31 Dec 2018

4,552,138

342,264

289,185

34,19780

Trading liabilities

81,194————

81,194

Derivatives

294,448

304

403

1,754

—

296,909

Financial liabilities designated at fair value

23,41023,44740,49839,72339,474

166,552

Debt securities in issue

3,042

6,287

12,02837,1403,521

62,018Amounts due to Group companies

121,089

93,361

885

88,418137,417441,170

Other financial liabilities

109,254

40,894

22,377

2,850

1,194

176,569

Subordinated liabilities

22

—

65

1,294

3,995

5,376

Preference shares

—

—

98

—

—

98

5,718,380

509,695

379,224

205,513

185,6816,998,493

2,562,972

—

237

—

—

2,563,209

57,964————57,964

8,339,316

509,695

379,461

205,513

185,6819,619,666

87%

5%

4%

2%

2%

Loan and other credit-related commitments
Financial guarantees
Proportion of cash flows payable in period

The balances in the above tables incorporate all cash flows relating to principal and future coupon payments on an undiscounted basis(except for trading liabilities and trading derivatives). Trading liabilities and trading derivatives have been included in the ‘On demand’time bucket as they are typically held for short periods of time. The undiscounted cash flows payable under hedging derivative liabilities
are classified according to their contractual maturity. Investment contract liabilities have been included in financial liabilities designatedat fair value, whereby the policyholders have the options to surrender or transfer at any time, and are reported in the ‘Due after 5 years’time bucket. A maturity analysis prepared on the basis of the earliest possible contractual repayment date (assuming that all surrenderand transfer options are exercised) would result in all investment contracts being presented as falling due within one year or less. The
undiscounted cash flows potentially payable under loan commitments and financial guarantee contracts are classified on the basis of theearliest date they can be called. Cash flows payable in respect of customer accounts are primarily contractually repayable on demand or
at short notice.

102

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

29

Contingent liabilities, contractual commitments and guarantees
2019

2018

HK$m

HK$m

Guarantees and contingent liabilities– financial guarantees1

49,19957,964– performance & other guarantees2

266,272

234,265– other contingent liabilities

3,299

3,416

318,770

295,645– documentary credits and short-term trade-related transactions

22,45523,258– forward asset purchases and forward forward deposits placed

30,26814,087– undrawn formal standby facilities, credit lines and other commitments to lend

2,697,609

2,525,863

At 31 Dec

2,750,332

2,563,208

At 31 Dec
Commitments3:

1 Financial guarantees are contracts that require the issuer to make specified payments to reimburse the holder for a loss incurred because a
specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument. The amounts in theabove table are nominal principal amounts.
2 Performance and other guarantees include re-insurance letters of credit related to particular transactions, trade-related letters of credit issued
without provision for the issuing entity to retain title to the underlying shipment, performance bonds, bid bonds, standby letters of credit and othertransaction-related guarantees.
3 Includes HK$1,630,005m of commitments at 31 December 2019 (2018: HK$1,490,711m) to which the impairment requirements in HKFRS 9 areapplied where the group has become party to an irrevocable commitment.

The above table discloses the nominal principal amounts of commitments (excluding capital commitments), guarantees and othercontingent liabilities, which represent the amounts at risk should contracts be fully drawn upon and clients default. The amount of thecommitments shown above reflects, where relevant, the expected level of take-up of pre-approved facilities. As a significant portion ofguarantees and commitments is expected to expire without being drawn upon, the total of the nominal principal amounts is not
representative of future liquidity requirements.
It also reflects the group’s maximum exposure under a large number of individual guarantee undertakings. The risks and exposures fromguarantees are captured and managed in accordance with HSBC’s overall credit risk management policies and procedures. Guarantees
are subject to an annual credit review process.
Other contingent liabilities at 31 December 2019 included provisions made in relation to legal and regulatory matters as set out innote 38.

30

Other commitments

Capital commitments
At 31 December 2019, capital commitments, mainly related to the commitment for purchase of premises, were HK$7,413m(2018: HK$7,912m).

31

Offsetting of financial assets and financial liabilities

Financial assets and financial liabilities are offset and the net amount is reported in the balance sheet when there is a legally enforceable
right to offset the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability
simultaneously (‘the offset criteria’).
The ‘Amounts not set off in the balance sheet’ include transactions where:• the counterparty has an offsetting exposure with the group and a master netting or similar arrangement is in place with a right to set
off only in the event of default, insolvency or bankruptcy, or the offset criteria are otherwise not satisfied; and• in the case of derivatives and reverse repurchase/repurchase, stock borrowing/lending and similar agreements, cash and non-cash
collateral has been received/pledged.
For risk management purposes, the net amounts of loans and advances to customers are subject to limits, which are monitored and therelevant customer agreements are subject to review and updated, as necessary, to ensure that the legal right to set off remains
appropriate.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019103

Notes on the Consolidated Financial Statements

Offsetting of financial assets and financial liabilities
Amounts subject to enforceable netting arrangements
Amounts not offset in thebalance sheet

Grossamounts

Amounts
offsetNetamounts
reported in
the balance
sheet

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Derivatives

384,173(132,872)

251,301(213,466)(8,155)(15,070)

14,61029,341

280,642

Reverse repos, stock borrowing and similar
agreements classified as:

470,307(17,667)

452,640—(451,866)

(125)

649

20,387473,027– trading assets

28,779(90)

28,689—(28,680)—

9—28,689– non-trading assets

441,528(17,577)

423,951—(423,186)

(125)

640

20,387444,338

854,480(150,539)

703,941(213,466) (460,021)(15,195)

15,25949,728753,669

Derivatives

396,052(132,872)

263,180(213,466)(13,444)(14,238)

22,032

29,051

292,231

Repos, stock lending and similar
agreements classified as:

148,626(17,667)

130,959—(130,399)

(37)

523

43,022

173,981

1,978

(90)

1,888

—

(1,823)

—

65

—

1,888

146,648(17,577)

129,071—(128,576)

(37)

458

43,022

172,093544,678(150,539)

394,139(213,466) (143,843)(14,275)

22,55572,073466,212

Derivatives

380,939(120,409)

260,530(208,893)(5,637)(31,801)

14,19932,339292,869

Reverse repos, stock borrowing and similar
agreements classified as:

444,711(31,283)

413,428—(413,374)

(42)

12

29,862443,290– trading assets

23,112—

23,112—(23,100)—

12—

23,112– non-trading assets

421,599(31,283)

390,316—(390,274)(42)—

29,862

420,178825,650(151,692)

673,958(208,893)(419,011)(31,843)

14,211

62,201

736,159

Derivatives

391,064(120,409)

270,655(208,893)(9,558)(18,754)

33,45024,898295,553

Repos, stock lending and similar
agreements classified as:

146,026(31,283)

114,743—(114,548)

(4)

191

26,560141,303

2,023

—

2,023

—

(2,007)

—

16

—

2,023

144,003(31,283)

112,720—(112,541)

(4)

175

26,560139,280

537,090(151,692)

385,398(208,893)(124,106)(18,758)

33,641

51,458436,856

Financial
instruments

Non-cashcollateralCashcollateralNet
amountAmounts not
subject toenforceablenettingarrangements1

Balance
sheet
total

At 31 Dec 2019
Financial assets2

Financial liabilities3– trading liabilities– non-trading liabilities

At 31 Dec 2018
Financial assets2

Financial liabilities3– trading liabilities– non-trading liabilities

1 These exposures continue to be secured by financial collateral, but the group may not have sought or been able to obtain a legal opinion
evidencing enforceability of the offsetting right.
2 Amounts presented in the balance sheet included balances due from Group companies of HK$85,124m (2018: HK$103,358m).
3 Amounts presented in the balance sheet included balances due to Group companies of HK$133,693m (2018: HK$139,410m).

32

Segmental analysis

The group's Executive Committee (‘EXCO’) reviews operating activities on a number of bases, including by global business and bycountries. Global businesses are our reportable segments under HKFRS 8 'Operating Segments'.

Basis of preparation
The Executive Committee (‘EXCO’) is considered the Chief Operating Decision Maker ('CODM') for the purpose of identifying the group’sreportable segments. Global business results are assessed by the CODM on the basis of performance measured in accordance withHKFRSs. Although the CODM reviews information on a number of bases, business performance is assessed and capital resources areallocated by global business, and the segmental analysis is presented on that basis. The global businesses are therefore considered ourreportable segments under HKFRS 8 'Operating Segments'.
Our operations are closely integrated and, accordingly, the presentation of data includes internal allocations of certain items of income
and expenses. These allocations include the costs of certain support services and global functions to the extent that they can bemeaningfully attributed to operational business lines and geographical regions. While such allocations have been made on a systematicand consistent basis, they necessarily involve a degree of subjectivity. Costs which are not allocated to global businesses are included inthe ‘Corporate Centre’.
Where relevant, income and expense amounts presented include the results of inter-segment funding along with inter-company andinter-business line transactions. All such transactions are undertaken on arm’s length terms. The intra-group elimination items for the
global businesses are presented in the Corporate Centre.

104

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Our global businesses
The group provides a comprehensive range of banking and related financial services to its customers in its four global businesses. The
products and services offered to customers are organised by these global businesses.
• Retail Banking and Wealth Management (‘RBWM’) offers a broad range of products and services to meet the personal banking andwealth management needs of individual customers. Typically, customer offerings include personal banking products (current andsavings accounts, mortgages and personal loans, credit cards, debit cards and local and international payment services) and wealthmanagement services (insurance and investment products, global asset management services and financial planning services).
• Commercial Banking (‘CMB’) offers a broad range of products and services to serve the needs of our commercial customers, including
small- and medium-sized enterprises, mid-market enterprises and corporates. These include credit and lending, international trade andreceivables finance, treasury management and liquidity solutions (payments and cash management and commercial cards),
commercial insurance and investments. CMB also offers its customers access to products and services offered by other global
businesses, for example Global Banking and Markets (‘GB&M’), which include foreign exchange products, raising capital on debt andequity markets and advisory services.
• GB&M provides tailored financial solutions to major government, corporate and institutional clients and private investors worldwide.
The client-focused business lines deliver a full range of banking capabilities including financing, advisory and transaction services, amarkets business that provides services in credit, rates, foreign exchange, equities, money markets and securities services, andprincipal investment activities.
• Global Private Banking (‘GPB’) provides a range of services to high net worth individuals and families with complex and international
needs within the Group’s priority markets.
• The Corporate Centre was established to align certain functions of the group. The Corporate Centre includes Balance SheetManagement, certain interests in associates and joint ventures, as well as the results of our financing operations and central support
costs with associated recoveries.
Performance by global business is presented in the ‘Financial Review’ section.
Information by geographical region
Hong Kong

Rest of
Asia-PacificIntra-segment
elimination

Total

HK$m

HK$m

HK$m

HK$m

Total operating income

218,525

81,030(18)

299,537

Profit before tax

88,95747,476—

136,433

Total assets

6,221,486

3,155,935(715,707)

8,661,714

Total liabilities

5,724,204

2,773,936(715,707)

7,782,433

Credit commitments and contingent liabilities (contract amounts)

1,705,308

1,363,794—

3,069,102

Total operating income

195,249

75,297(2,238)268,308

Profit before tax

88,017

46,566—

134,583

Total assets

6,036,854

2,939,955(713,355)

8,263,454

Total liabilities

5,590,770

2,573,119(713,355)

7,450,534

Credit commitments and contingent liabilities (contract amounts)

1,584,981

1,273,872—

2,858,853

For the year ended 31 Dec 2019

At 31 Dec 2019

For the year ended 31 Dec 2018

At 31 Dec 2018

Information by country/territory
Revenue1

Non-current assets2

For the year ended 31 Dec

At 31 Dec

2019
HK$m

2018
HK$m

2019
HK$m

2018
HK$m

Hong Kong

147,456

142,665

132,935

110,125

Mainland China

18,153

17,653

158,215

147,444

Australia

7,337

7,658

2,130

825

India

9,339

7,880

2,339

1,934

Indonesia

3,701

3,702

3,932

3,566

Malaysia

6,107

6,330

1,820

962

Singapore

10,776

10,053

2,820

1,415
2,201

Taiwan

3,064

3,509

2,802

Other

13,44811,019

3,421

3,075

Total

219,381

210,469

310,414271,547

1 Revenue (defined as ‘Net operating income before change in expected credit losses and other impairment charges') is attributable to countries
based on the location of the principal operations of the branch, subsidiary, associate or joint venture.
2 Non-current assets consist of property, plant and equipment, goodwill, other intangible assets, interests in associates and joint ventures andcertain other assets.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019105

Notes on the Consolidated Financial Statements

33

Related party transactions

The group’s related parties include the parent, fellow subsidiaries, associates, joint ventures, post-employment benefit plans for thegroup’s employees, Key Management Personnel (‘KMP’) as defined by HKAS 24, close family members of KMP and entities that arecontrolled or jointly controlled by KMP or their close family members.
Particulars of transactions with related parties are set out below.

(a)Inter-company

The group is wholly owned by HSBC Asia Holdings Limited, which in turn is a wholly-owned subsidiary of HSBC Holdings plc(incorporated in England).
During 2019, over 8,500 employees performing shared services in Hong Kong have been transferred from the group to a separate service
company, HSBC Global Services (Hong Kong) Limited (the ‘ServCo’), which is a fellow subsidiary of the Group set up in Hong Kong aspart of recovery and resolution planning to provide functional support services to the group. There were no changes to employment
terms and conditions or pension benefits as a result of these transfers. For the year ended 31 December 2019, the group recognised amanagement charge of HK$15,718m for the services provided by ServCo, which is reported under ‘General and administrative
expenses’ (2018: HK$1,098m), mainly in relation to the remuneration and other costs associated with employees and assets transferred
to ServCo.
During the year, the Bank has completed the restructuring of its internal regulatory capital and loss-absorbing capacity (‘LAC’)-eligible
debt and equity instruments such that they are all held by its immediate parent, HSBC Asia Holdings Limited, in order to comply with
the Financial Institutions (Resolution) (Loss-absorbing Capacity Requirements – Banking Sector) Rules which came into operation on
14 December 2018.
The group entered into transactions with its fellow subsidiaries in the normal course of business, including the acceptance andplacement of interbank deposits, correspondent banking transactions and off-balance sheet transactions. The activities were on
substantially the same terms, including interest rates and security, as for comparable transactions with third-party counterparties.
The group shared the costs of certain IT projects with its fellow subsidiaries and also used certain processing services of fellow
subsidiaries. The Bank also acted as agent for the distribution of retail investment funds for fellow subsidiaries and paid professional fees
for services provided by fellow subsidiaries. These transactions and services are priced on an arm’s length basis.
The aggregate amount of income and expenses arising from these transactions during the year and the balances of amounts due to andfrom the relevant parties at the year end were as follows:
2019

2018

Immediate
holding company

Ultimate holding
company

Fellow
subsidiaries

Immediate
holding company

Ultimate holding
company

Fellow
subsidiaries

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Income and expenses for the year
Interest income

1

6

1,450

—

—

1,220

3,678

3,967

2,022

1,563

5,545

1,681

Fee income

—

—

2,383

—

43

2,547

Fee expense

—

—

1,296

—

—

1,153

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

—

2

152

—

5

1,289

Other operating income

—

976

773

—

1,348

2,531

Other operating expenses2

—

3,846

31,657—

3,405

13,682

Assets—823

151,094—327

149,122– trading assets3

—

67

1,989

—

123

11,586– derivative assets—

633

63,652——

78,994– other assets3,6—

123

85,453—204

58,542

189,690

1,290

187,550—

254,547

212,358

—

—

622

—

15

97

126,237—

9—87,065298

Interest expense1

At 31 Dec

Liabilities– trading liabilities3– financial liabilities designated at fair value3,4– derivative liabilities——

67,419——70,320– other liabilities3,6

1,492

1,221

119,500—

96,000120,551– subordinated liabilities3,5,6

20,994

61,961

69——

71,467– preference shares

—

—

—

—

—

98

Guarantees——

19,179——17,763

Commitments

—

—

2,388

—

—

14,3191 Interest expense included distribution on preference shares and interest on subordinated liabilities.
2 In 2019, payments of HK$428m (2018: HK$459m) were made for software costs which were capitalised as intangible assets in the balance sheetof the group.
3 These balances are presented under ‘Amounts due from/to Group companies’ in the consolidated balance sheet.
4 The balance at 31 December 2019 included subordinated liabilities of HK$126,237m to meet Total Loss Absorbing Capacity (‘TLAC’) requirements(2018: HK$87,065m). The carrying amount of financial liabilities designated at fair value was HK$7,482m higher than the contractual amount atmaturity (2018: HK$1,289m). The cumulative loss in fair value attributable to changes in credit risk was HK$2,313m (2018: HK$310m). Thebalances are largely under Level 2.
5 The balance at 31 December 2019 included subordinated liabilities of HK$61,961m to meet TLAC requirements (2018: HK$78,450m).
6 The fair value hierarchy of assets and liabilities at amortised cost are under level 2 and the fair value has no material difference with carrying value.

106

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

(b)Share option and share award schemes

The group participates in various share option and share plans operated by HSBC whereby share options or shares of HSBC are granted
to employees of the group. The group recognises an expense in respect of these share options and share awards. The cost borne by theultimate holding company in respect of share options is treated as a capital contribution and is recorded within ‘Other reserves’. In
respect of share awards, the group recognises a liability to the ultimate holding company over the vesting period. This liability ismeasured at the fair value of the shares at each reporting date, with changes since the award dates adjusted through the capital
contribution account within ‘Other reserves’. The balances of the capital contribution and the liability at 31 December 2019 amounted to
HK$3,396m and HK$1,417m respectively (2018: HK$3,147m and HK$1,923m respectively).

(c)Post-employment benefit plans

At 31 December 2019, HK$9.1bn (2018: HK$12.3bn) of the group’s post-employment plan assets were under management by groupcompanies, earning management fees of HK$22m in 2019 (2018: HK$29m). At 31 December 2019, the group’s post-employment benefit
plans had placed deposits of HK$581m (2018: HK$486m) with its banking subsidiaries, earning interest payable to the schemes of HK$3m (2018: HK$2m). The above outstanding balances arose from the ordinary course of business and on substantially the same terms,
including interest rates and security, as comparable transactions with third-party counterparties.

(d)

Associates and joint ventures

The group provides certain banking and financial services to associates and joint ventures, including loans, overdrafts, interest and noninterest bearing deposits and current accounts. Details of interests in associates and joint ventures are set out in note 14.
The disclosure of the year-end balance and the highest amounts outstanding during the year is considered to be the most meaningful
information to represent the amount of transactions and outstanding balances during the year.
Transactions and balances during the year with associates and joint ventures
2019
Highest balance
during the year

2018
Balance at
31 December

Highest balance
during the year

Balance at
31 December

HK$m

HK$m

HK$m

HK$m

Amounts due from associates – unsubordinated

34,81316,00130,411

23,487

Amounts due to associates

19,602

4,016

15,821

2,141

1

1

1

1

Commitments

The above outstanding balances arose in the ordinary course of business and on substantially the same terms, including interest rates
and security, as comparable transactions with third party counterparties.

(e)

Key Management Personnel

Key Management Personnel are defined as those persons having authority and responsibility for planning, directing and controlling theactivities of the Bank and the group. It includes members of the Board of Directors and Executive Committee of the Bank and the Boardof Directors and Group Managing Directors of HSBC Holdings plc.
Compensation of Key Management Personnel

Salaries and other short-term benefits

2019

2018

HK$m

HK$m

336

337

Post employment benefits

910

Termination benefits

1—

Share-based payments

104

92

Total

450

439

Transactions, arrangements and agreements involving Key Management Personnel
2019

2018

HK$m

HK$m

Highest average assets1

48,944

47,132Highest average liabilities1

47,211

48,251

Contribution to group‘s profit before tax

1,144

936

Guarantees

7,177

7,060

Commitments

5,275

3,841

During the year

At the year end

1 The disclosure of the highest average balance during the year is considered the most meaningful information to represent transactions during theyear.

Transactions, arrangements and agreements are entered into by the group with companies that may be controlled by Key Management
Personnel of the group and their immediate relatives. These transactions are primarily loans and deposits, and were entered into in theordinary course of business and on substantially the same terms, including interest rates and security, as comparable transactions withpersons or companies of a similar standing or, where applicable, with other employees. The transactions did not involve more than thenormal risk of repayment or present other unfavourable features.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019107

Notes on the Consolidated Financial Statements

Change in expected credit losses recognised for the year, and expected credit loss allowances against balances outstanding at the end of
the year, in respect of Key Management Personnel were insignificant (2018: insignificant).
On 8 October 2019, HBAP acted as Joint Global Co-ordinator and Underwriter on aggregated EUR4.25bn and GBP800m Senior Noteissuances for CK Hutchison Group Telecom Finance S.A. in 6 tranches, with tenors of 4 to 15 years and coupon rates of 0.375% to2.625%. CK Hutchison Group Telecom Finance S.A. is a wholly-owned subsidiary of an associated body corporate (CK Hutchison
Holdings Limited) of Mr Victor Li, a non-executive Director of the Bank.

(f)Loans to directors

Directors are defined as the Directors of the Bank, its ultimate holding company, HSBC Holdings plc and intermediate holding
companies. Loans to directors also include loans to companies that are controlled by, and entities that are connected with these
directors. Particulars of loans to directors disclosed pursuant to section 17 of the Companies (Disclosure of Information about Benefits of
Directors) Regulation are as follows:
Aggregate amount outstanding at
31 DecBy the Bank1

Maximum aggregate amountoutstanding during the year

2019

2018

2019

2018

HK$m

HK$m

HK$m

HK$m

4,530

1,231

4,730

8,360

6

8

8

10

4,536

1,239

4,738

8,370

By subsidiaries

1 Comparatives have been re-presented to include certain balances previously not included.

These amounts include principal and interest, and the maximum liability that may be incurred under guarantees.

34

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 independentof the risk taker.
Where fair values are determined by reference to externally quoted prices or observable pricing inputs to models, independent pricedetermination or validation is utilised. For inactive markets, the group 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, instrumentcomparability, consistency of data sources, underlying data accuracy and timing of prices.
Fair value of investment funds are sourced from the underlying fund managers which are based upon an assessment of the underlying
investees’ financial positions, results, risk profile and prospects.
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 Financefunction and Valuation Committees. Finance is responsible for establishing procedures governing valuation and ensuring fair values are incompliance with accounting standards. The fair values are reviewed by the group's Valuation Committees, which consist of independent
support functions. Within GB&M, these Committees are overseen by the Group's Valuation Committee Review Group, which considers allmaterial subjective valuations. The insurance business also holds portfolios of financial instruments for which the valuations are
subjective and an Investment Valuation Committee oversees those fair values.

Financial liabilities measured at fair value
In certain circumstances, the group records its own debt in issue at fair value, based on quoted prices in an active market for the specificinstrument. 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 which is appropriate to thegroup'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 ‘Financial liabilities designated at fair value’ and aremeasured at fair value. The credit spread applied to these instruments is derived from the spreads at which the group issues structured
notes.
Gains and losses arising from changes in the credit spread of liabilities issued by the group reverse over the contractual life of the debt,
provided that the debt is not repaid at a premium or a discount.

108

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

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 the group 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
Fair Value Hierarchy
Level 1

Level 2

Level 3

Third-party
totalIntercompany2

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

426,072

196,132557

622,761—

622,761

2,282

213,242833

216,357

64,285

280,642

89,152

32,06832,291

153,511—

153,511

1,096,572

363,804

5,622

1,465,998—

1,465,998

At 31 Dec 2019
AssetsTrading assets1
Derivatives
Financial assets designated and otherwise mandatorily
measured at fair value through profit or loss
Financial investments
Liabilities
Trading liabilities1

78,111

9,421—

87,532—87,532Derivatives

2,892

219,498

2,422

224,81267,419292,231—

139,720

20,571

160,291—

160,291

395,769

162,841228

558,838—

558,838

3,219

209,450

1,206

213,875

78,994

292,869

75,10536,59921,155

132,859—

132,859

1,146,426

352,490

4,709

1,503,625—

1,503,625

Financial liabilities designated at fair value1
At 31 Dec 2018
AssetsTrading assets1
Derivatives
Financial assets designated and otherwise mandatorily
measured at fair value through profit or loss
Financial investments
Liabilities
Trading liabilities1

74,376

6,818—

81,194—

81,194

Derivatives

3,348

220,043

1,842

225,233

70,320295,553—

139,782

21,361

161,143—

161,143

Financial liabilities designated at fair value1

1 Amounts with HSBC Group entities are not reflected here.
2 Derivatives balances with HSBC Group entities are largely under ‘Level 2’.

Transfers between Level 1 and Level 2 fair values
AssetsLiabilities

Financialinvestments

Trading
assetsDesignatedandotherwise
mandatorily
measured
at fair value

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Derivatives

Trading
liabilities

Designated atfair value

Derivatives

At 31 Dec 2019
Transfers from Level 1 to Level 2

32,281

9,198

—

—

131

—

—

Transfers from Level 2 to Level 1

16,872

15,069

2,359

—

599

—

—

At 31 Dec 2018
Transfers from Level 1 to Level 2

9,955

1,389

—

—

349

—

—

Transfers from Level 2 to Level 1

121,667

18,109

—

—

376

—

—

Transfers between levels of the fair value hierarchy are deemed to occur at the end of each quarterly reporting period. Transfers into andout of levels of the fair value hierarchy are primarily attributable to changes in observability of valuation inputs and price transparency.

Movements in Level 3 financial instruments
There were no material transfers between Level 3 and Level 1 or Level 2 as a result of change in observability of valuation inputs,
settlement, nor material gains/loss recognised in the income statement/other comprehensive income during the year in relation tofinancial instruments carried at fair value in Level 3 (2018: immaterial). The increase in Level 3 assets was mainly due to the purchase ofprivate equity fund and other alternative investments of HK$11,463m (2018: HK$12,200m) to back policyholder liabilities to support
growth in the insurance business.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019109

Notes on the Consolidated Financial Statements

Fair value adjustments
Fair value adjustments are adopted when the group 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 recognitionof profits or losses within the income statement, such as when models are enhanced and therefore fair value adjustments may no longer
be required.

Bid-offerHKFRS 13 requires use of the price within the bid-offer spread that is most representative of fair value. Valuation models will typicallygenerate 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 conservativevalues for uncertain parameters and/or model assumptions, than those used in the group’s valuation model.

Credit valuation adjustment (‘CVA’) and debit valuation adjustment (‘DVA’)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 the group 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 the group may default, and that thegroup may not pay the full market value of the transactions.
The group 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.
The group calculates the CVA by applying the probability of default (‘PD’) of the counterparty, conditional on the non-default of the group,to the group’s expected positive exposure to the counterparty and multiplying the result by the loss expected in the event of default.
Conversely, the group calculates the DVA by applying the PD of the group, conditional on the non-default of the counterparty, to the
expected positive exposure of the counterparty to the group and multiplying the result by the loss expected in the event of default. Bothcalculations are performed over the life of the potential exposure.
For most products the group uses a simulation methodology, which incorporates a range of potential exposures over the life of theportfolio, to calculate the expected positive exposure to a counterparty. The simulation methodology includes credit mitigants, such ascounterparty netting agreements and collateral agreements with the counterparty.
The methodologies do not, in general, account for ‘wrong-way risk’ which arises when the underlying value of the derivative prior to any
CVA is positively correlated to the PD of the counterparty. When there is significant wrong-way risk, a trade-specific approach is applied
to reflect this risk in the valuation.

Funding fair value adjustment (‘FFVA’)
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, whereavailable and is adjusted for events that may terminate the exposure, such as the default of the group or the counterparty. The FFVA and
DVA are calculated independently.

Model limitation
Models used for portfolio valuation purposes may be based upon a simplifying set of assumptions that do not capture all material market
characteristics. In these circumstances, model limitation adjustments are adopted.

Inception profit (Day 1 profit or loss reserves)
Inception profit adjustments are adopted when the fair value estimated by a valuation model is based on one or more significant
unobservable inputs.

Effects of changes in significant unobservable assumptions to reasonably possible alternatives
The key unobservable inputs to Level 3 financial instruments include volatility and correlation for structured notes and deposits valued
using option models, bid quotes for corporate bonds valued using approaches that take into account market comparables, and multiple
items for private equity and strategic investments. In the absence of an active market, the fair value of private equity and strategic
investments is estimated on the basis of an analysis of the investee’s financial position and results, risk profile, prospects and otherfactors, as well as by reference to market valuations for similar entities quoted in an active market, or the price at which similar
companies have changed ownership. The change in fair values due to changes in reasonably possible alternative assumptions for theseunobservable inputs is not significant.
Favourable and unfavourable changes are determined on the basis of sensitivity analysis. 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 thevaluation technique employed, the availability and reliability of observable proxies and historical data. When the available data is not
amenable to statistical analysis, the quantification of uncertainty is judgemental, but remains guided by the 95% confidence interval. The
sensitivity of Level 3 fair values to reasonably possible alternative assumptions is not significant.

110

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

35

Fair values of financial instruments not carried at fair value

Fair values of financial instruments not carried at fair value and bases of valuation
Fair Value Hierarchy

Carrying
amountQuotedmarket price
Level 1

Observable
inputsLevel 2Significant
unobservable
inputsLevel 3

Total

HK$m

HK$m

HK$m

HK$m

HK$m

Reverse repurchase agreements – non-trading

422,333—

417,294

5,385

422,679

Loans and advances to banks

328,905—

323,304

5,501

328,805

3,720,875—

56,4753,654,716

3,711,191

434,300

77,108382,368356

459,832

Repurchase agreements – non-trading

106,396—

106,398—

106,398

Deposits by banks

179,819—

179,823—

179,823

Customer accounts

5,432,424—

5,432,803—

5,432,803

Debt securities in issue

106,933—

107,641—

107,641

Subordinated liabilities

4,066

—

952

2,999

3,951

Reverse repurchase agreements – non-trading

406,327—

396,061

10,723406,784

Loans and advances to banks

338,151—

322,443

15,531

337,974

3,528,702—

52,262

3,473,497

3,525,759

367,401

8,543

356,836—

365,379

Repurchase agreements – non-trading

70,279—70,282—70,282

Deposits by banks

164,664—

164,662—

164,662

Customer accounts

At 31 Dec 2019
AssetsLoans and advances to customers
Financial investments – at amortised cost
Liabilities

At 31 Dec 2018
AssetsLoans and advances to customers
Financial investments – at amortised cost
Liabilities

5,207,666—

5,207,871—

5,207,871

Debt securities in issue

58,236—58,808—58,808Subordinated liabilities

4,081

—

960

2,919

3,879

98

—

—

98

98

Preference shares

The fair values above are stated at a specific date and may be significantly different from the amounts which will actually be paid on thematurity or settlement dates of the instruments. In many cases, it would not be possible to realise immediately the estimated fair values
given the size of the portfolios measured. Accordingly, these fair values do not represent the value of these financial instruments to thegroup as a going concern.
Other financial instruments not carried at fair value are typically short term in nature or re-priced to current market rates frequently.
Accordingly, their carrying amount is a reasonable approximation of fair value. They include cash and balances at central banks, items in
the course of collection from and transmission to other banks, Hong Kong Government certificates of indebtedness and Hong Kong
currency notes in circulation, all of which are measured at amortised cost.

Valuation
Fair value is an estimate of 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. It does not reflect the economic benefits and costs that the group expects to flow from an
instrument’s cash flow over its expected future life. Our valuation methodologies and assumptions in determining fair values for which noobservable market prices are available may differ from those of other companies.

Repurchase and reverse repurchase agreements – non-trading
Fair values approximate carrying amounts as these balances are generally short dated.

Loans and advances to banks and customers
To determine the fair value of loans and advances to banks and customers, loans are segregated, as far as possible, into portfolios ofsimilar characteristics. Fair values are based on observable market transactions, when available. When they are unavailable, fair values
are estimated using valuation models incorporating a range of input assumptions. These assumptions may include: value estimates fromthird-party brokers reflecting over-the-counter trading activity; forward-looking discounted cash flow models, taking account of expectedcustomer prepayment rates, using assumptions that the group believes are consistent with those that would be used by market
participants in valuing such loans; new business rates estimates for similar loans; and trading inputs from other market participants
including observed primary and secondary trades. From time to time, we may engage a third-party valuation specialist to measure thefair value of a pool of loans.
The fair value of loans reflects expected credit losses at the balance sheet date and estimates of market participants’ expectations ofcredit losses over the life of the loans, and the fair value effect of repricing between origination and the balance sheet date. For credit
impaired loans, fair value is estimated by discounting the future cash flows over the time period they are expected to be recovered.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019111

Notes on the Consolidated 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 are determined using quoted market prices at the balance sheet date where available, or by reference to quoted market prices
for similar instruments.

36

Structured entities

The group is involved with both consolidated and unconsolidated structured entities through the securitisation of financial assets,
conduits and investment funds, established either by the group or a third party.

Consolidated structured entities
The group uses consolidated structured entities to securitise customer loans and advances it originates to diversify its sources of funding
for asset origination and capital efficiency purposes. The loans and advances are transferred by the group to the structured entities forcash or synthetically through credit default swaps, and the structured entities issue debt securities to investors. The group's transactions
with these entities are not significant.

Unconsolidated structured entities
The term ‘unconsolidated structured entities’ refers to all structured entities not controlled by the group. The group enters intotransactions with unconsolidated structured entities in the normal course of business to facilitate customer transactions and for specificinvestment opportunities.
Nature and risks associated with the group’s interests in unconsolidated structured entities
Securitisations

HSBC
managed funds

Non-HSBC
managed funds

Other

Total

0–4

58

47

95

40

240

4–15

8

25

89

2

124

15–39

—

6

41

—

47

39–196

—

1

26

—

27

196+

—

1

4

—

5

Number of entities at 31 Dec 2019

66

80

255

42

443

HK$m

HK$m

HK$m

HK$m

HK$m

Total asset values of the entities (HK$bn)

Total assets in relation to the group's interests in the unconsolidated
structured entities

27,63624,25850,241

13,140115,275– trading assets

—

774

—

—

774

– financial assets designated and otherwise mandatorily measured at fairvalue through profit or loss—

23,48450,241—73,725– derivatives

—

—

—

—

—

27,636——

12,74240,378– financial investments

—

—

—

—

—

– other assets

—

—

—

398

398

– loans and advances to customers

Total liabilities in relation to the group's interests in the unconsolidated
structured entities
Other off balance sheet commitments
The group’s maximum exposure at 31 Dec 2019

112

—

—

—

—

—

857

1,797

14,664

3,958

21,27628,49326,05564,90517,098

136,551

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019

Nature and risks associated with the group’s interests in unconsolidated structured entities (continued)
Securitisations

HSBC
managed funds

Non-HSBC
managed funds

Other

Total

0–4

38

39

97

36

210

4–15

7

18

84

1

110

15–39

1

4

38

—

43

39–196

—

1

21

—

22

196+

—

1

5

—

6

Number of entities at 31 Dec 2018

46

63

245

37

391

HK$m

HK$m

HK$m

HK$m

HK$m

Total asset values of the entities (HK$bn)

Total assets in relation to the group's interests in the unconsolidated
structured entities

17,907

20,54040,101

15,59894,146– trading assets

—

76

—

—

76

– financial assets designated and otherwise mandatorily measured at fairvalue through profit or loss—

19,292

40,101—

59,393– derivatives

—

—

—

—

—

17,907——

15,25333,160– financial investments

—

1,172

—

—

1,172

– other assets

—

—

—

345

345

Total liabilities in relation to the group's interests in the unconsolidated
structured entities

—

—

—

—

—

Other off balance sheet commitments

19

—

8,905

6,877

15,801

17,926

20,54049,00622,475

109,947– loans and advances to customers

The group's maximum exposure at 31 Dec 2018

The maximum exposure to loss from the group’s interests in unconsolidated structured entities represents the maximum loss it could
incur as a result of its involvement with these entities regardless of the probability of the loss being incurred.
• For commitments, guarantees and written credit default swaps, the maximum exposure to loss is the notional amount of potential
future losses.
• For retained and purchased investments in and loans to unconsolidated structured entities, the maximum exposure to loss is the
carrying value of these interests at the balance sheet reporting date.
The maximum exposure to loss is stated gross of the effects of hedging and collateral arrangements entered into to mitigate the group’s
exposure to loss.

Securitisations
The group has interests in unconsolidated securitisation vehicles through holding notes issued by these entities.

HSBC managed funds
The group establishes and manages money market funds and non-money market investment funds to provide customers with investment
opportunities. The group, as fund manager, may be entitled to receive management and performance fees based on the assets undermanagement. The group may also retain units in these funds.

Non-HSBC managed funds
The group purchases and holds units of third-party managed funds in order to facilitate business and meet customer needs. In addition toentities, asset and liability classes disclosed above, the group enters into derivative contracts with non-HSBC managed funds.

Other
The group has established structured entities in the normal course of business, such as structured credit transactions for customers, toprovide finance to public and private sector infrastructure projects, and for asset and structured finance transactions. In addition to theinterest disclosed above, the group enters into derivative contracts, reverse repos and stock borrowing transactions with structured
entities. These interests arise in the normal course of business for the facilitation of third-party transactions and risk management
solutions.

Structured entities sponsored by the group
The amount of assets transferred to and income received from such sponsored entities during 2019 and 2018 were not significant.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019113

Notes on the Consolidated Financial Statements

37

Bank balance sheet and statement of changes in equity

Bank balance sheet at 31 December 2019
2019

2018

HK$m

HK$m

Cash and balances at central banks

156,273

147,447

Items in the course of collection from other banks

15,43718,021

Hong Kong Government certificates of indebtedness

298,944

280,854

Trading assets

496,660

439,155

Derivatives

267,018

276,558

AssetsFinancial assets designated and otherwise mandatorily measured at fair value through profit or loss
Reverse repurchase agreements – non-trading
Loans and advances to banks

7,087

6,298

235,823

243,203

184,429

159,636

2,024,194

1,947,307

Financial investments

830,648866,566

Amounts due from Group companies

332,865

347,652

Investments in subsidiaries

93,35588,169Interests in associates and joint ventures

39,83039,830Goodwill and intangible assets

11,242

8,419

Property, plant and equipment

79,20875,897Loans and advances to customers

Deferred tax assets

819

682

131,368

130,057

5,205,200

5,075,751

Hong Kong currency notes in circulation

298,944

280,854

Items in the course of transmission to other banks

17,87822,786

Repurchase agreements – non-trading

61,79355,142

Deposits by banks

129,703

121,618

Customer accounts

3,287,463

3,186,542

Prepayments, accrued income and other assets
Total assets
Liabilities

Trading liabilities

49,39947,491

Derivatives

277,421279,056

Financial liabilities designated at fair value

44,74842,545

Debt securities in issue

53,584

41,398Retirement benefit liabilities

1,426

2,085

Amounts due to Group companies

384,490439,262

Accruals and deferred income, other liabilities and provisions

110,893

98,983Current tax liabilities

7,556

1,600

Deferred tax liabilities

9,199

8,836

Subordinated liabilities

3,114

3,133

4,737,611

4,631,331

Share capital

172,335

172,335

Other equity instruments

44,61535,879Other reserves

27,101

23,346

Retained earnings

223,538

212,860

Total liabilities
EquityTotal equity
Total equity and liabilities

114

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019467,589

444,420

5,205,200

5,075,751

Bank statement of changes in equity for the year ended 31 December 2019
Other reserves

SharecapitalOther
equityinstruments

Retainedearnings

Property
revaluation
reserve

Financialassets at
FVOCI
reserve7

Cash
flow
hedge
reserve

Foreignexchangereserve

Other1Total
equity

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

172,335

35,879212,860

39,506

1,037

(84)

(12,846)(4,267)444,420

Profit for the year——

79,694

—

—

—

—

—

79,694

Other comprehensive income/(expense) (netof tax)——(1,993)

2,836

2,467

(35)

(481)

—

2,794

– debt instruments at fair value throughother comprehensive income

—

—

—

—

1,438

—

—

—

1,438

– equity instruments designated at fair value
through other comprehensive income

—

—

—

—

1,029

—

—

—

1,029

– cash flow hedges

—

—

—

—

—

(35)

—

—

(35)

– changes in fair value of financial liabilities
designated at fair value upon initialrecognition arising from changes in own
credit risk——

(2,007)

—

—

—

—

—

(2,007)– property revaluation

—

—

—

2,836

—

—

—

—

2,836

– remeasurement of defined benefit asset/
liability

—

—

14

—

—

—

—

—

14

– exchange differences

—

—

—

—

—

—

(481)

—

(481)

Total comprehensive income/(expense)
for the year——

77,701

2,836

2,467

(35)

(481)

—

82,488Other equity instruments issued2—

44,615

—

—

—

—

—

—

44,615

Other equity instruments repaid2—(35,879)

—

—

—

—

—

—

(35,879)

Dividends paid3——(68,369)

—

—

—

—

—

(68,369)

Movement in respect of share-based
payment arrangements
Transfers and other movements

—

—

(30)

—

—

—

—

227

197

—

—

1,376

(1,366)

—

—

—

107

117

At 31 Dec 2019

172,335

44,615

223,538

40,976

3,504

(119)

(13,327)(3,933)

467,589

At 31 Dec 20177

151,360

14,737

205,582

39,799

1,688

(118)

(9,473)(13,041)

390,534

–

–

(896)

–

(356)

–

–

–

(1,252)

151,360

14,737

204,686

39,799

1,332

(118)

(9,473)(13,041)

389,282

Profit for the year––

75,742

–

–

–

–

–

75,742Other comprehensive income/(expense) (netof tax)

–

–

(535)

8,410

(295)

34

(3,373)–4,241– debt instruments at fair value throughother comprehensive income

–

–

–

–

(261)

–

–

–

(261)

– equity instruments designated at fair value
through other comprehensive income

–

–

–

–

(34)

–

–

–

(34)

– cash flow hedges

–

–

–

–

–

34

–

–

34

– changes in fair value of financial liabilities
designated at fair value upon initialrecognition arising from changes in own
credit risk

–

–

(208)

–

–

–

–

–

(208)

– property revaluation

–

–

–

8,410

–

–

–

–

8,410

– remeasurement of defined benefit asset/
liability

–

–

(327)

–

–

–

–

–

(327)

– exchange differences

–

–

–

–

–

–

(3,373)–(3,373)

Total comprehensive income/(expense) for
the year––

75,207

8,410

(295)

34

(3,373)–

79,983

Other equity instruments issued2–

21,142

–

–

–

–

–

–

21,142

Dividends paid3––(47,440)

–

–

–

–

–

(47,440)

At 1 Jan 2019

Impact on transition to HKFRS 9
At 1 Jan 2018

Movement in respect of share-based
payment arrangements

–

–

(213)

–

–

–

–

215

2

Transfers and other movements4,6

20,975–(19,380)(8,703)

–

–

–

8,559

1,451

At 31 Dec 2018

172,335

35,879212,860

39,506

1,037

(84)

(12,846)(4,267)444,420

For footnotes, please refer to page 65.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019115

Notes on the Consolidated Financial Statements

38

Legal proceedings and regulatory matters

The group is party to legal proceedings and regulatory matters in a number of jurisdictions arising out of its normal business operations.
Apart from the matters described below, the Bank considers that none of these matters are material. The recognition of provisions isdetermined in accordance with the accounting policies set out in note 1.2(n). While the outcome of legal proceedings and regulatory
matters is inherently uncertain, management believes that, based on the information available to it, appropriate provisions have been
made in respect of these matters as at 31 December 2019. Any provision recognised does not constitute an admission of wrongdoing or
legal liability. It is not practicable to provide an aggregate estimate of potential liability for our legal proceedings and regulatory matters
as a class of contingent liabilities.

Anti-money laundering and sanctions-related matters
In December 2012, among other agreements, HSBC Holdings plc agreed to an undertaking with the UK Financial Services Authority,
which was replaced by a Direction issued by the UK Financial Conduct Authority ('FCA') in 2013, and consented to a cease-and-desist
order with the US Federal Reserve Board (‘FRB’), both of which contained certain forward-looking anti-money laundering (‘AML’) andsanctions-related obligations. HSBC also agreed to retain an independent compliance monitor (who is, for FCA purposes, a ‘Skilled
Person’ under section 166 of the Financial Services and Markets Act and, for FRB purposes, an ‘Independent Consultant’) to produce
periodic assessments of the Group’s AML and sanctions compliance programme (the ‘Skilled Person/Independent Consultant’). In
December 2012, HSBC Holdings plc also entered into an agreement with the Office of Foreign Assets Control (‘OFAC’) regarding
historical transactions involving parties subject to OFAC sanctions. Reflective of HSBC’s significant progress in strengthening its financial
crime risk management capabilities, HSBC’s engagement with the current Skilled Person will be terminated and a new Skilled Personwith a narrower mandate will be appointed to assess the remaining areas that require further work in order for HSBC to transition fully tobusiness-as-usual financial crime risk management. The Independent Consultant will continue to carry out an annual OFAC compliancereview at the FRB’s discretion.
Through the Skilled Person/Independent Consultant’s prior reviews, as well as internal reviews conducted by HSBC, certain potential
AML and sanctions compliance issues have been identified that HSBC is reviewing further with the FRB, FCA and/or OFAC. The Financial
Crimes Enforcement Network of the US Treasury Department as well as the Civil Division of the US Attorney’s Office for the Southern
District of New York are investigating the collection and transmittal of third-party originator information in certain payments instructed
over HSBC’s proprietary payment systems. HSBC is cooperating with all of these investigations.
Based on the facts currently known, it is not practicable at this time for HSBC to predict the resolution of these matters, including thetiming or any possible impact on HSBC, which could be significant.

Tax-related investigations
Various tax administration, regulatory and law enforcement authorities around the world have been conducting investigations andreviews of HSBC companies in connection with allegations of tax evasion or tax fraud, money laundering and unlawful cross-borderbanking solicitation.
HSBC continues to cooperate with tax-related investigations by tax administration, regulatory or law enforcement authorities. Based on
the facts currently known, it is not practicable at this time for HSBC to predict the resolution of these ongoing matters, including thetiming or any possible impact on HSBC.

Singapore Interbank Offered Rate (‘Sibor’), Singapore Swap Offer Rate (‘SOR’) and Australia Bank Bill
Swap Rate (‘BBSW’)
In July and August 2016, HSBC and other panel banks were named as defendants in two putative class actions filed in the New York
District Court on behalf of persons who transacted in products related to the Sibor, SOR and BBSW benchmark rates. The complaints
allege, among other things, misconduct related to these benchmark rates in violation of US antitrust, commodities and racketeering laws,
and state law.
In the Sibor/SOR litigation, following a decision on the defendants’ motion to dismiss in October 2018, the claims against a number of
HSBC entities were dismissed, and the Bank remained as the only HSBC defendant in this action. In October 2018, the Bank filed amotion for reconsideration of the decision based on the issue of personal jurisdiction; this motion was denied in April 2019. Also in
October 2018, the plaintiffs filed a third amended complaint, naming only the Sibor panel members, including the Bank, as defendants;
the court dismissed the third amended complaint in its entirety in July 2019 against all defendants. In August 2019, the plaintiffs filed an
appeal to the Second Circuit Court of Appeals, which remains pending.
In the BBSW litigation, in November 2018, the court dismissed all foreign defendants, including all the HSBC entities, on personal
jurisdiction grounds. In April 2019, the plaintiffs filed an amended complaint, which the defendants have moved to dismiss.
There are many factors that may affect the range of outcomes, and the resulting financial impact, of these matters, which could besignificant.

United States Bankruptcy Court for the Southern District of New York litigation
In June 2018, a claim was issued against the Bank in the United States Bankruptcy Court for the Southern District of New York by the
Chapter 11 Trustee of CFG Peru Investments Pte. Ltd. (Singapore) (the ‘Trustee Complaint’). The Trustee Complaint makes allegations
under the Peruvian Civil Code, Hong Kong and U.S. common law and the Bankruptcy Code concerning the Bank's alleged conduct incommencing the winding-up proceedings and pursuing the appointment of joint provisional liquidators for affiliates of CFG Peru
Investments Pte. Ltd. The Trustee is seeking damages and equitable subordination or disallowance of the Bank’s Chapter 11 claims in a
related bankruptcy proceeding.
The Bank is seeking to dismiss the Trustee Complaint. Based on the facts currently known, it is not practicable at this time to predict theresolution of this matter, including the timing or any possible impact, which could be significant.

Foreign exchange rate investigations
In January 2018, HSBC Holdings plc entered into a three-year deferred prosecution agreement with the Criminal Division of the
US Department of Justice ('DoJ') (the ‘FX DPA’), regarding fraudulent conduct in connection with two particular transactions in 2010 and2011. This concluded the DoJ’s investigation into HSBC’s historical foreign exchange activities. Under the terms of the FX DPA, HSBC116

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019has a number of ongoing obligations, including implementing enhancements to its internal controls and procedures in its Global Markets
business, which will be the subject of annual reports to the DoJ. In addition, HSBC agreed to pay a financial penalty and restitution.
There are many factors that may affect the range of outcomes, and the resulting financial impact of this matter, which could besignificant.

39

Ultimate holding company

The ultimate holding company of the Bank is HSBC Holdings plc, which is incorporated in England.
The largest group in which the accounts of the Bank are consolidated is that headed by HSBC Holdings plc. The consolidated accounts of
HSBC Holdings plc are available to the public on the HSBC Group’s website at www.hsbc.com or may be obtained from 8 Canada
Square, London E14 5HQ, United Kingdom.

40

Events after the balance sheet date

The Directors of the Group approved a 2020 business update after 31 December 2019, setting out a plan that aims to reallocate capital toareas that can deliver stronger returns, to reduce costs across the Group, and to simplify the business. One change as part of this plan isa change to the global businesses that form the group’s reportable segments as described in note 32. The existing Retail Banking &Wealth Management and Global Private Banking global businesses will be merged to create one new global business, Wealth andPersonal Banking, which will become a reportable segment during 2020.
The ECL at 31 December 2019 was estimated based on a range of forecast economic conditions as at that date. Since early January
2020, the coronavirus outbreak has spread across mainland China and beyond, causing disruption to business and economic activity. The
impact on GDP and other key indicators will be considered when determining the severity and likelihood of downside economic scenariosthat will be used to estimate ECL under HKFRS 9 in 2020.

41

Approval of financial statements

The Consolidated Financial Statements were approved and authorised for issue by the Board of Directors on 18 February 2020.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2019117

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