The Hongkong and Shanghai
Banking Corporation Limited
Annual Report and Accounts 2018

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

Capital42

Statement of Directors’ Responsibilities

46

Auditor’s Report

47

Financial Statements
Consolidated income statement

52

Consolidated statement of comprehensive income

53

Consolidated balance sheet

54

Consolidated statement of cash flows

55

Consolidated statement of changes in equity

56

Notes on the Financial Statements
1

Basis of preparation and significant accounting policies

572

Effects of reclassification upon adoption of HKFRS 9

70

3

Operating profit

74

4

Insurance business

76

5

Employee compensation and benefits

77

6

Tax expense

797

Dividends

81

8

Trading assets

81

9

Derivatives

81

10

82

11

Financial assets designated and otherwise mandatorily
measured at fair value
Loans and advances to customers

12

Financial investments

84

13

Assets pledged, assets transferred and collateral received

84

14

Investments in subsidiaries

85

15Interests in associates and joint ventures

86

16

Goodwill and intangible assets

89

17

Property, plant and equipment

90

18

Prepayments, accrued income and other assets

91

19

Customer accounts

91

20

Trading liabilities

91

21

Financial liabilities designated at fair value

92

22

Debt securities in issue

92

23

Accruals and deferred income, other liabilities and provisions

92

24

Subordinated liabilities

93

25

Preference shares

93

26

Share capital

94

27

Other equity instruments

94

28

Maturity analysis of assets and liabilities

94

29

97

30

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

31

Other commitments

98

32

Offsetting of financial assets and financial liabilities

99

33

Segmental analysis

100

34

Related party transactions

101

35

Fair values of financial instruments carried at fair value

103

36

Fair values of financial instruments not carried at fair value

106

37

Structured entities

108

38

Bank balance sheet and statement of changes in equity

110

39

Legal proceedings and regulatory matters

112

40

Ultimate holding company

113

41

Events after the balance sheet date

113

42

Approval of financial statements

113

83

This document comprises the Annual Report and Accounts 2018
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.

98

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

1

Financial Highlights | Report of the Directors

Financial Highlights
2018

2017

HK$m

HK$m

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

210,469

186,443

Profit before tax

134,583

115,619

Profit attributable to shareholders

103,01388,530Total shareholders’ equity

752,758

696,480

Total equity

812,920752,986

Total capital

557,180522,244

Customer accounts

5,207,666

5,138,272

Total assets

8,263,454

7,943,346

14.8

13.7

For the year

At the year-end

Ratios%Return on average ordinary shareholders’ equity
Post-tax return on average total assets

1.4

1.2

Cost efficiency ratio

41.5

43.5

Net interest margin

2.06

1.88

Advances-to-deposits ratio

67.8

64.8

Common equity tier 1 capital

16.5

15.9

Tier 1 capital

17.8

17.0

Total capital

19.8

18.9

Capital ratios

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 2018

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 Group’s aim is to be the world’s leading international bank.
As a subsidiary of the HSBC Group, the group applies a disciplined
approach in managing its portfolio of businesses to focus on areas
where it has a clear competitive advantage. The Group has set
clear strategic actions to deliver growth, improve returns, andenhance customer and employee experience. We will accelerate
growth from our Asian franchise by building on the strength inHong Kong, investing in the Pearl River Delta, the Association ofSoutheast Asian Nations countries, and Wealth in Asia including
Insurance and Asset Management. In addition, we will be theleading bank to support drivers of global investment, including the
China-led Belt and Road Initiative, and transition to a low carbon
economy whilst gaining market share and deliver growth from ourinternational network. We will continue to implement HSBC Global
Standards as a competitive advantage and to increase the qualityof earnings.
The group’s strong presence across the Asia-Pacific region will
help maintain its competitive advantage in connecting business
opportunities within the region, as well as between Asia-Pacificand other parts of the world.

Financial Statements
The state of affairs of the Bank and the group, and theconsolidated profit of the group, are shown on pages 52 to 113.

Subordinated liabilities, Preference Shares andShare Capital
Details on subordinated liabilities issued by the group are set out
in notes 24 and 34. Details on preference shares and share capitalof the Bank are set out in notes 25, 26 and 27 on the Financial
Statements.

Dividends
The interim dividends paid in respect of 2018 are set out in note 7
on the Financial Statements.

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

Laura May Lung Cha*, GBM
Deputy 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.

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;
Chairman of Infrastructure New South Wales; and Chairman and a
Director of 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; an
independent non-executive Director of Treasury Wine Estates Limited; anInternational Advisor of China Union Pay; and a Group General Manager of
HSBC Holdings plc. She holds a Bachelor of Social 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 andan 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 a Doctor of Philosophy (Economics) from University ofPennsylvania.

Yiu Kwan Choi*

Chairman
He is Group Chief Executive and an executive Director of HSBC
Holdings plc. He holds a Bachelor of Arts (Hons) in Economics from
Portsmouth Polytechnic.
His previous roles with the Group include: Chief Executive of Retail
Banking and Wealth Management, Chief of Staff to Group Chief Executive
and Group Head of Strategy and Planning, Chief Executive Officer of
Global Asset Management, Group Treasurer and Deputy Head of Global
Markets.

He is an independent non-executive Director of HSBC Bank (China)
Company Limited. He holds a higher certificate in Accountancy from
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.

Peter Tung Shun Wong

Irene Yun-lien Lee*

Deputy Chairman & Chief Executive
He is a Group Managing Director and a member of the GroupManagement Board of HSBC Holdings plc; a non-executive Director ofHang Seng Bank Limited; and Vice Chairman and a non-executive Directorof Bank of Communications Co., Ltd. He is also Chairman of HSBC Bank
(China) Company Limited. He holds a Bachelor of Arts, a Master ofBusiness Administration and a Master of Science from Indiana University.

She is executive Chairman of Hysan Development Company Limited andan independent non-executive Director of HSBC Holdings plc, Hang Seng
Bank Limited and Cathay Pacific Airways Limited. She holds a Bachelor ofArts (Distinction) in History of Art from Smith College, Northampton,
Massachusetts, USA. She is also a member of the Honourable Society ofGray’s Inn, UK and a Barrister-at-Law in England and Wales.

John Michael Flint#

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20183

Report of the Directors

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.

Bin Hwee Quek (née Chua)*, JP
She is an independent non-executive Director of CapitaLand Commercial
Trust Management Limited and Mapletree Oakwood Holdings Pte. Ltd.
She is also a Director of several government or government-fundedorganisations in Singapore, including Duke-NUS Graduate Medical
School, Health Promotion Board, Maritime and Port Authority ofSingapore, and National Heritage Board.
She was an audit partner of PricewaterhouseCoopers (PwC) Singapore
and held many leadership positions including Vice Chairman of PwC
Singapore and Deputy Markets Leader of PwC Asia Pacific and Americas.
She holds a Bachelor of Accountancy (Hons) from The University ofSingapore and is a Chartered Accountant with the Institute of Singapore
Chartered Accountants.

Kevin Anthony Westley*, BBS
He is an independent non-executive Director of Hutchison Port Holdings
Management Pte. Ltd. and Fu Tak Iam Foundation Limited and a memberof the investment committee of The West Kowloon Cultural Development
Authority. He holds a Bachelor of Arts (Hons) from the 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.

Marjorie Mun Tak Yang*, GBS
She is Chairman of Esquel Holdings Inc. She holds a B.Sc. in Mathematics
from Massachusetts Institute of Technology and a Master of Business
Administration from Harvard Business School.

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

During the year, John Flint was appointed a Director on 16
January 2018 and Chairman on 21 February 2018. Stuart Gulliver
stepped down as Chairman and a Director on 20 February 2018
and John Slosar resigned on 24 July 2018. Save for the above, 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 2018 to the date of this report will be available on the
Bank’s website https://www.hsbc.com.hk/legal/regulatorydisclosures/.

Secretary
Neil Olofsson succeeded Paul Stafford as Corporation Secretarywith effect from 1 April 2018.

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’ and officers’ 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
No transactions, arrangements or contracts that were significant
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 Bank, 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 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 is determined in accordance with therequirements 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, theirretention 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, all employees including
executive Directors are required to certify each year that they havenot entered 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

4

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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, Stuart Gulliver, John Flint, Peter Wong and Louisa
Cheang acquired or were awarded shares of HSBC Holdings plc
under the terms of the HSBC Share Plan 2011. John Flint was also
granted options over ordinary shares in HSBC Holdings plc underthe 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
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.

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
12 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 heldby experienced full-time employees 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 is
responsible for the development of strategy and the oversight ofimplementation of Board approved strategies and direction. The
Chief Executive is responsible for ensuring implementation of thestrategy 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 Asia-Pacific Global Business andGlobal Function head reports to the Chief Executive.

DonationsBoard Committees

Donations made by the Bank and its subsidiaries during the year
amounted to HK$302m (2017: HK$386m).

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.

Compliance with the Banking (Disclosure) Rules
The Directors are of the view that the Annual Report and Accounts
2018 and Banking Disclosure Statements 2018, 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 non-executive
Chairman; the Deputy Chairman and Chief Executive; two Deputy
Chairmen who are independent non-executive Directors; one
Director with executive responsibilities for a subsidiary’s
operations; one non-executive Director; and another 10
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

The Board has also established an Asset and Liability Management
Committee, a Risk Management Meeting and a Financial Crime
Risk Management Committee. The Executive Committee has thedelegated authority to approve any changes in the membershipand terms of reference of the Asset and Liability Management
Committee, the Risk Management Meeting and the Financial
Crime Risk Management Committee. The Board had establishedFinancial System Risk Advisory Committees for North Asia andSouth Asia as sub-committees of the Risk Committee withresponsibilities to advise on the effectiveness of the policies,
procedures and the framework of controls established bymanagement relating to financial crime risks. Both subcommittees consisted of external professional advisors. Yiu Kwan
Choi, who is an independent non-executive Director of the Bank,
was also a member of the sub-committee for North Asia. Bothsub-committees met once in 2018 and were subsequently
demised on 19 April 2018.
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),
Raymond Cheng (Chief Operating Officer Asia-Pacific), Gordon
French (Head of Global Banking and Markets Asia-Pacific),
Kathleen Gan (Chief Financial Officer Asia-Pacific), Tony Cripps(Chief Executive Officer Singapore), Mukhtar Hussain (Head of Belt

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20185

Report of the Directors

and Road Initiative Asia-Pacific), Darren Furnarello (Head ofFinancial Crime Compliance Asia-Pacific), David Liao (Chief
Executive Officer China), Kevin Martin (Head of Retail Banking and
Wealth Management Asia-Pacific), Mark McKeown (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 andHead of International Asia-Pacific), Susan Sayers (General Counsel
Asia-Pacific), Stuart Tait (Head of Commercial Banking AsiaPacific), Martin Tricaud (Chief Executive Officer Australia) andHelen Wong (Chief Executive Officer Greater China). Neil Olofsson(Corporation Secretary) is the Committee Secretary. In attendance
are: Kaber Mclean (Head of Remediation Management Office AsiaPacific), Patrick Humphris (Head of Communications Asia-Pacific),
Amo Tauialo (Head of Global Internal Audit Asia-Pacific) and PhilipMiller (Deputy Corporation Secretary). The Committee met 11
times in 2018.

Asset and Liability Management Committee
The Asset and Liability Management Committee is chaired by the
Chief Financial Officer and is an advisory committee to provide
recommendations and advice to support the Chief Financial
Officer's individual accountability for issues and risks with regards
to capital, liquidity risk, funding risk, interest rate risk in thebanking book, structural foreign exchange risk and structural /strategic equity risk. The Committee consists of Kathleen Gan(Chief Financial Officer Asia-Pacific), Peter Wong (the Bank's
Deputy Chairman and Chief Executive), the Head of Asset, Liability
and Capital Management Asia-Pacific, the Head of Balance SheetManagement Asia-Pacific and other senior executives of the Bank
most of whom are members of the Executive Committee. The
Committee met 12 times in 2018.

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 Mark McKeown (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 2018.

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 of the
Head of Financial Crime Compliance Asia-Pacific, the Head ofFinancial Crime Threat Mitigation Asia-Pacific, the Head ofOperational Risk Asia-Pacific, the Head of Remediation Office
Asia-Pacific, the Head of Global Internal Audit Asia-Pacific, theChief Operating Officer, Compliance, Asia-Pacific, the Head ofRegulatory Compliance Asia-Pacific and other senior executives of
the Bank most of whom are members of the Executive Committee.
The Committee met 10 times in 2018.

Audit Committee
The Audit Committee has non-executive responsibility foroversight of and advice to the Board on matters relating tofinancial reporting. The current members of the Committee, allbeing 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 2018.
The Audit Committee monitors the integrity of the financial
statements and oversees the internal control systems overfinancial reporting, covering all material controls. The Committee
reviews the adequacy of resources, qualifications and experience
6of staff of the accounting and financial reporting function and theirtraining programmes and budget. The Committee also reviews thefinancial statements before submission to the Board. It monitors
and reviews the effectiveness of the internal audit function andreviews the Bank’s financial and accounting policies and practices.
The Committee advises the Board on the appointment of theexternal auditor and reviews and monitors the external auditor’s
independence and objectivity and the effectiveness of the audit
process. The Committee reviews matters escalated for its attention
by subsidiaries’ audit committees and reviews minutes ofmeetings of the Asset and Liability Management Committee.

Risk Committee
The Risk Committee has non-executive responsibility for oversightof and advice to the Board on high-level risk-related matters andrisk governance. The current members of the Committee, all being
independent non-executive Directors, are Graham Bradley(Chairman of the Committee), Dr Christopher Cheng, Yiu Kwan
Choi, Irene Lee, Zia Mody and Kevin Westley. The Committee met
five times in 2018.
All of the Bank’s activities involve, to varying degrees, themeasurement, evaluation, acceptance 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
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 biannually and recommends any proposedchanges to the Board for approval. The Committee reviews
management’s assessment of risk against the risk appetitestatement and provides scrutiny of management’s proposed
mitigating actions. The Committee monitors the risk profiles for allof the risk categories within the group’s business. The Committee
also monitors the effectiveness of the Bank’s risk management
and internal controls, including operational and compliance
controls, and risk management systems. Regular reports from the
Risk Management Meeting, which is the executive bodysupporting the executive accountability of the group Chief Risk
Officer for the ongoing monitoring, assessment and managementof the risk environment and the effectiveness of the risk
management framework, are also presented at each Risk
Committee meeting to report on these items.
The Committee reviews matters escalated for its attention bysubsidiaries’ risk committees and reviews minutes of meetings of
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 and experience on the Board.
The current members of the Committee, being a majority of
independent non-executive Directors, are Marjorie Yang (Chairmanof the Committee), John Flint (Chairman of the Board) and Laura
Cha. The Deputy Chairman and Chief Executive attends eachmeeting of the Committee. The Committee met twice in 2018.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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, approve specified matters subject to their 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 nonexecutive Deputy Chairmen and the Chairmen of the Audit andRisk Committees. The Committee met twice times in 2018.

Remuneration Committee
The Group Remuneration Committee is responsible for setting theprinciples, parameters and governance framework for the Group‘sremuneration policy 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 group. The current members of the Committee, allbeing independent non-executive Directors, are Irene Lee(Chairman of the Committee), Marjorie Yang, Dr Christopher
Cheng, Jennifer Li and Bin Hwee Quek. The Committee met fivetimes in 2018.

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, isbased 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.

An annual review of the Bank’s remuneration strategy applicableto the Bank as a Group’s subsidiary and its operation iscommissioned externally and carried out independently of
management. The review conducted by Deloitte LLP confirms thatthe Bank’s remuneration policy is consistent with the principles
set out in the HKMA Supervisory Policy Manual CG-5 ‘Guideline on
a Sound Remuneration System’.

Banking structural reform and recovery andresolution planning
During 2018, the HSBC Group continued to work with regulators
on banking structural reform including the implementation ofrecovery and resolution regimes. This included further progress inrelation to implementing changes to the legal and operating
structures of the HSBC Group, which would allow it to be resolvedin an orderly manner in the event of failure and in a manner thatminimises disruption to financial stability and the risk to publicfunds.
In Hong Kong, the Financial Institutions (Resolution) Ordinance(‘FIRO’), which came into effect on 7 July 2017, established thelegal basis for a resolution regime in Hong Kong to mitigate therisks posed by the failure of systemically important financial
institutions to the stability and effective working of the Hong Kong
financial system. Under FIRO, there are a number of options
available to regulators for implementing an orderly resolution of afailed bank. These options include a bail-in stabilisation option,
which allows regulators to recapitalise a failing bank by imposing
losses on its shareholders and certain creditors, thereby stabilisingand restoring it to viability. The preferred resolution strategy forthe group is a bail-in at an intermediate holding company (‘IHC’)level in Hong Kong to recapitalise the group as a whole. For thispurpose, the ownership of the group was transferred in November
2018 to HSBC Asia Holdings Limited, a newly incorporated IHC
that is a wholly-owned subsidiary of HSBC Holdings plc. The
transfer of ownership of the group to HSBC Asia Holdings Limited
was an internal legal entity restructuring which did not impact thebusiness and management of the group.
In order to ensure the effective use of the bail-in stabilisation
option, banks are required to issue loss-absorbing capacity (‘LAC’)
instruments that can be written down or converted into equity inthe event of failure. The LAC rules in Hong Kong were passed in
December 2018, with phased implementation periods. For thegroup and HSBC Asia Holdings Limited, the LAC requirements are
expected to be implemented in 2019.
During 2018, the group also made progress to remove internal
operational dependencies (for instance, where one group entity
provides critical services to another) to further facilitate therecovery and resolution planning of the group. In particular, thegroup transferred critical shared services to a separate internalgroup of service companies (‘ServCo group’), which is outside of
the group but remains wholly-owned by HSBC Holdings plc. The
transfer to the ServCo group of relevant employees, critical sharedservices and assets in Hong Kong was substantially completed on
1 January 2019. The establishment of the ServCo group does notchange how the group operates and there were no changes to
employment terms and conditions or pension benefits as a resultof 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.

• 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 2018 of HSBC Holdingsplc.

On behalf of the Board

John Flint, Chairman
19 February 2019

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20187

Financial Review

Financial Review
Results for 2018
Profit before tax for 2018 reported by The Hongkong and Shanghai Banking Corporation Limited (‘the Bank’) and its subsidiaries (together‘the group’) increased by HK$18,964m, or 16%, to HK$134,583m.
Consolidated income statement 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

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

—

—

—

—

164

164

57,301

3,441

—

—

(64)

60,678Year ended 31 Dec 2018

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

5,851

508

737

110

3,100

10,306

Total 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 expectedcredit losses and other credit impairment charges

88,90752,91151,5086,243

10,900210,469

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

Net loans and advances to customers

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

Net interest income

50,78931,237

19,147

1,868

7,196

110,237

Net fee income

20,695

10,443

9,936

1,916

160

43,150Net income/(expense) from financial instruments
measured at fair value

Profit before tax
Balance at 31 Dec 2018Year ended 31 Dec 2017

17,9592,560

16,180963

928

38,590Gains less losses from financial investments

149

64

1

—

1,894

2,108

Dividend income

36

1

—

—

195

232

53,275

2,933

—

—

(32)

56,176

Net insurance premium income/(expense)
Other operating income

1,488

336

189

51

2,676

4,740

Total operating income

144,391

47,57445,453

4,798

13,017

255,233

Net insurance claims and benefits paid and movement inliabilities to policyholders(65,941)(2,849)———(68,790)

Net operating income before loan impairment charges
and other credit risk provisions

78,45044,72545,453

4,798

13,017

186,443

Loan impairment (charges)/releases and other credit risk
provisions(1,907)(2,157)

(451)

(2)

80

(4,437)

Net operating income

76,54342,56845,002

4,796

13,097

182,006

Operating expenses(34,807)(16,115)(20,653)(2,679)(6,813)(81,067)

Operating profit

41,736

26,45324,349

2,117

6,284

100,939

Share of profit in associates and joint ventures

86

—

—

—

14,594

14,68041,822

26,45324,3492,117

20,878

115,619

Net loans and advances to customers

1,049,006

1,143,241

1,004,350

115,064

17,3193,328,980

Customer accounts

2,701,399

1,311,873

905,991

187,825

31,184

5,138,272

Profit before tax
Balance at 31 Dec 2017

18

Includes inter-segment elimination

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Results Commentary(Unaudited)

The group reported profit before tax of HK$134,583m, an increaseof 16% compared with 2017, driven by higher net interest income.
Net interest income increased by HK$16,226m, or 15%,compared with 2017, driven by Hong Kong from improved deposit
spreads, mainly in Retail Banking and Wealth Management('RBWM') and Commercial Banking ('CMB'), which benefited frominterest rate rises, coupled with balance sheet growth, primarily inloans and advances to customers, partly offset by compressed
lending spreads. Net interest income also increased in mainland
China mainly from growth in loans to customers and improved
yields.
Net fee income increased by HK$1,081m, or 3%, compared with2017, mainly in Hong Kong from securities brokerage, unit trustand global custody due to higher turnover, coupled with higher
mandatory provident fund and credit cards fee income, partly
offset by lower underwriting and remittance fees. Fee income inmainland China also increased, mainly from unit trust,underwriting, trade-related fees, credit facilities and credit cards.
Net income from financial instruments measured at fairvalue decreased by HK$12,625m, or 33%, compared with 2017,
driven by lower insurance income, mainly in Hong Kong due torevaluation losses on the equity portfolio from the unfavourable
equity market performance in 2018, as compared to revaluation
gains in 2017. To the extent that revaluation is attributable topolicyholders, there is an offsetting movement reported under ‘Net
insurance claims and benefits paid and movement in liabilities topolicyholders’. The decrease was partly offset by higher trading
income in Hong Kong, mainly from increased holdings of trading
debt securities, higher structured equities revenue and revaluation
gains on funding swaps. Trading income in mainland China also
increased due to a favourable effect from translation of balance
sheet exposures and higher income from debt securities trading.
Gains less losses from financial investments decreased by
HK$1,607m, or 76%, compared with 2017, mainly in Hong Kongfrom the non-recurrence of the gain on disposal of our investment
in Vietnam Technological and Commercial Joint Stock Bank('TechCom Bank') in 2017.

Other operating income increased by HK$5,566m, or 117%,
compared with 2017, primarily driven by the favourable movementin the present value of in-force long-term insurance business('PVIF'), mainly in Hong Kong from higher new business sales, thefuture sharing of lower investment returns with policyholders, andfavourable actuarial and interest rate assumption updates in 2018.
In addition, the non-recurrence of regulatory driven changes in
actuarial assumptions in Singapore in 2017 also contributed to theoverall favourable movement in PVIF in the year. The change in
PVIF was partly offset by a corresponding movement in ‘Net
insurance claims and benefits paid and movement in liabilities topolicyholders’.
Net insurance claims and benefits paid and movement inliabilities to policyholders decreased by HK$10,951m, or 16%,
compared with 2017, reflecting lower investment returns topolicyholders due to the unfavourable equity market performancein 2018 as compared with the favourable equity market
performance in 2017, partly offset by the non-recurrence of thelarge reinsurance arrangement in prior year, coupled with higher
premium income and the favourable movement in PVIF in 2018.
Change in expected credit losses and other credit
impairment charges (under HKFRS 9) amounted to HK$4,720m
for the year ended 2018, mainly from Hong Kong and mainland
China in CMB and RBWM, and to a lesser extent Indonesia in
CMB and Malaysia in Global Banking and Markets ('GB&M').
Loan impairment charges and other credit risk provisions in 2017
(under HKAS 39) amounted to HK$4,437m, mainly from Hong
Kong in CMB and RBWM, and to a lesser extent Indonesia andmainland China mainly in CMB.
Total operating expenses increased by HK$6,357m, or 8%,
compared with 2017, driven by higher IT-related and staff costs
from investments to support digital and business growth
initiatives.
Share of profit in associates and joint ventures increased by
HK$1,578m, or 11%, compared with 2017, mainly from our shareof higher profits from Bank of Communications Co., Limited,coupled with a favourable effect of foreign exchange translation.

Net insurance premium income increased by HK$4,502m, or
8%, compared with 2017, driven by the non-recurrence of a majorreinsurance arrangement in 2017, coupled with higher premiumfrom new business sales and higher renewals. This was largely
offset by a corresponding movement in ‘Net insurance claims andbenefits paid and movement in liabilities to policyholders’.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 20189

Financial Review

Net interest income(Unaudited)

Net interest income
Average interest-earning assets

2018

2017

HK$m

HK$m

126,463

110,237

6,151,920

5,850,010%%

Net interest spread

1.93

1.80

Contribution from net free funds

0.13

0.08

Net interest margin

2.06

1.88

Net interest income (‘NII’) increased by HK$16,226m, or 15%
compared with 2017, driven by Hong Kong from improved
customer deposit spreads and balance sheet growth, mainly inloans and advances to customers, coupled with higher yields on
financial investments which benefited from interest rate rises.
These increases were partly offset by compressed lending
spreads, increases in financial liabilities to meet the ‘Total Loss
Absorbing Capacity’ regulatory requirement, coupled with theimpact of re-pricing on these financial liabilities as market interest
rates increased. NII also increased in mainland China from balance
sheet growth and improved yields, partly offset by higher cost offunds on debt securities issued to support business growth. To alesser extent, NII also increased in Singapore and Malaysia from
improved yields and balance sheet growth.
Average interest-earning assets increased by HK$302bn, or
5%, compared with 2017, driven by Hong Kong primarily due toan increase in loans and advances to customers, notably incorporate term lending and mortgages. To a lesser extent,
increases were also noted in mainland China, Australia, Singapore,
Taiwan and Malaysia, mainly from growth in loans and advances
to customers.

In Hong Kong, the net interest margin for the Bank increased by
25 basis points, mainly due to improved customer deposit spreads
and a change in asset portfolio mix due to growth in customer
lending, coupled with higher re-investment yields on financial
investments following interest rate increases. These increases
were partly offset by compressed lending spreads and increases infinancial liabilities to meet the ‘Total Loss Absorbing Capacity’regulatory requirement, coupled with the impact of re-pricing onthese financial liabilities as market interest rates increased.
At Hang Seng Bank, the net interest margin increased by 25
basis points, mainly from improved customer deposit spreads anda change in asset portfolio mix due to growth in customer lending,coupled with higher re-investment yields on financial investments
following interest rate increases, partly offset by compressed
lending spreads.
In mainland China, the increase in net interest margin was driven
by higher yield from portfolio mix changes due to growth incustomer lending, improved lending spreads and customer deposit
spreads, coupled with an increase in contribution from net free
funds, partly offset by higher cost of funds from increased funding
to support business growth.

Net interest margin increased by 18 basis points compared with2017, driven by Hong Kong and mainland China.

Insurance business(Unaudited)

The following table shows the profit from insurance manufacturing operations and insurance distribution income earned by banking
operations.
Summary income statement of insurance manufacturing operations
2018

2017

HK$m

HK$m

Net interest income

13,65012,571

Net fee expense(3,162)(2,487)

Net income/(expense) from financial instruments measured at fair value(6,279)15,475

Net insurance premium income

60,71356,176

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

4,629

305

Insurance manufacturing operations

Other operating income

529

470

Total operating income

70,08082,510Net insurance claims and benefits paid and movement in liabilities to policyholders(57,839)(68,790)

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

12,241

13,720Change in expected credit losses and other credit impairment charges
Net operating income

1—

12,242

13,720Total operating expenses(2,217)(1,967)

Operating profit

10,025

11,753

Share of profit in associates and joint ventures

246

86

Profit before tax

10,271

11,839Distribution income earned by banking operations1

5,726

5,301

1

Distribution income earned by banking operations are presented separately. Comparatives have been represented accordingly.

10

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Insurance manufacturing
Profit before tax from the insurance manufacturing businessdecreased by HK$1,568m, or 13%, driven by the unfavourable
equity market performance in 2018 compared to the favourable
equity market performance in 2017.
Net interest income increased by 9% from growth in insurance
fund size, reflecting net inflows from new and renewal of life
insurance premiums.
Net income from financial instruments measured at fair value
decreased due to revaluation losses on the equity portfolio
supporting insurance contracts from unfavourable equity market
performance in 2018, compared to revaluation gains in 2017.
Net insurance premium income increased, mainly in Hong Kong
due to the non-recurrence of a major reinsurance arrangement
entered into in 2017, coupled with higher new business sales andrenewals.
The favourable movement in the present value of in-force longterm insurance business (‘PVIF’) was driven by Hong Kong, fromthe future sharing of lower investment returns with policyholders,higher new business sales, and favourable actuarial and interest
rate assumption updates in 2018. In addition, the non-recurrenceof regulatory driven changes in actuarial assumptions in Singapore
in 2017 also contributed to the overall favourable movement in
PVIF in the year, although this was partly offset by the impact fromhigher lapse rate experience in 2018.
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.

Balance sheet commentary compared with
1 January 2018 (Unaudited)
The consolidated balance sheet at 31 December 2018 is set out in
the Financial Statements.
The effect of transitioning to HKFRS 9 ‘Financial Instruments’ on 1
January 2018 was a reduction in our total assets of HK$14bn from31 December 2017, and the reclassification of certain items within
the balance sheet as set out in note 2 on the Financial Statements.
The commentary that follows compares our balance sheet at 31
December 2018 with that at 1 January 2018.
Gross loans and advances to customers grew by HK$241bn,
or 7%, including unfavourable foreign exchange translation effectsof HK$53bn. Excluding this impact, the underlying increase of
HK$294bn was driven by increases in corporate and commercial
lending and residential mortgages, mainly in Hong Kong andAustralia.
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 2018. Change in expected credit
losses in 2018 in relation to average gross customer advances
remained low at 0.13% (2017: 0.14%).

Interest in associates and joint ventures
At 31 December 2018, 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 15 on the
Financial Statements for further details). As discussed in that note,in future periods the value in use may increase or decreasedepending on the effect of changes to model inputs. It is expectedthat the carrying amount will increase in 2019 due to retained
profits earned by BoCom. At the point where the carrying amountexceeds the value in use, impairment would be recognised. The
group would continue to recognise its share of BoCom’s profit orloss, but the carrying amount would be reduced to equal the value
in use, with a corresponding reduction in income. An impairment
review would continue to be performed at each subsequent
reporting period, with the carrying amount and income adjusted
accordingly.
Customer deposits rose by HK$85bn, or 2%, to HK$5,208bn
from 1 January 2018, the advances-to-deposits ratio was 67.8% at
the end of the year, compared with 64.2% at 1 January 2018.
Shareholders’ equity grew by HK$68bn to HK$753bn at
31 December 2018, mainly reflecting current year’s profit, net of
dividend payment, coupled with additional tier 1 capital
instruments issued, partly offset by a decrease in foreign exchange
reserve due to depreciation of various currencies against the Hong
Kong dollar.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

11

Risk

We use an enterprise-wide risk management framework at alllevels of the organisation and across all risk types, underpinned byour risk culture.

Risk
Risk Management(Unaudited)

This section describes the enterprise-wide risk management
framework and the significant policies and practices employed by
HSBC in managing its material risks, both financial and nonfinancial.

Our risk management framework

The framework fosters continuous monitoring, promotes risk
awareness and encourages sound operational and strategic
decision making. It also ensures a consistent approach tomonitoring, managing and mitigating the risks we accept andincur in our activities.
The following diagram and descriptions summarise key aspects ofthe framework, including governance and structure, our risk
management tools and our risk culture, which together help alignemployee behaviour with our risk appetite.

Key aspects of risk management framework
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 governance

Responsible for the enterprise-wide management of all risks, including
key policies and frameworks for the management of risk within thegroup.

Three lines of defence model

Our ‘Three lines of defence’ model defines roles and responsibilities forrisk management. An independent Risk function ensures the necessarybalance in risk/return decisions.

Risk governance

Roles and
responsibilities

Risk appetite

Processes and tools

Enterprise-wide risk management tools

Processes to identify/assess, monitor and mitigate risks to ensure weremain within our risk appetite.

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

Internal controls

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.

Systems and infrastructure

Systems and/or processes that support the identification, capture andexchange of information to support risk management activities.

Systems and tools
Our risk culture
Risk culture refers to HSBC’s norms, attitudes and behaviours
related to risk awareness, risk taking and risk management.
HSBC has long recognised the importance of a strong risk culture,
the fostering of which is a key responsibility of senior executives.
Our risk culture is reinforced by HSBC Values and our Global
Standards. It is instrumental in aligning the behaviours ofindividuals with our attitude to assuming and managing risk,
which helps to ensure that our risk profile remains in line with ourrisk appetite.
We use clear and consistent employee communications on risk
to convey strategic messages and set the tone from the Boardand senior management. We also deploy mandatory training on
risk and compliance topics to embed skills and understanding inorder to strengthen our risk culture and reinforce the attitude torisk in the behaviour expected of employees, as described in ourrisk policies.

12

We operate a global whistleblowing platform, HSBC Confidential,
allowing staff to report matters of concern confidentially. We also
maintain an external email address for concerns about accounting
and internal financial controls or auditing matters(accountingdisclosures@hsbc.com). The Group has a strict policy
prohibiting retaliation against those who raise their concerns. All
allegations of retaliation reported are escalated to senior
management.
Our risk culture is also reinforced by our approach toremuneration. Individual awards, including those for senior
executives, are based on compliance with HSBC Values and theachievement of financial and non-financial objectives which arealigned to our risk appetite and global strategy.

Risk Governance
The Board has ultimate responsibility for the effective
management of risk and approves the group’s risk appetite. It isadvised by the Risk Committee on risk appetite and its alignment

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

with strategy, risk governance and internal controls, and high-levelrisk related matters.
Executive accountability for the ongoing monitoring, assessmentand management of risk environment and the effectiveness of therisk management framework resides with the group’s Chief Risk
Officer. He is supported by the Risk Management Meeting(‘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.
Day-to-day responsibility for risk management is delegated tosenior managers with individual accountability for decision
making. All employees 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.

as remuneration, and is therefore forward-looking in describing
the group’s desired risk appetite profile. The RAS consists ofqualitative statements and quantitative metrics, covering financial
and non-financial risks and is formally approved by the Board
every six months on the recommendation of the group's Risk
Committee. It is fundamental to the development of business line
strategies, strategic and business planning, and senior
management balanced scorecards.
The group’s performance against the RAS is reported to the RMM
on a monthly basis so that any actual performance which falls
outside the approved risk appetite is discussed and appropriate
mitigating actions are determined. This reporting allows risks to bepromptly identified and mitigated, and informs risk-adjusted
remuneration to drive a strong risk culture.

We use a defined executive risk governance structure to help
ensure appropriate oversight and accountability of risk, whichfacilitates reporting and escalation to the RMM.

Global businesses and strategic countries are required to havetheir own RASs, which are monitored to ensure they remainaligned with the group’s RAS. All RASs and business activities are
guided and underpinned by a set of qualitative principles.
Additionally, quantitative metrics are defined along with appetiteand tolerance thresholds for key risk areas.

Our responsibilities

Risk map

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

The group's risk map provides a point-in-time view of its risk
profile across HSBC’s risk taxonomy. It assess the potential forthese risks to have a material impact on the group's financial
results, reputation and the sustainability of its business. Risks thathave an ‘amber’ or ‘red’ risk rating require monitoring andmitigating action plans to be either in place or initiated to manage
the risk down to acceptable levels.

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 responsibilities, encouraging collaboration and 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 andensuring that the right controls and assessments are in place tomitigate them.
• The second line of defence sets the policy and guidelines for
managing specific risk areas, provides advice and guidance inrelation to the risk, and challenges the first line of defence on
effective risk management.
• The third line of defence is our Internal Audit function, which
provides independent and objective assurance of the adequacyof the design and operational effectiveness of the group’s risk
management framework and control governance process.

Independent 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 operations 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.

Enterprise-wide risk management tools
The Group uses a range of tools to identify, monitor and manage
risk. The key enterprise-wide risk management tools are
summarised below.

Risk appetite
The Risk Appetite Statement (‘RAS’) sets out the aggregate level
and risk types that the group is willing to accept in order toachieve its business objectives. It provides a benchmark forbusiness decisions that are based on balancing risk and return,and making the best use of our capital. The group's RAS isinterlinked with the group’s strategic and financial plans, as well

Top and emerging risks
We use a top and emerging risks process to provide a forwardlooking view of issues that have the potential to threaten theexecution of our strategy or operations over the medium to longterm.
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 between six months and one year, and has the potential
to materially 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
already have been carried out to assess the impact.
An ‘emerging risk’ is defined as a thematic issue with large
unknown components that may form and crystallise beyond a oneyear time horizon. If it were to materialise, it could have a material
effect on a combination of the group’s long-term strategy,
profitability and/or reputation. Existing mitigation action plans arelikely 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 top and emerging risks are discussed on page 16.

Stress testing
The group operates a comprehensive stress testing programmethat supports our risk management and capital planning. It
includes execution of stress tests mandated by our regulators, aswell as internal stress tests and reverse stress tests. Our stresstesting is supported by dedicated teams and infrastructure and isoverseen at the most senior level of the group.
Our stress testing programme assesses our capital strength
through a rigorous examination of our resilience to external
shocks. It also helps us understand and mitigate risks and informs
our decisions about capital levels.
Internal stress tests are an important element in our risk
management and capital management frameworks. Our capitalplan is assessed through a range of stress scenarios which explore

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

13

Risk

risks identified by management. They include potential adverse
macroeconomic, geopolitical and operational risk events, andother potential events that are specific to the group. The selectionof scenarios reflects our top and emerging risks identification
process and our risk appetite. Stress testing analysis helps
management understand the nature and extent of vulnerabilities towhich the group is exposed. Using this information, management
decides whether risks can or should be mitigated throughmanagement actions or, if they were to crystallise, should beabsorbed through capital. This in turn informs decisions about
preferred capital levels.

Reverse stress tests are conducted annually at group and, whererequired, subsidiary entity level in order to understand which
potential extreme conditions would make our business model nonviable. Reverse stress testing identifies potential stresses andvulnerabilities which the group might face, and helps inform earlywarning triggers, management actions and contingency plansdesigned to mitigate risks.

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

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.

Operational risk
Operational risk is the risk to achieving
our strategy or objectives as a result of
inadequate or failed internal processes,
people and systems or from external
events.

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, and incur fines andpenalties and suffer damage to ourbusiness as a consequence.

14

Arising from

Measurement, monitoring and management of risk

• Credit risk arises principally fromdirect lending, trade finance andleasing business, but also fromcertain other products such as
guarantees and derivatives.

Credit risk is:• measured as the amount which could be lost if a customer orcounterparty 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.

• Exposure to market risk is separated
into two portfolios: trading and nontrading. Market risk exposuresarising from our insurance
operations are discussed on thefollowing page.

Market risk is:• measured in terms of value at risk (‘VaR’), which measures thepotential losses on risk positions over a specified time horizon for agiven level of confidence, and assessed using stress testing;• 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.

• Operational risk arises from day-today operations or external events,
and is relevant to every aspect of ourbusiness.
• Regulatory compliance risk andfinancial crime risk are discussed
below.

Operational risk is:• measured using the risk and control assessment process, whichassesses the level of risk and effectiveness of controls;• monitored using key indicators and other internal control activities; and• managed primarily by global business and functional managers who
identify and assess risks, implement controls to manage them andmonitor the effectiveness of these controls using the operational risk
management framework.

• Regulatory compliance risk is part ofoperational risk, and arises from therisks associated with breaching our
duty to clients and othercounterparties, inappropriate market
conduct and breaching otherregulatory requirements.

Regulatory compliance risk is:• measured by reference to identified metrics, incident assessments,
regulatory feedback and the judgement and assessment of ourregulatory compliance teams;• monitored against the first line of defence risk and control
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 2018

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

Arising from

Measurement, monitoring and management of risk

Financial crime risk
Financial crime risk is the risk that weknowingly or unknowingly help parties
to commit or to further potentially
illegal activity through HSBC.

• Financial crime risk is part ofoperational risk and arises from dayto-day banking operations.

Financial crime 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.

Other material risks
Reputational risk
Reputational risk is the risk of failure to • Primary reputational risks arise
meet stakeholders' expectations as adirectly from an action or inaction by
result of any event, behaviour, action or
HSBC, its employees or associatedinaction, either by HSBC itself, ourparties that are not the consequence
employees or those with whom we areof another type of risk. Secondary
associated.
reputational risks are those arisingindirectly and are a result of a failure
to control any other risks.

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

• 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.

Sustainability risk
Sustainability risk is the risk that• Sustainability risk arises from thefinancial services provided toprovision of financial services tocustomers by the group indirectly resultcompanies or projects which
in unacceptable impacts on people orindirectly result in unacceptableon the environment.
impacts on people or on theenvironment.

Reputational risk is:• measured by reference to our reputation as indicated by our
dealings with all relevant stakeholders, including media, regulators,
customers and employees;• monitored through a reputational risk management framework thatis integrated into the group’s broader risk management framework;and• managed by every member of staff and is covered by a number ofpolicies and guidelines. There is a clear structure of committees andindividuals charged with mitigating reputational risk.
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.

Sustainability risk is:• measured assessing the potential sustainability effect of acustomer’s activities and assigning a sustainability risk rating to allhigh risk transactions;• monitored by the RMM and by the group's sustainability riskfunction; and• managed using sustainability risk policies covering project financelending and sector-based sustainability policies for sectors andthemes with potentially high environmental or social impact.

Our insurance manufacturing subsidiaries are separately regulated from our banking operations. Risks in the insurance entities aremanaged using methodologies and processes appropriate to insurance manufacturing operations, but remain subject to oversight atgroup level. Our insurance operations are also subject to some of the same risks as our banking operations, which are covered by thegroup’s respective risk management processes.
Description of risks – insurance manufacturing operations(Audited)
Risks

Arising from

Measurement, monitoring and management of risk

• 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 andclaims-handling procedures.

Exposure to financial risks arises from:• market risk of changes in the fairvalues of 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 risks are measured in terms of exposure to fluctuations
in key financial variables;– credit risk is measured as the amount which could be lost if acounterparty fails to make repayments; and– liquidity risk is measured using internal metrics including
stressed operational cash flow projections;• monitored within 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.

Insurance risk
Insurance risk is the risk that, overtime, the cost of acquiring andadministering an insurance contract
and paying claims and benefits may
exceed the total amount of premiums
and investment income received.

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.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

15

Risk

Top and emerging risks

Geopolitical risk

(Unaudited)

Our operations and portfolios are exposed to risks associated with
political instability, civil unrest and military conflict, which could
lead to disruption to our operations, physical risk to our staff and/or physical damage to our assets. In addition, rising protectionism
and the increasing trend of using trade and investment policies as
diplomatic tools may also adversely affect global trade flows.

Our approach to identifying and monitoring top and emerging
risks is described on page 13. During 2018, we made a number ofchanges to our top and emerging risks to reflect our assessmentof the issues facing HSBC. Our current top and emerging risks are
as follows:• Economic outlook and capital flows;• Geopolitical risk;• The credit cycle;• Cyber-threat and unauthorised access to systems;• Regulatory developments including conduct, with adverse
impact on business model and profitability;• Financial crime risk environment;• Ibor transition;• Risks associated with workforce capability, capacity andenvironmental factors with potential impact on growth; and• Risks arising from the receipt of services from third parties.

Economic outlook and capital flows
Economic activity diverged across the global economy during
2018. The US benefited from a fiscal stimulus that helped to drive
GDP growth above its long-term trend. The growth rate in tradedependent regions like the European Union ('EU') declined on theback of a slowing Chinese economy, and trade and geopoliticaltensions. Tightening global financial conditions alongside thetapering off of fiscal stimulus in the US is expected to lead to more
moderate growth in global economic activity in 2019. Oil prices
will likely remain volatile as contrasting supply and demand
factors prevail in turn.
The stand-off between the US and China on a variety of economic
and technological issues is likely to continue in 2019, althoughfurther liberalising initiatives in a vein similar to theComprehensive and Progressive Agreement for Trans-PacificPartnership ('CPTPP') and the EU-Japan trade deal, as well assome re-organisation of global supply chains, could partly offset
rising protectionism. Nevertheless, the net impact on trade flows
could be negative, and may damage HSBC’s traditional lines ofbusiness.
Emerging markets are set to face challenging cross-currents. The
reduction in global liquidity and consequent increase in the cost of
external funding could expose vulnerabilities that spread more
broadly. However, China has pledged to enact some stimulus tooffset the effects of tariff hikes. This should help emerging markets
achieve reasonable growth rates even in the face of headwinds,
though downside risks abound.

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 pages
13-14.

Geopolitical risk remained heightened throughout 2018. In Asia,
US-China competition and confrontation across multiple
dimensions will likely continue, including economic power andtechnology leadership. US investment and export restrictions on
Chinese imports could disrupt investment decisions, leading to aslow decoupling of US and Chinese technology sectors.

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
Steadily rising US interest rates and the looming end of theEuropean Central Bank's ('ECB’) quantitative easing programme,alongside the uncertainty caused by trade and geopoliticaltensions, caused a correction in stock indices and a widening in
corporate bond spreads in in the fourth quarter of 2018. The Bankfor International Settlements ('BIS') estimates that 80% of US
leveraged loans are 'covenant-lite'. Pressures in this segment
could come to a head and spill over to other asset classes. The
International Monetary Fund deems that thin liquidity coverage('LCRs') and stable funding ('SFRs') ratios for international banks’
US dollar positions could cause offshore dollar liquidity to tighten
abruptly during periods of high volatility, possibly affecting HSBC’s
positions.
After reining in excess leverage during 2018, China has pledged
renewed stimulus in 2019 to counter various adverse effects on
economic activity. This could lead to renewed global concerns
about Chinese debt levels. Following sharp foreign exchange ('FX')
depreciations in Turkey and Argentina in 2018, there currently
appear to be no major emerging market currency misalignments.
However, debt servicing burdens are high in some majorcountries, making them vulnerable to shocks.

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

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Cyber threat and unauthorised access to systems

Mitigating actions

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.

• 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.

Key threats include unauthorised access to online customer
accounts, advanced malware attacks and distributed denial ofservice (‘DDOS’) attacks.
Destructive malware (including ransomware), DDOS attacks andorganised cyber criminals targeting payments are increasingly
dominant threats across the industry. In 2018, the Group was
subjected to a small number of DDOS attacks on our externalfacing websites, which were successfully mitigated across theGroup with no destructive malware (including ransomware) or
payment infrastructure attacks reported.

Mitigating actions• We continue to strengthen and significantly invest in bothbusiness and technical controls in order to prevent, detect andrespond to an increasingly hostile cyber threat environment.
We continue to evaluate the threat environment for the mostprevalent attack types and their potential outcomes todetermine the most effective controls to mitigate those threats.
• Specifically, we continue to enhance our controls to protect
against advanced malware, data leakage, infiltration of
payment systems and denial of service attacks as well as
enhance our ability to quickly detect and respond toincreasingly sophisticated cyber-attacks. Ensuring our staff
continue to be 'cyber aware' is a key element of our defence
strategy.
• Cyber risk is a priority area for the Board and is routinely
reported at Board level to ensure appropriate visibility,
governance and executive support for our ongoingcybersecurity programme.

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.
In September 2017, HSBC Holdings plc (‘HSBC Holdings’) and
HSBC North America Holdings Inc. (‘HNAH’) consented to a civil
money penalty order with the US Federal Reserve Board (‘FRB’) in
connection with its investigation into HSBC’s foreign exchange
activities. Under the terms of the order, HSBC Holdings and HNAH
agreed to undertake certain remedial steps and to pay a civil
money penalty to the FRB.
In January 2018, HSBC Holdings entered into a three-year deferred
prosecution agreement with the US Department of Justice (‘DoJ’)(‘FX DPA’), regarding fraudulent conduct in connection with twoparticular transactions in 2010 and 2011. This concluded the DoJ’s
investigation into HSBC’s historical foreign exchange activities.

• 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.
This included enhancements to trade, voice and audio
surveillance and implementation of algorithmic trading forbenchmark orders.

Financial crime risk environment
Financial institutions remain under considerable regulatory
scrutiny regarding their ability to prevent and detect financial
crime. Financial crime threats continue to evolve, often in tandemwith geopolitical developments. The highly speculative, volatileand opaque nature of virtual currencies as well as the pace of new
currencies and associated technological developments, create
challenges in effectively managing financial crime risks. The
evolving regulatory landscape continues to present execution
challenge. An increasing trend towards greater data privacy
requirements may affect our ability to effectively manage financial
crime risks.
In December 2012, among other agreements, HSBC Holdings
consented to a cease-and-desist order with the FRB and agreed toan undertaking with the UK Financial Conduct Authority (‘FCA’) tocomply with certain forward-looking anti-money laundering(‘AML’) and sanctions-related obligations. HSBC Holdings 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 annual assessments of the Group’s AML
and sanctions compliance programme. HSBC Holdings enteredinto an agreement with the Office of Foreign Assets Control(‘OFAC’) regarding historical transactions involving parties subject
to OFAC sanctions. The Skilled Person/Independent Consultant willcontinue to conduct country reviews and provide periodic reports
for a period of time at the FCA’s and FRB’s discretion.

Mitigating actions• We continued to enhance our financial crime risk management
capabilities. We are investing in the next generation of tools tofight financial crime through the application of advanced
analytics and artificial intelligence.
• We are developing procedures and controls to manage therisks associated with direct and indirect exposure to virtual
currencies.
• 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.
• We continue to to take steps designed to ensure that thereforms we have put in place are both effective and sustainable
over the long term.

Under the terms of the FX DPA, HSBC has a number of ongoingobligations, including continuing to cooperate with authorities andimplementing enhancements to its internal controls andprocedures in its Global Markets business, which will be thesubject of annual reports to the DoJ. In addition, HSBC agreed to
pay a financial penalty and restitution.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

17

Risk

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 recommendations of the Financial Stability Board, afundamental review and reform of the major interest rates
benchmarks, including Ibors, are underway across the world’s
largest financial markets. In some cases, the reform will include
replacing interest rate benchmarks with alternative risk free rates('RFRs'). This replacement process is at different stages, and is
progressing at different speeds, across several major currencies.
There is therefore uncertainty as to the basis, method and timingof transition and their implications on the participants in thefinancial markets.
The group has identified a number of potential prudential, conduct
and systemic risks associated with the transition.

Mitigating actions• We have established a global programme across all of ourglobal businesses to coordinate HSBC’s transition activities andto assess the potential risks and impacts of any transition.
• We will continue to engage with industry participants and theofficial sector to support an orderly transition.

Risks associated with workforce capability, capacityand environmental factors with potential impact on
growthOur success in delivering our strategic priorities, as well as
proactively managing the regulatory environment, depends on thedevelopment and retention of our leadership and high-performing
employees. The ability to continue to attract, train, motivate andretain highly qualified professionals in an employment market
where expertise is often mobile and in short supply is critical,
particularly as our business lines execute their strategic businessoutlooks. This may be affected by external and environmental
factors, such as changes to immigration policies and regulations
and tax reforms in key markets that require active responses.

Mitigating actions• HSBC University is focused on developing opportunities andtools for current and future skills, personal skills and leaders tocreate an environment for success.
• We continue to develop succession plans for key management
roles, with actions agreed and reviewed on a regular basis.
• We actively respond to immigration changes through the global
immigration programme. Other political and regulatory
challenges are being closely monitored to minimise the impact
on the attraction and retention of talent and key performers.
• HSBC is building the healthiest human system wherecolleagues can thrive. A number of initiatives have beenlaunched to improve our ways of working and encourage an
open and positive culture (e.g. simplifying processes andgovernance, and adopting new behaviours). We also promote adiverse and inclusive workforce and provide active support
across a wide range of health and well-being activities.

Risks arising from the receipt of services from third
parties
We utilise 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. This includes adequate control
over the selection, governance and oversight of third parties,
particularly for key processes and controls that could affectoperational resilience. Any deficiency in our management of risks
arising from the use of third parties could affect our ability to meetstrategic, regulatory or client expectations.

Mitigating actions• We continue to embed our delivery model in the first line ofdefence through a dedicated team. Processes, controls andtechnology to assess third party service providers against key
criteria and associated control monitoring, testing andassurance have been deployed.
• A dedicated oversight forum in the second line of defence
monitors the embedding of policy requirements andperformance against risk appetite. In the fourth quarter of 2018,second line of defence oversight capabilities were established.

Credit Risk
(Audited)

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 certain other products, such as guarantees andderivatives.
Credit risk generates the largest regulatory capital requirement of
the risks we incur. The group has standards, policies andprocedures dedicated to controlling and monitoring risk from all
such activities. The group’s principal credit risk management
procedures and policies, which follow policies established by
HSBC Group Head Office, include the following:• Formulating credit policies which are consistent with the Group
credit policy and documenting these in detail in dedicatedmanuals.
• Establishing and maintaining the group’s large credit exposure
policy. This policy delineates the group’s maximum exposures
to individual customers, customer groups and other risk
concentrations.
• Establishing and complying with lending guidelines on thegroup’s attitude towards, and appetite for, lending to specified
market sectors and industries.
• Undertaking an objective assessment of risk. All commercial
non-bank credit facilities originated by the group in excess ofdesignated limits are subject to review prior to the facilities
being committed to customers.
• Controlling exposures to banks and other financial institutions.
The group’s credit and settlement risk limits to counterparties
in the finance and government sectors are designed to optimise
the use of credit availability and avoid excessive risk
concentration.
• Managing exposures to debt securities by establishing controls
in respect of the liquidity of securities held for trading andsetting issuer limits for financial investments. Separate portfolio
limits are established for asset-backed securities and similar
instruments.
• Controlling cross-border exposures to manage country andcross-border risk through the imposition of country limits, with
sub-limits by maturity and type of business.
• Controlling exposures to selected industries. When necessary,
restrictions are imposed on new business, or exposures in thegroup’s operating entities are capped.

18

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

• Maintaining and developing risk ratings in order to categorise
exposures meaningfully and facilitate focused management of
the attendant risks. Rating methodology is based upon a wide
range of financial analytics together with market data-based
tools which are core inputs to the assessment of counterparty
risk. Although automated risk-rating processes are increasingly
used for the larger facilities, ultimate responsibility for setting
risk grades rests in each case with the final approving
executive. Risk grades are reviewed frequently andamendments, where necessary, are implemented promptly.
Both the group’s Risk Management Meeting (‘RMM’) and
HSBC Group Head Office receive regular reports on credit
exposures. These include information on large credit exposures,concentrations, industry exposures, levels of impairment
provisioning and country exposures.
RMM has the responsibility for risk approval authorities andapproving definitive risk policies and controls. It monitors risk
inherent to the financial services business, receives reports,
determines action to be taken and reviews the efficacy of the risk
management framework.

The Executive Committee (‘EXCO’) and RMM are supported by a
dedicated group risk function headed by the Chief Risk Officer,
who is a member of both EXCO and RMM and reports to the Chief
Executive.
The Risk Committee also has responsibility for oversight andadvice to the Board on risk matters. The key responsibilities of the
Risk Committee in this regard include preparing advice to theBoard on the overall risk appetite tolerance and strategy within thegroup, and seeking such assurance as it may deem appropriatethat account has been taken of the current and prospective
macroeconomic and financial environment. The Risk Committee isalso responsible for the periodic review of the effectiveness of theinternal control and risk management frameworks and advising
the Board on all high level risk matters. The Risk Committee
approves the appointment and removal of the group’s Chief
Risk Officer.

Maximum exposure to credit risk
(Audited)

Our credit exposure is spread across a broad range of asset classes, including those measured at amortised cost and fair value, and offbalance sheet financial instruments. The following table presents the maximum exposure to credit risk from balance sheet and offbalance sheet financial instruments, before taking account of any collateral held or other credit enhancements (unless such credit
enhancements meet accounting offsetting requirements). For financial assets recognised on the balance sheet, the maximum exposure
to credit risk equals their carrying amount; for financial guarantees and similar contracts granted, it is the maximum amount that wewould have to pay if the guarantees were called upon. For loan commitments and other credit-related commitments, it is generally thefull amount of the committed facilities.
Maximum exposure to credit risk before collateral held or other credit enhancements
2018

2017

HK$m

HK$m

Cash and sight balances at central banks

205,660

208,073

Items in the course of collection from other banks

25,38025,714

Hong Kong Government certificates of indebtedness

280,854

267,174

Trading assets

439,363

389,133

Derivatives

292,869

300,243

Financial assets designated at fair value

33,02318,656

Reverse repurchase agreements – non-trading

406,327

330,890

Placings with and advances to banks

338,151

433,005

Loans and advances to customers

3,528,702

3,328,980

Financial investments

1,865,168

1,711,598

Amounts due from Group companies

70,455

227,729

Other assets

159,483

93,610Financial guarantees and other similar contracts1

291,915

288,779

Loan and other credit-related commitments

2,879,365

2,779,845

At 31 Dec

10,816,715

10,403,429

1

Performance and other guarantees were included. Comparatives have been represented to conform to the current year presentation.

Total exposure to credit risk remained broadly unchanged in 2018 with loans and advances continuing to be the largest element.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

19

Risk

Summary of credit risk
(Audited)

The group has adopted the requirements of HKFRS 9 from 1 January 2018. The scope of impairment under HKFRS 9 covers amortised
cost financial assets, loan commitments and financial guarantees, as well as debt instruments measured at Fair Value through Other
Comprehensive Income (‘FVOCI’). Impairment is calculated in three stages and financial instruments are allocated into one of the threestages, where the transfer mechanism depends on whether there is a significant increase in credit risk between its first recognition andthe relevant reporting period, or there is objective evidence of impairment and therefore considered to be in default or otherwise creditimpaired. After the allocation, the measurement of expected credit loss (‘ECL’), which is the product of probability of default (‘PD’), loss
given default (‘LGD’) and exposure at default (‘EAD’), will reflect the change in risk of default occurring over the remaining life of the
instruments.
The table below 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'). Due to the forward-looking nature of HKFRS 9, thescope of financial instruments on which ECL are recognised is greater than the scope of HKAS 39.
Summary of financial instruments to which the impairment requirements in HKFRS 9 are applied
Gross carrying/nominal amountAt 31 Dec 2018
Loans and advances to customers at amortised cost
Placings with and advances to banks at amortised cost

Allowance for
ECL1

HK$m

HK$m

3,545,258(16,556)

338,177(26)

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

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

25,380—– Hong Kong Government certificates of indebtedness

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

406,327—– financial investments

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

150,691(47)

Amounts due from Group companies

58,631—

1,490,711(376)

50,307(280)

Fair value

Allowance for ECL

HK$m

HK$m

1,497,767(44)

Other financial assets measured at amortised cost

Loans and other credit related commitments
Financial guarantee

At 31 Dec 2018
Debt instruments measured at Fair Value through Other Comprehensive Income (‘FVOCI’)2
1
2

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

20

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

The following table provides an overview of the group's credit risk by stage, and the associated ECL coverage. The financial assets
recorded in each stage have the following characteristics:
Stage 1:
Stage 2:
Stage 3:
POCI:

Unimpaired and without significant increase in credit risk on which a 12-month allowance for ECL is recognised.
A significant increase in credit risk has been experienced since initial recognition on which a lifetime ECL is recognised.
Objective evidence of impairment, and are therefore considered to be in default or otherwise credit-impaired on whicha lifetime ECL is recognised.
Purchased or originated at a deep discount that reflects the incurred credit losses on which a lifetime ECL is recognised.

Summary of credit risk (excluding debt instruments measured at FVOCI) by stage distribution and ECL coverage by industry sector
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
Placings withand advances
to banks

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

HK$m

POCI

Total

HK$m

%

%

%

%

%

19,024721

3,545,258(3,014)(3,713)(9,549)5,431—

1,266,999(1,625)(2,763)(1,412)(280) (16,556)

131,234

13,407721

2,064,626(1,297)(920)(8,017)

206,934

6,513

186

—

213,633

(92)

(30)

(120)

—

At 31 Dec
2018

0.1

2.1

50.2

38.8

0.5

(5,800)

0.1

6.5

26.0

—

0.5

(280) (10,514)

0.1

0.7

59.8

38.8

0.5

(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

The above table does not include balances due from Group companies.
1
2

Includes corporate and commercial.
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 table below presents the ageing of stage 2 loans and advances tocustomers by those less than 30 and greater than 30 days past due and therefore presents those amounts classified asstage 2 due to ageing (30 days past due) and those identified at an earlier stage (less than 30 days past due).
Stage 2 days past due analysis for loans and advances to customers
Gross carrying amount

Allowance for ECL

Of which:

Of which:

Of which:

Of which:

ECL coverage %Stage 2

1 to 29 DPD

30 and >DPDStage 2

1 to 29 DPD

30 and >
DPD

HK$m

HK$m

HK$m

HK$m

HK$m

Loans and advances to customers
at amortised cost

180,142

7,632

3,733

(3,713)– personal

42,395

6,366

3,443

(2,763)– corporate and commercial

131,234

1,264

80

6,513

2

210

Of which:

Of which:

Stage 2

1 to 29 DPD

30 and >
DPD

HK$m

%

%

%

(270)

(332)

2.1

3.5

8.9

(229)

(310)

6.5

3.6

9.0

(920)

(41)

(22)

0.7

3.2

27.5

(30)

—

—

0.5

—

—

At 31 Dec 2018

– non-bank financial institutions

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

21

Risk

Measurement uncertainty andsensitivity analysis of ECL estimates(Audited)

ECL impairment allowances recognised in the financial statements
reflect the effect of a range of possible economic outcomes,
calculated on a probability-weighted basis, based on the economic
scenarios described below. The recognition and measurement of
ECL involves the use of significant judgement and estimation. It isnecessary to formulate multiple forward-looking economic
forecasts and incorporate them into the ECL estimates. HSBC uses
a standard framework to form economic scenarios to reflectassumptions about future economic conditions, supplemented
with the use of management judgement, which may result inusing alternative or additional economic scenarios and/or
management adjustments.

Methodology
The group has adopted the use of three scenarios, representativeof our view of forecast economic conditions, sufficient to calculate
unbiased expected loss in most economic environments. They
represent a ’most likely outcome’ (the Central scenario), and two,less likely ’outer’ scenarios, referred to as the Upside 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. Key
scenario assumptions are set using the average of forecasts ofexternal economists, helping to ensure that the HKFRS 9 scenarios
are unbiased and maximise the use of independent information.
The Central, Upside and Downside scenarios selected withreference to external forecast distributions using the above
approach are termed the ‘consensus economic scenarios’.
For the Central scenario, the Group sets key assumptions such as
GDP growth, inflation, unemployment and policy interest rates,
using either the average of external forecasts (commonly referred
to as consensus forecasts) for most economies, or market prices.
An external provider’s global macro model, conditioned to follow
the consensus forecasts, projects the other paths required as
inputs to credit models. This external provider is subject to HSBC’s
risk governance framework, with oversight by a specialist internalunit.
The Upside and Downside scenarios 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. The Group determines the maximum divergence ofGDP 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, the Group also aligns the overallnarrative of the scenarios to the macroeconomic risks described in
HSBC’s ‘Top and emerging risks’. This ensures that scenarios
remain consistent with the more qualitative assessment of theserisks. The Group projects additional variable paths using theexternal provider’s global macro model.
The Upside and Downside scenarios are generated at the year-end
and are only updated during the year if economic conditions
change significantly. The Central scenario is generated every
quarter.
The group recognises that the consensus economic scenario
approach, using three scenarios, will be insufficient in certain
economic environments. Additional analysis may be requested atmanagement’s discretion. This may result in a change in theweighting scheme assigned to the three scenarios or the inclusionof extra scenarios. The group anticipates that there will be only
limited instances when the standard approach will not apply. We
invoked this additional step during 2018 to make a management
adjustment in respect of trade and tariff-related tensions. See'Global trade war scenario’ below.

Description of Consensus Economic Scenarios
The economic assumptions presented in this section have been
formed internally by HSBC specifically for the purpose of
calculating ECL.

The consensus Central scenario
The group’s central scenario is one of moderate growth over theforecast period 2019–2023. Global GDP growth is expected to be
2.9% on average over the period, which is marginally higher than
the average growth rate over the period 2013–2017. Across the
key markets, we note:• Expected average rates of GDP growth over the 2019–2023
period are lower than average growth rates achieved over the
2013–2017 period for mainland China and Hong Kong. For
mainland China, it is consistent with the theme of ongoingrebalancing from an export-oriented economy to deeper
domestic consumption.
• The average unemployment rate over the projection horizon is
expected to remain at or below the averages observed in the
2013–2017 period across all of our major markets.
• Inflation is expected to be stable despite steady GDP growthand strong labour markets and will remain close to central banktargets in our core markets over the forecast period.
• Major central banks are expected to gradually raise their main
policy interest rate. The US Federal Reserve Board (‘FRB’) willcontinue to reduce the size of its balance sheet. The ChineseCentral Bank is expected to continue to rely on its toolkit ofmeasures to control capital flows and manage domestic
credit growth.
• The West Texas Intermediate oil price is forecast to average
US$63 per barrel over the projection period.
The following table describes key macroeconomic variables andthe probabilities assigned in the Consensus Central scenario.
Central scenario (average 2019–2023)
Hong Kong

MainlandChina

GDP growth rate (%)

2.6

5.9

Inflation (%)

2.3

2.5

Unemployment (%)

3.1

4.0

Short term interest rate (%)

2.6

4.0

10Y treasury bond yields (%)

3.1

N/A

Property price growth (%)

1.0

5.8

Equity price growth (%)

3.8

9.6

Probability (%)

80.0

80.0

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

The consensus Upside scenario
Globally, real GDP growth rises in the first two years of the Upside
scenario before converging to the Central scenario. Increased
confidence, de-escalation of trade tensions and removal of tradebarriers, expansionary fiscal policy, stronger oil prices as well as
calming of geopolitical tensions are the risk themes that support
the 2018 year-end Upside scenario.
The following table describes key macroeconomic variables andthe probabilities assigned in the consensus Upside scenario.
Upside scenario (average 2019-2023)
Hong Kong

MainlandChina

GDP growth rate (%)

2.9

6.1

Inflation (%)

2.6

2.7

Unemployment (%)

2.9

3.7

Short term interest rate (%)

2.6

4.1

10Y treasury bond yields (%)

3.3

N/A

Property price growth (%)

1.4

7.3

Equity price growth (%)

7.1

13.6

Probability (%)

10.0

10.0

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

22

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

The Downside scenarios
The consensus Downside scenario

Globally, real GDP growth declines for two years in the Downside
scenario before recovering to the Central scenario. House pricegrowth either stalls or contracts and equity markets correct
abruptly in our major markets. The global slowdown in demand
drives commodity prices lower and results in an accompanying fallin inflation. Central Banks remain accommodative. This isconsistent with the key risk themes of the downside, such as anintensification of global protectionism and trade barriers, fasterthan expected tightening of Fed policy rate, China choosing torebalance with stringent measures, and weaker commodity prices.
The following table describes key macroeconomic variables andthe probabilities assigned in the consensus Downside scenario.
Downside scenario (average 2019-2023)
Hong Kong

MainlandChina

GDP growth rate (%)

2.2

5.8

Inflation (%)

1.9

2.2

Unemployment (%)

3.5

4.2

Short term interest rate (%)

0.6

3.6

10Y treasury bond yields (%)

1.6

N/A

Property price growth (%)

(0.8)

3.3

Equity price growth (%)

(1.6)

2.0

Probability (%)

5.0

5.0

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

Global trade war Downside scenarioContinued escalation of trade- and tariff-related tensions
throughout 2018 resulted in management modelling deeper
effects of a trade war scenario than currently captured by theconsensus Downside scenario for key Asia-Pacific economies. Thisadditional trade war scenario models the effects of a significant
escalation in global tensions, stemming from trade disputes but
going beyond increases in tariffs to affect non-tariff barriers, crossborder investment flows and threatens the international tradearchitecture. This scenario assumes actions that lie beyond
currently enacted and proposed tariffs and has been modelled as
an addition to the three consensus-driven scenarios for these
economies. This scenario has been assigned a 5% weight, leaving
5% assigned to the consensus Downside scenario, and has beenused in addition to the consensus economic scenarios for eight
Asia-Pacific markets, including the group's major markets of Hong
Kong and mainland China.
Key macro-economic variables are shown in the table below:
Global Trade War scenario (average 2019-2023)
Hong Kong

MainlandChina

GDP growth rate (%)

1.5

5.4

Inflation (%)

1.6

2.1

Unemployment (%)

4.7

4.3

Short term interest rate (%)

1.0

3.1

10Y treasury bond yields (%)

2.0

N/A

Property price growth (%)

(2.0)

2.9

Equity price growth (%)

(3.5)

1.1

Probability (%)

5.0

5.0

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

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.

How economic scenarios are reflected in the wholesalecalculation of ECL
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.

How economic scenarios are reflected in the retailcalculation of ECL
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.

Economic scenarios sensitivity analysis of ECL
estimates
The ECL outcome is sensitive to judgement and estimations madewith regards to the formulation and incorporation of multiple
forward-looking economic conditions described above. As a result,management assessed and considered the sensitivity of the ECL
outcome against the forward-looking economic conditions as partof the ECL governance process by recalculating the ECL undereach scenario described above for selected portfolios, applying a
100% weighting to each scenario in turn. The weighting isreflected in both the determination of significant increase in credit
risk as well as the measurement of the resulting ECL.
The economic scenarios are generated to capture HSBC’s view ofa range of possible forecast economic conditions that is sufficientfor the calculation of unbiased and probability-weighted ECL.
Therefore, the ECL calculated for each of the scenarios represent a
range of possible outcomes that have been evaluated to estimate
ECL. As a result, 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. A wider range of possible
ECL outcomes reflects uncertainty about the distribution of
economic conditions and does not necessarily mean that credit
risk on the associated loans is higher than for loans where the
distribution of possible future economic conditions is narrower.
The recalculated ECL for each of the scenarios should be read in
the context of the sensitivity analysis as a whole and in
conjunction with the narrative disclosures provided below.
Under certain economic conditions, economic factors caninfluence ECL in counter-intuitive ways (for example an increase in
GDP growth accompanied by rising interest rates resulting in an
increase in PDs) and it may be necessary to apply management
judgement to the output, which following management review of
the calculated ECL sensitivities, may require modelled output
adjustments.
ECL under each scenario is given as a percentage of theprobability-weighted ECL impairment allowance as at
31 December 2018.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

23

Risk

Wholesale analysis

Retail analysis

HKFRS 9 ECL sensitivity to future economic conditions 1

HKFRS 9 ECL sensitivity to future economic conditions

Hong Kong

Mainland China

ECL coverage of loans and advances tocustomers at 31 December 2018

Hong Kong

Mainland China

ECL coverage of loans and advances tocustomers at 31 December 2018

Reported ECL (HK$m)

1,267

647

Reported ECL (HK$m)

2,671

60

Drawn Amount (HK$m)

2,542,747

526,996

Drawn Amount (HK$m)

723,351

72,039

Reported ECL Coverage

0.05%

0.12%

Reported ECL Coverage

0.37%

0.08%

Coverage ratios by scenario:

Coverage ratios by scenario:

Consensus Central scenario

0.05%

0.12%

Consensus Central scenario

0.37%

0.08%

Consensus Upside scenario

0.05%

0.12%

Consensus Upside scenario

0.35%

0.08%

Consensus Downside scenario

0.05%

0.13%

Consensus Downside scenario

0.37%

0.09%

Global trade war scenario

0.17%

0.23%

Global trade war scenario

0.43%

0.09%

1

Excludes ECL and drawn amounts related to defaulted obligors.

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.

ECL coverage rates for retail are reflective of the portfolio quality
and sensitivity to the economic environment. The economic
uncertainty in Hong Kong increases the ECL by 6bp. This isreflective of the nature of book, which is primarily comprised ofmortgage portfolio with low LTVs.
Overall, as the level of uncertainty in economy or historicaleconomic variable correlations or credit quality changes,
corresponding changes in the ECL sensitivity would occur.

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 table below provides a reconciliation by stage of the group’s 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 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 theunderlying CRR/PD movements of the financial instruments transferring stage. This is captured, along with other credit quality
movements in the ‘changes in risk parameters - credit quality’ line item.
The ‘Net new and further lending/repayments’ represent the gross carrying/nominal amount and associated allowance ECL impact fromvolume movements within the group's lending portfolio.
Reconciliation of changes in gross carrying/nominal amount and allowances for placings with and advances to banks and loans andadvances to 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

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/repayments

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 release/(charge) for the year
Recoveries
Others940(21)

Total ECL charge for the year24

(5,658)The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

(4,739)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 isa point in time assessment of the probability of default of financial
instruments, whereas HKFRS 9 stages 1 and 2 are determinedbased on relative deterioration of credit quality since initialrecognition. Accordingly, for non-credit impaired financial
instruments, there is no direct relationship between the credit
quality assessment and HKFRS 9 stages 1 and 2, though typicallythe lower credit quality bands exhibit a higher proportion instage 2. The five credit quality classifications defined below eachencompass a range of granular internal credit rating grades
assigned to wholesale and retail lending businesses and theexternal ratings attributed by external agencies to debt securities,
as shown in the table below. Under HKAS 39, retail lending credit
quality was disclosed based on expected-loss percentages. UnderHKFRS 9 retail lending credit quality is now disclosed based on a
12-month probability-weighted PD. The credit quality
classifications for wholesale lending are unchanged and are basedon internal credit risk ratings.

Credit quality classification
Debt securities andother bills

Wholesale lending

Retail lending

External
credit rating

Internal
credit rating

12-month Baselprobability ofdefault %Internal
credit rating

12-monthprobabilityweighted PD %StrongA- and above

CRR1 to CRR2

0.000–0.169

Band 1 and 2

Good

BBB+ to BBB-

CRR3

0.170–0.740

Band 30.000–0.500
0.501–1.500

BB+ to B and unrated

CRR4 to CRR5

0.741–4.914

Band 4 and 5

1.501–20.000

Credit quality classification

SatisfactorySub-standard

B- to CCRR6 to CRR8

4.915–99.999

Band 620.001–99.999

Credit-impaired

Default

CRR9 to CRR10

100.000

Band 7100.000

Quality classification definitions‘Strong’ exposures demonstrate a strong capacity to meet financial commitments, with negligible or low probability of default.
‘Good’ exposures 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 impaired.

Distribution of financial instruments by credit quality(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)

213,391

Placings with and advances to banks held at
amortised cost

311,304

22,434

4,439

—

—

338,177(26)

338,151

Cash and sight 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

Other financial assets 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

72.0%

16.0%

12.0%

0.0%

0.0%

100%

—

—

2,139,267

261,579

145,681

2,248

115

2,548,890(376)

2,548,514

97,697104,379

69,593

1,628

1,169

274,466(314)

274,152

At 31 Dec 2018
Percentage of total credit quality
Loan and other credit related commitments2
Financial guarantee and similar contracts
1
2

The above table does not include balances due from Group companies.
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 valueof debt instruments at FVOCI as presented above will not reconcile to the balance sheet as it excludes fair value gains and losses.
Revocable loan and other commitments of HK$1,058bn which are out-of-scope of HKFRS 9 are presented within the strong credit quality classification.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

25

Risk

Distribution of financial instruments to which the impairment requirements in HKFRS 9 are applied, by credit quality and stage
allocation
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

Placings with and advances to banks at amortised cost

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

—

—

—

—

—

—

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.
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 valueof debt instruments at FVOCI as presented above will not reconcile to the balance sheet as it excludes fair value gains and losses.

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 their cash flow resources
rather than rely on the value of security offered. Depending on thecustomer’s standing and the type of product, facilities may beprovided unsecured. For other lending, a charge over collateral is
obtained and considered in determining the credit decision andpricing. In the event of default, the bank may use the collateral asa source of repayment.
Depending on its form, collateral can have a significant financial
effect in mitigating our exposure to credit risk. The tables below
provide a quantification of the value of fixed charges we hold overa borrower’s specific asset (or assets) where we have a history of
enforcing, and are able to enforce the collateral in satisfying a debt
in the event of the borrower failing to meet its contractual
obligations, and can be realised by sale in an established market
or where the collateral is cash. The collateral valuation in thetables below excludes any adjustments for obtaining and sellingthe collateral.
We may also manage our risk by employing other types ofcollateral and credit risk enhancements, such as second charges,
other liens and unsupported guarantees, but the valuation of such
mitigants is less certain and their financial effect has not been
quantified. In particular, loans shown in the tables below as notcollateralised may benefit from such credit mitigants.

26

Certain credit mitigants are used strategically in portfolio
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 pro actively. 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. CDS mitigants are held at portfolio level andare 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.
The loan-to-value (‘LTV’) ratios presented are calculated by directly
associating loans and advances with the collateral that individuallyand uniquely supports each facility. When collateral assets areshared by multiple loans and advances, whether specifically or,

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

more generally, by way of an all monies charge, the collateralvalue is pro-rated across the loans and advances protected by thecollateral.

Impairment allowances are calculated on a different basis, byconsidering other cash flows and adjusting collateral values forcosts of realising collateral.

Other types of collateral such as unsupported guarantees andfloating charges over the assets of a customer’s business are notmeasured in the tables below. 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.

Personal lending
The table below shows residential mortgage lending, including offbalance sheet loan commitments, by level of collateral. The
collateral included in the table below consists of fixed first charges
on real estate.

For credit impaired loans, the collateral values cannot be directlycompared with impairment allowances recognised. The loan-tovalue (‘LTV’) figures use open market values with no adjustments.
Residential mortgages including loan commitments by level of collateral
Gross carrying/nominal amount

ECL coverage

HK$m

%

965,1640.0– less than 70%

859,476

0.0– 71% to 90%

89,8210.0– 91% to 100%

15,8670.1

Partially collateralised (A):

3,121

0.0

– collateral value on A

2,792

Stage 1
Fully collateralised
LTV ratio:

Total

968,285

0.0

20,6380.4– less than 70%

15,9130.2– 71% to 90%

4,277

0.7

– 91% to 100%

448

2.9

Partially collateralised (B):

93

4.3

– collateral value on B

83

Stage 2
Fully collateralised
LTV ratio:

Total

20,731

0.4

1,694

9.3

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

1,210

4.9

– 71% to 90%

371

16.4

– 91% to 100%

113

32.7

Partially collateralised (C):

88

43.2

– collateral value on C

80

Total
At 31 Dec 2018

The LTV ratio is calculated as the gross on-balance sheet carrying
amount of the loan and any off-balance sheet loan commitment at
the balance sheet date divided by the value of collateral. The
methodologies for obtaining residential property collateral values
vary throughout the group, but are typically determined through a
combination of professional appraisals, house price indices or
statistical analysis. Valuations are updated on a regular basis and,as a minimum, at intervals of every three years. Valuations are
conducted more frequently when market conditions or portfolio
performance are subject to significant change or where a loan is
identified and assessed as impaired.

1,782

10.9

990,798

0.0

Corporate, commercial and non-bank financial institutions
lending
Collateral held is analysed below separately for commercial realestate and for other corporate, commercial and non-bank financial
institutions lending. This reflects the difference in level of collateral
held on the portfolios. In each case, the analysis includes offbalance sheet loan commitments, primarily undrawn credit lines.

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.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

27

Risk

Commercial real estate loans and advances including loan commitments by level of collateral
Gross carrying/nominal amount

ECL coverage

HK$m

%

Not collateralised

352,258

0.0

Fully collateralised

363,7290.1

Partially collateralised (A):31,1070.1– collateral value on A

17,246

Total

747,0940.0

Not collateralised

10,2280.2

Fully collateralised

19,4400.6

Partially collateralised (B):

1,235

0.8

Stage 1

Stage 2– collateral value on B

702

Total

30,903

0.5

Stage 3Not collateralised——

Fully collateralised

129

0.8

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

—

Total

129

0.8

Not collateralised——

Fully collateralised——

Partially collateralised (D):——– collateral value on D

—

POCI

Total
At 31 Dec 2018——778,126

0.1

The collateral included in the table above consist of fixed firstcharges on real estate and charges over cash for the commercial
real estate sector. The table includes lending to major property
developers which is typically secured by guarantees or is
unsecured.

performance of the collateral, or in circumstances where an
obligor’s credit quality has declined sufficiently to cause concernthat the principal payment source may not fully meet the
obligation (i.e. the obligor’s credit quality classification indicates it
is at the lower end e.g. sub-standard, or approaching impaired).

The value of commercial real estate collateral is determinedthrough a combination of professional and internal valuations andphysical inspection. Due to the complexity of collateral valuations
for commercial real estate, local valuation policies determine thefrequency of review based on local market conditions. Revaluation
are sought with greater frequency where, as part of the regularcredit assessment of the obligor, material concerns arise inrelation to the transaction which may reflect on the underlying

Commercial real estate lending includes the financing ofcorporate, institutional and high net worth customers who areinvesting primarily in income-producing assets and, to a lesser
extent, in their construction and development. The group hasaligned the definition of commercial real estate to reflect theinternal risk management view, and the comparatives presented
on page 31, have been represented.

28

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Other corporate, commercial and non-bank financial institutions loans and advances including loan commitments by level of collateral
Gross carrying/nominal amount

ECL coverage

HK$m

%

Not collateralised

2,082,196

0.0

Fully collateralised

352,225

0.1

Partially collateralised (A):

260,184

0.1– collateral value on A

108,264

Stage 1

Total

2,694,605

0.1

Not collateralised

144,940

0.4

Fully collateralised

34,7400.6

Partially collateralised (B):27,6080.4– collateral value on B

10,987

Total

207,288

0.5

Not collateralised

8,339

69.1

Fully collateralised

2,536

34.8

Partially collateralised (C):

3,361

51.6

– collateral value on C

1,237

Total

14,23658.9

Not collateralised

204

20.1

Fully collateralised

243

0.8

Partially collateralised (D):

274

86.5

– collateral value on D

269

Stage 2

Stage 3

POCI

Total
At 31 Dec 2018

The collateral used in the assessment of the above primarily
includes first legal charges over real estate and charges over cashin the commercial and industrial sector, and charges over cash
and marketable financial instruments in the financial sector.
It should be noted that the table above excludes other types ofcollateral which are commonly taken for corporate andcommercial lending such as unsupported guarantees and floating
charges over the assets of a customer’s business. While such
mitigants have value, and often provide rights in insolvency, theirassignable value is insufficiently certain. They are assigned novalue for disclosure purposes.
As with commercial real estate, the value of real estate collateralincluded in the table above is generally determined through a
combination of professional and internal valuations and physicalinspection. The frequency of revaluation is undertaken on a similarbasis to commercial real estate loans and advances; however, forlending activities that are not predominantly commercial realestate-oriented, collateral value is not as strongly correlated toprincipal repayment performance. Collateral values will generally
be refreshed when an obligor’s general credit performance
deteriorates and it is necessary to assess the likely performance of
secondary sources of repayment should reliance upon them provenecessary. For this reason, the table above reports values only forcustomers with CRR 8 to 10, reflecting that these loans andadvances generally have valuations which are comparatively
recent. For the purposes of the table above, cash is valued at its
nominal value and marketable securities at their fair value.

721

38.8

2,916,850

0.4Note 32 ‘Offsetting of financial assets and liabilities’ for further
details.

Other credit risk exposures
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 described in moredetail below.
Government, bank and other financial institution-issued securities
may benefit from additional credit enhancement, notably throughgovernment guarantees that reference these assets. Corporateissued debt securities are primarily unsecured. Debt securities
issued by banks and financial institutions include asset-backed
securities (‘ABS’) and similar instruments, which are supported byunderlying pools of financial assets. Credit risk associated with
ABS is reduced through the purchase of credit default swap(‘CDS’) protection.
The group’s maximum exposure to credit risk includes financial
guarantees and similar arrangements that it issues or enters into,and loan commitments to which it is irrevocably committed.
Depending on the terms of the arrangement, the group may haverecourse to additional credit mitigation in the event that aguarantee is called upon, or a loan commitment is drawn andsubsequently defaults. Further information about thesearrangements is provided in note 30 'Contingent liabilities andcommitments’.

Derivatives
The International Swaps and Derivatives Association (‘ISDA’)
Master Agreement is our preferred agreement for documenting
derivatives activity. It provides the contractual framework within
which dealing activity across a full range of over the counter(‘OTC’) products is conducted, and contractually binds both parties
to apply close-out netting across all outstanding transactions
covered by an agreement if either party defaults or another preagreed termination event occurs. It is common, and our preferredpractice, for the parties to execute a Credit Support Annex (‘CSA’)in conjunction with the ISDA Master Agreement. Under a CSA,
collateral is passed between the parties to mitigate thecounterparty risk inherent in outstanding positions. The majority of
our CSAs are with financial institution clients. Please refer to

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

29

Risk

not directly comparable to the current 2018 credit risk tables,
which are disclosed on an HKFRS 9 basis, these 2017 disclosures
have been shown below and not adjacent to 2018 tables.

2017 credit risk disclosures(Unaudited)

The disclosures below were included in our 2017 external reports
and do not reflect the adoption of HKFRS 9. As these tables are
Distribution of financial instruments by credit quality

Neither past due nor impaired

StrongGood

Satisfactory

Substandard

Past
due not
impaired

Impaired

Impairment
allowances

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

—

—

—

At 31 Dec 2017
Items in the course of collection fromother banks

24,420

219

1,075

—

Trading assets

324,060

27,25837,216599

389,133

Derivatives

253,480

38,202

7,855

706

300,243

Financial assets designated at fair value

17,032

855

767

2

18,656

Reverse repurchase agreements – nontrading

249,043

50,10331,744————

330,890

Placings with and advances to banks heldat amortised cost

401,097

28,366

3,433

109

—

—

—

433,005

Loans and advances to customers held at
amortised cost

25,714

1,772,405

805,145696,882

20,13629,87817,579(13,045)

3,328,980– personal992,682

101,938

56,398641

18,9304,686(2,106)

1,173,169– corporate and commercial

666,138

649,775

604,638

19,139

8,742

12,695(10,728)

1,950,399– non-bank financial institutions

113,585

53,43235,846

356

2,206

198

(211)

205,4121,628,709

40,98041,909————1,711,598

Financial investments
Other assets
Total
1

40,817

19,582

31,945

593

486

187

—

93,6104,711,063

1,010,710

852,826

22,14530,364

17,766(13,045)

6,631,829

The above table does not include balances due from Group companies.

Ageing analysis of past due but not impaired financial instruments
Up to 29 days

30-59 days

60-89 days

90-180 days

Over 180 days

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Loans and advances to customers held at amortised cost1

24,976

3,572

1,326

4

—

29,878– personal

15,272

2,704

954

—

—

18,930– corporate and commercial

7,498

868

372

4

—

8,742

– non-bank financial institutions

2,206

—

—

—

—

2,206

98

35

54

59

240

486

25,074

3,607

1,380

63

240

30,364

At 31 Dec 2017

Other assets
Total
1

The majority of the loans and advances to customers that are operating within revised terms following restructuring are excluded from this table.

Impairment allowances as a percentage of gross loans and advances to customers
Hong Kong

Rest of
Asia-Pacific

Total

HK$m

HK$m

HK$m

At 31 Dec 2017
Gross loans and advances to customers
Individually assessed impaired gross loans and advances
Collectively assessed– impaired loans and advances

6,284

9,259

15,543

2,101,416

1,225,066

3,326,482

673

1,363

2,036

– non-impaired loans and advances

2,100,743

1,223,703

3,324,446

Total gross loans and advances to customers

2,107,700

1,234,325

3,342,025

Impairment allowances(5,669)(7,376)(13,045)– individually assessed(3,429)(4,800)(8,229)– collectively assessed(2,240)(2,576)(4,816)

2,102,031

1,226,949

3,328,980

Fair value of collateral which has been taken into account in respectof individually assessed impaired loans and advances to customers

2,666

4,806

7,472

Individually assessed impaired gross loans and advances to customers as apercentage of gross loans and advances to customers

0.3%

0.8%

0.5%

Total allowances as a percentage of total gross loans and advances to customers

0.3%

0.6%

0.4%

Net loans and advances to customers

30

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Movement in impairment allowances on loans and advances to customers
Individuallyassessed

Collectively
assessed

Total

HK$m

HK$m

HK$m

At 1 Jan 2017

8,059

4,633

12,692

Amounts written off(2,189)(2,806)(4,995)

180

713

893

Net charge to income statement

2,194

2,136

4,330

Unwinding of discount of loan impairment

(235)

(17)

(252)

Exchange and other adjustments

220

157

377

8,229

4,816

13,045

Recoveries of loans and advances written off in previous years

At 31 Dec 2017

Residential mortgages including loan commitments by level of collateral
HK$m

Unimpaired loans
Fully collateralised

905,997

Partially collateralised– greater than 100% LTV (A)420– collateral value on A

378

Not collateralised

44

Total

906,461

Impaired loans
Fully collateralised

2,223– less than 70% LTV

1,635– 71% to 90% LTV

498– 91% to 100% LTV

90Partially collateralised– greater than 100% LTV (B)80– collateral value on B

69

Not collateralised

1

Total

2,304

At 31 Dec 2017

908,765

Commercial real estate loans and advances including loan commitments by level of collateral1
HK$m

Rated CRR/EL 1 to 7

597,335

Not collateralised

288,424

Fully collateralised

293,069

Partially collateralised (A)15,842– collateral value on A

8,297

Rated CRR/EL 8

1

Not collateralised—

Fully collateralised

1

Partially collateralised (B)—– collateral value on B—

Rated CRR/EL 9 to 10

133

Not collateralised

10

Fully collateralised

123

Partially collateralised (C)—– collateral value on C—

At 31 Dec 2017
1

597,469

Comparatives have been restated to align the definition of commercial real estate to reflect the internal risk management view.

Other corporate, commercial and non-bank financial institutions loans and advances rated CRR/EL 8 to 10 only, including loan
commitments, by level of collateral1
HK$m

Rated CRR/EL 8

1,494

Not collateralised

331

Fully collateralised

70

Partially collateralised (A)1,093– collateral value on A

97

Rated CRR/EL 9 to 10

12,769Not collateralised

7,236

Fully collateralised

2,807

Partially collateralised (B)2,726– collateral value on B

1,658

At 31 Dec 201714,2631Comparatives have been restated to align the definition of commercial real estate to reflect the internal risk management view.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

31

Risk

Liquidity and Funding Risk
(Audited)

Strategies and processes in the management ofliquidity risk
HSBC has an internal liquidity and funding risk management
framework (‘LFRF’) which aims to allow it to withstand very severe
liquidity stresses. It is designed to be adaptable to changing
business models, markets and regulations. The management ofliquidity and funding is primarily undertaken locally (by country) in
our operating entities in compliance with the Group’s LFRF andlocal regulations, and with practices and limits set by the GroupManagement Board (‘GMB’) through the group's RMM andapproved by the Board. Our general policy is that each defined
operating entity should be self-sufficient in funding its own
activities.

Structure and organisation of the liquidity risk
management function
The Group Treasurer, who reports to the Group CFO, has
responsibility for the oversight of the LFRF. Asset, Liability andCapital Management (‘ALCM’) teams are responsible for theapplication of the LFRF at a local operating entity level.
The elements of the LFRF are underpinned by a robust governanceframework, the two major elements of which are:systemic or other crises, while minimising adverse long-term
implications for the business.
Along with ALCM, the Balance Sheet Management teams form
the first line of defence in the management of liquidity risk,
ensuring continuous compliance with the firm’s risk appetite
operating within their risk mandates.
Liquidity risk assurance is provided by Risk. Second line liquidity
risk assurance performs the following activities:• reviews and challenges assumptions of current liquidity andfunding risk management framework;• reviews and challenges methods and calculation processes of
all aspects of liquidity and funding risk;• reviews results of liquidity and funding metrics against limits
and proposed limit changes prior to approval at governanceforums; and• reviews risk items that require escalation.

Scope and nature of liquidity risk reporting andmeasurement
Where possible, the group maintains standardised platforms
utilising common data feeds in order to ensure consistency ofstandard internal and regulatory reporting and flexibility to deliver
ad hoc requests.

• Asset and Liability Management Committees (‘ALCOs’) at thegroup and entity level; andHedging and mitigating liquidity risk at HSBC

• annual internal liquidity adequacy assessment (‘ILAA’) used tovalidate risk tolerance and set risk appetite.

The key aspects of the internal LFRF which is used to ensure that
HSBC maintains an appropriate overall liquidity risk profile are:

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.

• stand-alone management of liquidity and funding by operating
entity;The group ALCO delegates to the group Tactical Asset and Liability
Management Committee (‘TALCO’) the task of reviewing various
analyses of the group pertaining to sites’ liquidity and funding.
TALCO’s primary responsibilities include but are not limited to:• reviewing the funding structure of operating entities and theallocation of liquidity among them; and• monitoring liquidity and funding limit breaches and providing
direction to those operating entities that have not been able torectify breaches on a timely basis.
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;• projecting cash flows under various stress scenarios andconsidering the level of liquid assets necessary in relation
thereto;• monitoring liquidity and funding ratios against internal andregulatory requirements;• maintaining a diverse range of funding sources with adequate
back-up facilities;

HSBC’s business strategy and overall liquidity risk profile• minimum liquidity coverage ratio (‘LCR’) requirement, including
by currency, for each operating entity;• minimum net stable funding ratio ('NSFR’) requirement for each
operating entity;• legal entity depositor concentration limit;• three-month and 12-month cumulative rolling term contractual
maturity limits covering deposits from banks, deposits fromnon-bank financial institutions and securities issued;• annual ILAA by operating entity;• intra-day liquidity;• liquidity funds transfer pricing; and• forward-looking funding assessments.

Management of liquidity and funding risk
Liquidity coverage ratio(Unaudited)

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. HQLA consist of cash or
assets that can be converted into cash at little or no loss of market
value.
At 31 December 2018, all the group’s principal operating entities
were well above regulatory minimums and above the internally
expected levels established by the Board.

• managing the concentration and profile of term funding;

Net stable funding ratio• managing contingent liquidity commitment exposures within pre- (Unaudited)
determined limits;
The NSFR measures stable funding relative to required stable• maintaining debt financing plans;
funding, and reflects a bank’s long-term funding profile (funding
with a term of more than a year). It is designed to complement• monitoring of depositor concentration in order to avoid undue
the LCR.
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 from32

At 31 December 2018, all the group’s principal operating entities
were within the NSFR risk tolerance level established by the Boardand applicable under the LFRF.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Liquid assets of HSBC's principal operating entities(Unaudited)

Liquid assets are held and managed on a stand-alone operating
entity basis. They include those held directly by each operating
entity's BSM department, primarily for the purpose of managing
liquidity risk in line with the LFRF, and any unencumbered liquid
assets held outside BSM departments for any other purpose. The
LFRF gives ultimate control of all unencumbered assets andsources of liquidity to BSM.
Overall adequacy of liquidity risk management at HSBC
(Unaudited)

All operating entities are required to manage liquidity risk andfunding risks on a standalone basis in accordance with the LFRF,
which includes the preparation of an ILAA document, in order toensure that:

The LFRF requires all operating entities to monitor material single
currency LCR. Limits are approved and monitored by local ALCO.

Liquidity and funding risk profile(Unaudited)

The Banking (Liquidity) Rules (‘BLR’) were introduced by the
HKMA in 2014 and became effective from 1 January 2015. The
group is required to calculate its LCR on a consolidated basis inaccordance with rule 11(1) of the BLR. During 2018 the group isrequired to maintain an LCR of not less than 90%, increasing to
not less than 100% from January 2019. Effective from 1 January
2018, the group is also required to calculate its NSFR on aconsolidated basis in accordance with rule 11(1) of the BLR andmaintain an NSFR of not less than 100%.
The average LCRs for the period are as follows:
Quarter ended• liquidity resources are adequate, both as to the amount andquality;• there is no significant risk that liabilities cannot be met as theyfall due;• a prudent structural funding profile is maintained;• adequate liquidity resources continue to be maintained; and• the operating entity's liquidity risk framework is adequate androbust.
The key objectives of the ILAA process are to:• demonstrate that all material liquidity and funding risks arecaptured within the internal framework;• validate the operating entity's risk tolerance/appetite bydemonstrating that reverse stress testing scenarios are
acceptably remote and vulnerabilities have been assessed
through the use of severe stress scenarios; andAverage LCRs

31 Dec31 Dec

2018

2017

%

%

161.0

153.6

The liquidity position of the group remained strong in 2018. The
average LCR increased by 7.4% from 153.6% for the quarter
ended 31 December 2017 to 161.0% for the quarter ended 31
December 2018, mainly as a result of the growth in customer
deposits.
The majority of HQLA included in the LCR are Level 1 assets as
defined in the BLR, which consist mainly of government debt
securities.
The total weighted amount of HQLA for the period are as follows:
Weighted amount (averagevalue) at quarter ended
31 Dec• provide review and challenge of the operating entity's ILAA
document.

31 Dec

2018

2017

HK$m

HK$m

Concentration of funding and liquidity sources

Level 1 assets

1,489,744

1,405,999

Depositor concentration and term funding maturity concentration

Level 2A assets

67,33365,248

Level 2B assets

9,638

20,071

1,566,715

1,491,318(Unaudited)

The LCR metric assume a stressed outflow based on a portfolio of
depositors within retail, corporate and financial deposit segment.
The validity of these assumptions is challenged if the portfolio of
depositors is not large enough to avoid depositor concentration.
Operating entities are exposed to term re-financing concentration
risk if the current maturity profile results in future maturities being
overly concentrated in any defined period.
At 31 December 2018, all the group’s principal operating entities
were within the risk tolerance levels set for depositor
concentration and term funding maturity concentration. These risk
tolerances were established by the Board and applicable under the
LFRF.
Sources of funding(Audited)

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.
Currency mismatch in the LCR(Unaudited)

In time of stress it cannot automatically be assumed that one
currency can always be converted for another, even if thosecurrencies are ‘hard’ currencies. LCR must therefore be assessedby currency, if the currency is material.

Total

The NSFRs for the period are as follows:
Quarter ended

Net stable funding ratio

31 Dec31 Dec

2018

2017

%

%

149.7

N/A

The funding position of the group remained robust in 2018. The
NSFR was 149.7% for the quarter ended 31 December 2018,highlighting a surplus of stable funding relative to the required
stable funding requirement. The NSFR requirements have been
implemented with effect from 2018 and accordingly the NSFR for
the quarter ended 31 December 2017 is not shown.
Interdependent assets and liabilities included in the group's NSFR
are certificates of indebtedness held and legal tender notes issued.

Additional contractual obligations(Unaudited)

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.
Further details of the group’s liquidity information disclosures canbe viewed in the Banking Disclosure Statement 2018, which will
be available in the Regulatory Disclosure Section of our website:www.hsbc.com.hk.

In some currencies, convertibility is restricted by regulators andcentral banks and this restriction results in local currency not
being convertible offshore or even onshore.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

33

Risk

Market Risk
(Audited)Market risk is the risk that movements in market factors, including
foreign exchange rates and commodity prices, interest rates,
credit spreads and equity prices, will reduce our income or thevalue of our portfolios.
There were no significant changes to our policies and practices forthe management of market risk in 2018.
Exposure to market risk
Exposure to market risk is separated into two portfolios:• Trading portfolios comprise positions arising from market-making andwarehousing of customer-derived positions.
• Non-trading portfolios comprise positions that primarily arise from theinterest rate management of our retail and commercial banking assets
and liabilities, financial investments designated as available-for-sale andheld-to-maturity, and exposures arising from our insurance operations.

The diagram below illustrates the main business areas wheretrading and non-trading market risks reside and market risk
measures to monitor and limit exposures.

governance to manage them. In certain cases where the market
risks cannot be fully transferred, we identify the impact of varying
scenarios on valuations or on net interest income resulting fromany residual risk positions.
The Regional Markets Model Oversight Committee (‘MOC’) is aformal governance committee established to provide oversight onmodel risk management related matters for traded risk models
used in the region. The Regional Markets MOC is responsible foroverseeing, monitoring, and escalating model risk management
related matters within Traded risk. It supports accountable
individual model approvers in the oversight of model risk. The
Regional Markets MOC is accountable to the Global Markets MOC
which oversees all traded risk models at Group level. The Regional
MOC informs the Regional Risk Management Meeting aboutmaterial model risks and model related issues.
Our control of market risk in the trading and non-trading portfolios
is based on a policy of restricting individual operations to trading
within a list of permissible instruments authorised for each site byGroup Risk, of enforcing new product approval procedures, and ofrestricting trading in the more complex derivative products only tosites with appropriate levels of product expertise and robust
control systems.

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 BSM

GB&M, BSM,
GPB, CMB and RBWM

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.

Risk measure

VaR | Sensitivity | Stress
Testing

VaR | Sensitivity | Stress
Testing

Sensitivity analysis

Risk types

Note–Balance Sheet Management (‘BSM’), for external reporting purposes, forms part ofCorporate Centre while daily operations and risk are managed within GB&M.

Where appropriate, the group applies similar risk management
policies and measurement techniques to both trading and nontrading portfolios. The group’s objective is to manage and control
market risk exposures in order to optimise return on risk while
maintaining a market profile consistent with our established risk
appetite.
The nature of the hedging and risk mitigation strategies performed
across the group corresponds to the market risk management
instruments available within each operating jurisdiction. These
strategies range from the use of traditional market instruments,
such as interest rate swaps, to more sophisticated hedging
strategies to address a combination of risk factors arising at
portfolio level.

Market risk governance(Unaudited)

Market risk is managed and controlled through limits approved by
the Risk Management Meeting of the Group Management Board(‘GMB’) for HSBC Holdings plc and the various global businesses.
These limits are allocated across business lines and to the group’s
legal entities. The management of market risk is principally
undertaken in Global Markets through risk limits. Value at Risk(‘VaR’) limits are set for portfolios, products, and risk types, withmarket liquidity being the primary factors in determining the levelof limits set.
Each major operating entity has an independent market risk
management and control function which is responsible formeasuring market risk exposures in accordance with the policies
defined by Group Risk, and monitoring and reporting these
exposures against the prescribed limits on a daily basis. Each
operating entity is required to assess the market risks arising oneach product in its business and to transfer them to either its local
GB&M unit for management, or to separate books managed under
the supervision of the local Asset and Liability Management
Committee (‘ALCO’).

Market risk measures(Audited)

Monitoring and limiting market risk exposures(Unaudited)

Sensitivity analysis measures the impact of individual market
factor movements on specific instruments or portfolios includinginterest rates, foreign exchange rates and equity prices, forexample, the impact of a one basis point change in yield. We use
sensitivity measures to monitor the market risk positions withineach risk type.
Sensitivity limits are set for portfolios, products and risk types,
with the depth of the market being one of the principal factors indetermining the level of limits set.

Value at risk
VaR is a technique that estimates the potential losses on risk
positions as a result of movements in market rates and prices overa specified time horizon and to a given level of confidence. The
use of VaR is integrated into market risk management and is
calculated for all trading positions regardless of how we capitalise
those exposures. Where there is no approved internal model, we
use the appropriate local rules to capitalise exposures.
In addition, we calculate VaR for non-trading portfolios in order tohave a complete picture of market risk. Where VaR is not
calculated explicitly, alternative tools are used as summarised in
the Market Risk stress testing section below.
Our models are predominantly based on historical simulation
which incorporate the following features:• historical market rates and prices are calculated with reference
to foreign exchange rates and commodity prices, interest rates,
equity prices and the associated volatilities;• potential market movements utilised for VaR are calculatedwith reference to data from the past two years; and• VaR measures are calculated to a 99% confidence level and use
a one-day holding period.
The models also incorporate the effect of the option features on
the underlying exposures. The nature of the VaR models meansthat an increase in observed market volatility will lead to anincrease in VaR without any changes in the underlying positions.

Our aim is to ensure that all market risks are consolidated within
operations that have the necessary skills, tools, management and34

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

VaR model limitations

Stress testing

Although a valuable guide to risk, VaR should always be viewed in
the context of its limitations. For example:(Audited)• the use of historical data as a proxy for estimating future events
may not encompass all potential events, particularly thosewhich are extreme in nature;• the use of a holding period assumes that all positions can beliquidated or the risks offset during that period. This may not
fully reflect the market risk arising at times of severe illiquidity,
when the holding period may be insufficient to liquidate orhedge all positions fully;• the use of a 99% confidence level, by definition does not take
into account losses that might occur beyond this level ofconfidence; and• VaR is calculated on the basis of exposures outstanding at theclose of business and therefore does not necessarily reflect
intra-day exposures.

Back-testing
We routinely validate the accuracy of our VaR models by backtesting them against both actual and hypothetical profit and loss
against the trading VaR numbers. Hypothetical profit and loss
excludes non-modelled items such as fees, commissions andrevenues of intra-day transactions.
The actual number of profits or losses in excess of VaR over thisperiod can therefore be used to gauge how well the models are
performing. We back-test VaR at various levels which reflects thefull legal entity scope of the group, including entities that do nothave local permission to use VaR for regulatory purposes. Backtesting using the regulatory hierarchy includes entities which haveapproval to use VaR in the calculation of market risk regulatory
capital requirement.

Risk not in VaR framework(Unaudited)

Stress testing is an important tool 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.
Stress testing is implemented at the legal entity, regional, sites
and the overall group levels. A standard set of scenarios is utilised
consistently across all sites within the group. Scenarios are
tailored to capture the relevant potential events or market
movements at each level. The risk appetite around potential stresslosses for the region is set and monitored against referral limits.
Market risk reverse stress tests are undertaken based upon thepremise that there is a fixed loss. The stress testing process
identifies which scenarios lead to this loss. The rationale behind
the reverse stress test is to understand scenarios which arebeyond normal business settings that could have contagion andsystemic implications.
Stressed VaR and stress testing, together with reverse stresstesting, provide management with insights regarding the ‘tail risk’beyond VaR for which the group’s appetite is limited.

Market risk in 2018
(Unaudited)

Market sentiment in 2018 remained fragile with short term market
volatilities amid the sustained US-China trade tensions. The
prospect of rising USD interest rates and tightening USD liquidity
have brought volatility to emerging markets in Asia and also
increased the cost of USD funding. US-China trade talk outcome,geopolitical events including the evolving situation in the Korean
Peninsula, the US policy priorities as well as the key elections in
Asia are among the key drivers for market volatility in 2019.

Trading portfolios

The risks not in VaR (‘RNIV’) framework aims to capture andcapitalise material market risks that are not adequately covered inthe VaR model, such as the LIBOR tenor basis.
Risk factors are reviewed on a regular basis and are either
incorporated directly in the VaR models, where possible, or
quantified through the VaR-based RNIV approach or a stress test
approach within the RNIV framework. A stressed VaR RNIV iscomputed for the risk factors considered in the VaR-based RNIV
approach. Stress-type RNIVs are also included where appropriate.

(Audited)

Value at risk of the trading portfolios
Trading VaR predominantly resides within Global Markets. Thiswas slightly lower at 31 December 2018 compared to 31
December 2017 due to the reduction in the credit trading VaR andinterest rate trading VaR, which was driven by reduction in theinventory position under the fixed income business.

The trading VaR for the year is shown in the table below.
Trading value at risk, 99% 1 day1
Foreign exchange
and commodity

Interest rate

EquityCreditspreadPortfolio
diversification2

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Year end

43

123

51

42

(123)

136

Average

35

150

30

33

163

Maximum

59

199

58

75

222

Year end

48

128

19

69

Average

48

118

13

28

111

Maximum

84

202

25

73

189

At 31 Dec 2018

At 31 Dec 2017

1
2

(123)

141

Trading portfolios comprise positions arising from the market-making and warehousing of customer-derived positions.
Portfolio diversification is the market risk dispersion effect of holding a portfolio containing different risk types. It represents the reduction in unsystematic market risk that occurs whencombining 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 theVaR 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 daysfor different risk types, it is not meaningful to calculate a portfolio diversification benefit for these measures.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

35

Risk

Non-trading portfolios

Operational Risk

(Unaudited)(Unaudited)

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.

Operational risk is the risk to achieving our strategy or objectives
as a result of inadequate or failed internal processes, people andsystems or from external events. Responsibility for minimising
operational risk lies with HSBC’s staff. All staff are required to
manage the operational risks of the business and operational
activities for which they are responsible.

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.

• identify and manage our operational risks in an effective
manner;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 (simulation
modelling), where all other 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. Sites
include business line interest rate pass-on assumptions, reinvestment of maturing assets and liabilities at market rates pershock scenario and prepayment risk. BSM is modelled based on
no management actions i.e. the risk profile at the month end isassumed to remain constant throughout 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

189,054215,266

181,740

218,262

At 31 Dec 2018
Renminbi
At 31 Dec 2017
Renminbi

Operational risk management framework
HSBC’s Operational Risk Management Framework (‘ORMF’) is ouroverarching approach for managing operational risk, the purposeof which is to:• remain within the operational risk appetite, which helps theorganisation to understand the level of risk it is willing toaccept; and• drive forward-looking risk awareness and assist management
focus.
Business and functional managers throughout the organisation are
responsible for maintaining an acceptable level of internal control
commensurate with the scale and nature of operations, and for
identifying and assessing risks, designing controls and monitoring
the effectiveness of these controls. The ORMF helps managers tofulfil these responsibilities by defining a standard risk assessment
methodology and providing a tool for the systematic reporting ofoperational loss data.
A Group-wide risk management system is used to record theresults of the operational risk management process. Operationalrisk and control self-assessments, long with issue and actionplans, are entered and maintained by business units. Business andfunctional management monitor the progress of documented
action plans to address shortcomings. To help ensure that
operational risk losses are consistently reported and monitored atgroup level, all group companies are required to report individual
losses when the net loss is expected to exceed US$10,000, and toaggregate all other operational risk losses under US$10,000.
Losses are entered into the Group-wide risk management system
and reported to the group‘s Risk Management Meeting on amonthly basis.
Activities to strengthen our risk culture and better embed theapproach, particularly the three lines of defence model, continued
to be a key focus in 2018. The ORMF sets our roles andresponsibilities for managing operational risk on a daily basis.

Operational risk exposures in 2018
(Unaudited)

In 2018, we continued our ongoing work to strengthen thosecontrols that manage our most material risks. Among othermeasures, we:• further enhanced our controls to help ensure that we know ourcustomers, ask the right questions, monitor transactions andescalate concerns to detect, prevent and deter financial crimerisk;• implemented a number of initiatives to raise our standards inrelation to the conduct of our business;• increased monitoring and enhanced detective controls tomanage those fraud risks which arise from new technologies
and new ways of banking;• strengthened internal security controls to prevent cyberattacks;• improved controls and security to protect customers whenusing digital channels;• enhanced our third-party risk management capability to help
enable the consistent risk assessment of any third-party
service; and• enhanced controls associated with IT privileged access.

36

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Regulatory Compliance Risk
(Unaudited)

Overview
The Regulatory Compliance (‘RC’) function provides independent,
objective oversight and challenge and promotes a complianceoriented culture, supporting the business in delivering fairoutcomes for customers, maintaining the integrity of financial
markets and achieving HSBC’s strategic objectives.

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 RC. Reportable eventsare escalated to the RMM and the Risk Committee, as appropriate.

Conduct of businessIn 2018, we continued to take steps to raise our standards relating
to conduct, which included:• delivering further global mandatory conduct training to all
employees in 2018;• incorporating the assessment of expected values andbehaviours as key determinants in recruitment, performanceappraisal and remuneration processes;• improving our group-wide market surveillance capability;• introducing policies and procedures to strengthen support forpotentially vulnerable customers;• enhancing the quality and depth of conduct management
information and how it is used across the group;• implementing an assessment process to check theeffectiveness of our conduct initiatives across the group; and• assessing conduct standards and practices within our key thirdparty suppliers and distributors.

Financial Crime Risk
(Unaudited)

Overview
HSBC continued to embed a sustainable financial crime risk
management capability across the Group. We are making good
progress with enhancing our financial crime control frameworkwith the three-year programme that began in 2017 to further
strengthen the management of anti-bribery and corruption risk.
We continue to take further steps to refine and strengthen our
defences against financial crime by applying advanced analytics
and artificial intelligence.

Key Developments in 2018
During 2018, we continued to increase its efforts to assist withkeeping financial crime out of the financial system. We integrated
into our day-to-day operations the majority of the financial crime
risk core capabilities delivered through the Global Standards
programme, which we set up in 2013 to enhance our risk
management policies, processes and systems. The programme
infrastructure is expected to close in 2019.
We began several initiatives to define the next phase of financial
crime risk management. We invested in the use of artificial
intelligence and advanced analytics techniques to achieve an
intelligence-led financial crime risk management framework forthe future.
Working in partnership is vital to managing financial crime risk.
HSBC is a strong proponent of public-private partnerships andinformation-sharing initiatives. During 2018, Financial Crime Risk
created new alliances in Hong Kong and Singapore and continued
to develop existing partnerships which includes Australia in orderto bring further benefit to the group by enhancing theunderstanding of financial crime risks.

Key risk management processes

controls around identifying and managing the risks of bribery andcorruption across our business. We also introduced atransformation programme to strengthen the anti-fraud
capabilities of the group and have deployed anti-tax evasion
controls. We continue to strengthen our governance and policy
frameworks and improve our management information on
standardised financial crime controls. We are investing in the next
generation of capabilities to fight financial crime by applying
advanced analytics and artificial intelligence. Our commitment toenhance our risk assessment capabilities remains, aiming todeliver more proactive risk management and improve thecustomer experience.

Skilled Person / Independent Consultant
Following expiration in December 2017 of the AML Deferred
Prosecution Agreement entered into with the US Department ofJustice (‘DoJ’), the then Monitor has continued to work under the
Direction issued by the UK Financial Conduct Authority (‘FCA’) in2012 in his capacity as a Skilled Person under section 166 of the
Financial Services and Markets Act. He has also continued to workin his capacity as an Independent Consultant under the 2012
Cease and Desist Order issued by the US Federal Reserve Board(‘FRB’). The Skilled Person and the Independent Consultant willcontinue working for a period of time at the FCA’s and FRB’s
discretion.
The Skilled Person has assessed HSBC’s progress towards being
able to effectively manage its financial risk on a business as usual
basis. The Skilled Person has issued five country reports and twoquarterly reports in 2018. The Skilled Person has noted that HSBC
continues to make material progress towards its financial crime
risk target end state in terms of key systems, processes andpeople. Nonetheless, the Skilled Person has identified some areasthat require further work before HSBC reaches a business as usual
state. The Skilled Person has not highlighted potential instances offinancial crime.
The Independent Consultant completed his fifth annual
assessment. The Independent Consultant concluded that HSBC
continues to make significant strides toward establishing aneffective sanctions compliance programme, commending HSBC
on a largely successful affiliates remediation exercise. He has,
however, determined that that certain areas within HSBC’s
sanctions compliance programme require further work and, assuch, HSBC’s sanctions programme does not yet operate in abusiness-as-usual state. The Independent Consultant hascommenced his sixth annual assessment which is due to concludein March 2019.

Reputational Risk
(Unaudited)

Overview
Reputational risk is the risk of failing to meet stakeholder
expectations as a result of any event, behaviour, action or inaction,either by HSBC, our employees or those with whom we areassociated. Stakeholders’ expectations change constantly, and so
reputational risk is dynamic and varies between geographicalregions, groups and individuals. We have an unwaveringcommitment to operating at the high standards we set forourselves in every jurisdiction. Any material lapse in standards ofintegrity, compliance, customer service or operating efficiency
may represent a potential reputational risk.

Key developments in 2018
In the second half of 2018, as part of a revised enterprise risk
management framework, it was agreed that reputational risk
would be classified as a ‘transverse’ risk, which spans bothfinancial and non-financial risk categories. It was also agreed thatthe overall risk stewardship for reputational risk would betransferred to a single risk steward, the Group Chief Risk Officer.
As a result, the reputational risk policy will be revised and updated
in 2019. The governance structure, however, remains unchanged.

We continued to deliver against our anti-bribery and corruption
transformation programme to further enhance the policies and
The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

37

Risk

Governance and structure
The development of policies and an effective control environment
for the identification, assessment, management and mitigation of
reputational risk, are considered by the Group Reputational Risk
Committee which is chaired by the Group Chief Risk Officer. It is
the highest decision-making forum in the Group for dealing withmatters arising from clients or transactions that either present a
serious potential reputational risk to the Group or merit a Groupled decision to ensure a consistent risk management approachacross the regions, global businesses and global functions. The
committee is responsible for keeping the RMM apprised of areas
and activities presenting significant reputational risk and, whereappropriate, for making recommendations to the RMM to mitigate
such risk.

Key risk management processes
Our Reputational Risk and Client Selection team oversees theidentification, management and control of significant reputationalrisks across the group. It is responsible for monitoring policies forthe group’s reputational risk management, implementing
strategies to protect against reputational risk, and advising the
global businesses and global functions to help them identify,
assess and mitigate such risks, where possible. Each global
business has an established reputational risk management
governance process. The global functions manage and escalate
reputational risks within established operational risk frameworks.
Our policies set out our risk appetite and operational procedures
for all areas of reputational risk, including financial crime
prevention, regulatory compliance, conduct-related concerns,
environmental impacts, human rights matters and employee
relations.

Risks of insurance manufacturing operations(Audited)

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

HSBC’s bancassurance model
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.
The majority of sales are of savings and investment products.
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 an assessment of operational scale and risk
appetite. Manufacturing insurance allows us to retain the risks andrewards associated with writing insurance contracts by keeping
part of the underwriting profit and investment income within thegroup. It also reduces distribution costs for our products by using
our established branch network, and enables us to control thequality of the sale process and the products themselves to ensure
our customers receive products which address their specific needs
at the best value. We have life insurance manufacturing operations
in six locations: mainland China, Hong Kong, India, Macau,
Malaysia and Singapore.
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.

Risk management of insurance manufacturing
operations
GovernanceInsurance 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.

Measurement
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.
The business has a current appetite to remain above 140% with atolerance of 110%. In addition to economic capital, the regulatory
solvency ratio is also a metric used to manage risk appetite on an
entity basis.

38

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

The tables below show the composition of assets and liabilities by contract type. 92% (2017: 91%) of both assets and liabilities arederived from Hong Kong.
Balance sheet of insurance manufacturing subsidiaries by type of contract

Non-linked

Unit-linked

Shareholders'assets andliabilities

HK$m

HK$m

HK$m

HK$m

Financial assets:

447,459

41,32534,503523,287– financial assets designated and otherwise mandatorily measured at fair value

82,266

40,106

1,206

123,578

912

—

1

913

347,894547

32,023

380,464

Total

At 31 Dec 2018

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

3,444

—

—

3,444

– other financial assets

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

PVIF

Liabilities under investment contracts designated at fair value

30,4206,218—

36,638

Liabilities under insurance contracts

433,668

34,921—

468,589

Deferred tax

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

Financial assets:

415,60954,80732,680503,096– financial assets designated at fair value

66,49753,4082,278

122,183– derivatives

1,336

1

2

1,339

– financial investments – held-to-maturity

274,909—

26,034300,943– financial investments – available-for-sale49,268—695

49,963– other financial assets

23,599

1,398

3,671

28,668

Reinsurance assets

15,974

155—

16,129——44,621

44,621

8,279

4

4,026

12,309439,862

54,966

81,327576,155

Total equity
Total equity and liabilities
At 31 Dec 2017

PVIF
Other assets and investment properties
Total assets
Liabilities under investment contracts designated at fair value

30,364

7,905—

38,269Liabilities under insurance contracts

391,348

46,669—438,017

Deferred tax

409

—

7,668

8,077

Other liabilities——

12,33012,330Total liabilities

422,12154,57419,998496,693——

79,462

79,462

422,12154,574

99,460576,155

Total equity
Total equity and liabilities

Stress and scenario testing
Stress testing forms a key part of the risk management framework
for the insurance business. We participate in local and Group-wide
regulatory stress tests, including the Bank of England 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 tomitigate the impact of this scenario, the insurance operations havea range of strategies that could be employed including thehedging of investment risk, repricing current products to reflect
lower interest rates, improving risk diversification, moving towards
less capital intensive products, and developing investment
strategies to optimise the expected returns against the cost of
economic capital.

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 (insurance)
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.
DPF products expose HSBC 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 can become
insufficient to cover the policyholders' financial guarantees, inwhich case the shortfall has to be met by HSBC. Reserves are held
against the cost of such guarantees, calculated by stochastic
modelling.
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.
All our insurance manufacturing subsidiaries have market riskmandates which specify the investment instruments in which they
are permitted to invest and the maximum quantum of market risk
which 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:

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

39

Risk

• For products with DPF, adjusting bonus rates to manage theliabilities to policyholders. The effect is that a significant portionof the market risk is borne by the policyholders.

• For new products with investment guarantees, considering thecost when determining the level of premiums or the pricestructure.

• 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 uncertainty over the receipt
of all future premiums and the timing of claims; and because
the forecast payment dates of liabilities may exceed theduration 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 and associated liabilities, andALCOs employ the outcomes in determining how best to
structure asset holdings to support liabilities.

• Periodically reviewing products identified as higher risk, whichcontain investment guarantees and embedded optionality
features linked to savings and investment products for active
management.

• Using derivatives to protect against adverse market movements
or better match liability cash flows.

• Designing new products to mitigate market risk, such aschanging the investment return sharing portion between
policyholders and the shareholder.
• Exiting, to the extent possible, investment portfolios whose risk
is considered unacceptable.
• Repricing premiums charged to policyholders.
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.

31 Dec 201831 Dec 2017

Impact on profit
after tax for the year

Impact on total
equityImpact on profit after
tax for the year

HK$m

HK$m

HK$m

HK$m

(229)

(547)

97

(4,525)4,976+100 basis points parallel shift in yield curves-100 basis points parallel shift in yield curves

Impact on total equity

81

399

(651)

10% increase in equity prices

1,433

1,433

1,534

1,643

10% decrease in equity prices(1,366)(1,366)(1,560)(1,669)10% increase in USD exchange rate compared to all currencies

267

267

177

177

10% decrease in USD exchange rate compared to all currencies

(267)

(267)

(177)

(177)

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.

credit report containing a watch-list of investments with current
credit concerns, primarily investments that may be at risk of future
impairment or where high concentrations to counterparties arepresent in the investment portfolio. The report is circulatedmonthly to senior management in Group Insurance and theindividual country Chief Risk Officers to identify investments
which may be at risk of future impairment.
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 25.

Interest rate movements have a greater impact on total equity aschanges in market value of FVOCI and available-for-sale bonds are
not recognised in profit after tax.

The credit quality of the reinsurers’ share of liabilities underinsurance contracts is assessed as ‘strong’ or ‘good’ (as definedon page 25), with 100% of the exposure being neither past due
nor impaired (2017: 100%).

Credit risk (insurance)

Liquidity risk (insurance)

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 39.
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 and other publicly available information. Investment
credit exposures are monitored against limits by our local
insurance manufacturing subsidiaries, and are aggregatedand reported to Group Insurance Credit Risk and Group Credit
Risk functions. Stress testing is performed by Group Insurance
on investment credit exposures using credit spread sensitivities
and default probabilities.

Risk is managed by cashflow 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 are required to complete quarterly
liquidity risk reports for Group Insurance Risk function and anannual review of the liquidity risks to which they are exposed.
The following table shows the expected undiscounted cash flows
for insurance contract liabilities at 31 December 2018. The liquidity
risk exposure is wholly borne by the policyholders in the case ofunit-linked business and is shared with the policyholders for
non-linked insurance. The remaining contractual maturity ofinvestment contract liabilities is included in the table on page 95.

We use tools to manage and monitor credit risk. These include a
40

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Expected maturity of insurance contract liabilities
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

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

Non-linked insurance contracts

37,445133,236

268,173

291,343

730,197

Unit-linked

4,523

20,35732,084

48,606

105,570

41,968

153,593300,257

339,949

835,767

At 31 Dec 2018

At 31 Dec 2017

Insurance risk
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 40 analyses our life insurance risk exposures by type ofcontract.
HSBC Insurance primarily manages and mitigates its insurance
risk through asset and liability management, product design,pricing and overall proposition management (e.g. management oflapses by introducing surrender charges), underwriting policy,
claims management process and reinsurance which cedes risks
above our acceptable thresholds to an external reinsurer thereby
limiting our exposure.

long-term assumptions. The assumptions are informed by relevant
historical data and by research and analysis performed by theGroup’s Economic Research team and external experts, including
regulatory bodies. The valuation of PVIF will be sensitive to any
changes in these long-term assumptions in the same way that it issensitive to observed market movements, and the impact of suchchanges is included in the sensitivities presented below.
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 cash flow
modelling. Where shareholders provide options and guarantees topolicyholders, the cost of these options and guarantees is an
explicit reduction to PVIF.
The following table shows the impact on the PVIF from changes in
the risk-free rate at 31 December, across all insurance
manufacturing subsidiaries.
Impact on PVIF

Present value of in-force long-term insurance business

2018

2017

In calculating PVIF, expected cash flows are projected after
adjusting for a variety of assumptions made by each insurance
operation to reflect local market conditions and management’s
judgement of future trends, and after applying risk margins toreflect any uncertainty in the underlying assumptions. Variations in
actual experience and changes to assumptions can contribute tovolatility in the results of the insurance business.

HK$m

HK$m

Actuarial Control Committees for each key insurance entity meeton a quarterly basis to review and approve assumptions proposed
for use in the determination of the PVIF. All changes to noneconomic assumptions, economic assumptions that are notobservable and model methodology must be approved by the
Actuarial Control Committee.
Economic assumptions are either set in a way that is consistent
with observable market values or, in certain markets, long-term
economic assumptions are used. Setting such assumptions
involves the projection of long-term interest rates and the time
horizon over which observable market rates trend towards these+100 basis points shift in risk-free rate

228

166

-100 basis points shift in risk-free rate

3,136

1,513

The impact on PVIF shown above, as well as the impact on profit
after tax and net assets shown below, are illustrative only andemploy simplified scenarios. It should be noted that the effects
may not be linear and, therefore, the results cannot be
extrapolated. The sensitivities reflect the established risk sharing
mechanism with policyholders for participating products, but do
not incorporate other actions that could be taken by management
to mitigate effects, nor do they take account of consequentialchanges in policyholders’ behaviour.

Non-economic assumptions
The table below shows the sensitivity of profit and total equity toreasonably possible changes in non-economic assumptions acrossall our insurance manufacturing subsidiaries.

2018

2017

HK$m

HK$m

10% increase in mortality and/or morbidity rates

(448)

(454)

10% decrease in mortality and/or morbidity rates

454

459

10% increase in lapse rates

(408)

(434)

Effect on profit after tax and total equity at 31 Dec

10% decrease in lapse rates

468

495

10% increase in expense rates

(304)

(328)

10% decrease in expense rates

297

315

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.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201841

Capital

CapitalCapital 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.

Externally imposed capital requirements(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.

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 Banking (Capital) (Amendment) Rules 2014 came into effecton 1 January 2015 to implement the Basel III capital buffer
requirements in Hong Kong. The changes include the phase-infrom 2016 to 2019 of the Capital Conservation Buffer (‘CCB’)
which is designed to ensure banks build up capital outside periodsof stress of 2.5% of RWAs, the Countercyclical Capital Buffer(‘CCyB’) which is set on an individual country basis and is built up
during periods of excess credit growth to protect against future
losses, and the Higher Loss Absorbency (‘HLA’) requirement for
Domestic Systemically Important Banks (‘D-SIB’) of up to 3.5% of
RWAs. The CCyB for Hong Kong was 1.875% from 1 January
2018, and increased to 2.5% from 1 January 2019. This increase isconsistent with the Basel III phase-in arrangements for the CCyB.
On 16 March 2015, the HKMA announced the designation of thegroup as a D-SIB and the HLA requirement to be 2.5% of RWAs
which started to phase-in from 0.625% in 2016 and will reach full
implementation in 2019. On 21 December 2018, the HKMA
maintained the D-SIB designation as well as the HLA requirements
for the group.

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.
At

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

31 Dec

2018

2017

%

%

6.5

6.3

HK$m

HK$m

501,503

468,021

7,741,301

7,477,306

The increase in the leverage ratio from 31 December 2017 to
31 December 2018 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 2018, which will beavailable in the Regulatory Disclosures section of our website:www.hsbc.com.hk.

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.
42

31 DecThe Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Capital adequacy at 31 December 2018

Capital ratios(Unaudited)(Unaudited)

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 Financial Statements and differs fromthat used for regulatory purposes. Further information on theregulatory consolidation basis and a full reconciliation between thegroup’s accounting and regulatory balance sheets can be viewed
in the Banking Disclosure Statement 2018, which will be available
in the Regulatory Disclosures section of our website
www.hsbc.com.hk. Subsidiaries not included in the group's
consolidation for regulatory purposes are securities and insurancecompanies and the capital invested by the group in thesesubsidiaries is deducted from regulatory capital, subject to certain
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 2018, the effect of this requirement is to reduce theamount of reserves which can be distributed to shareholders by
HK$26,883m (31 December 2017: HK$27,703m).

At
31 Dec31 Dec

2018

2017

%

%

Common equity tier 1 (‘CET1’) capital

16.5

15.9

Tier 1 capital ratio

17.8

17.0

Total capital ratio

19.8

18.9

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

31 Dec

2018

2017

HK$m

HK$m

2,290,786

2,205,845

Counterparty credit risk

79,956

134,793

Market risk

117,826

115,081

Operational risk

325,344302,890

2,813,912

2,758,609

Total

Risk-weighted assets by global business(Unaudited)At
31 Dec31 Dec

2018

2017

HK$m

HK$m

Retail Banking and Wealth Management481,268

404,771

Commercial Banking

988,602927,472

Global Banking and Markets

896,143951,294

Global Private Banking

37,022

29,983

Corporate Centre

410,877445,089

2,813,912

2,758,609

Total

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201843

Capital

Capital base(Unaudited)

The following table sets out the composition of the group’s capital base under Basel III at 31 December 2018. The position at 31
December 2018 benefits from transitional arrangements which will be phased out.
Capital base(Unaudited)At
31 Dec31 Dec

2018

2017

HK$m

HK$m

Shareholders’ equity

645,810610,307– shareholders’ equity per balance sheet

752,758

696,480– revaluation reserve capitalisation issue(1,454)(1,454)– other equity instruments(35,879)(14,737)– unconsolidated subsidiaries(69,615)(69,982)

Non-controlling interests

26,034

24,416– non-controlling interests per balance sheet

60,16256,506– non-controlling interests in unconsolidated subsidiaries(9,316)(8,590)– surplus non-controlling interests disallowed in CET1

(24,812)(23,500)

Regulatory deductions to CET1 capital(208,070)(196,030)

Common equity tier 1 (‘CET1’) capital– valuation adjustments(1,599)(1,485)– goodwill and intangible assets(17,215)(15,347)– deferred tax assets net of deferred tax liabilities(2,378)(2,237)– cash flow hedging reserve– changes in own credit risk on fair valued liabilities– defined benefit pension fund assets

63

135

(198)

(183)

(24)

(79)

– significant capital investments in unconsolidated financial sector entities(99,407)(86,046)– property revaluation reserves1(60,429)(63,085)– regulatory reserve(26,883)(27,703)

Total CET1 capital

463,774

438,693

Total AT1 capital before regulatory deductions

37,72939,203– perpetual subordinated loans

35,87914,737—

19,367

Additional tier 1 (‘AT1’) capital– perpetual non-cumulative preference shares– allowable non-controlling interests in AT1 capital
Regulatory deductions to AT1 capital– significant capital investments in unconsolidated financial sector entities

1,850

5,099

—

(9,875)—(9,875)

Total AT1 capital

37,72929,328

Total tier 1 capital

501,503

468,02161,17867,874—

1,563

Tier 2 capital
Total tier 2 capital before regulatory deductions– perpetual cumulative preference shares– perpetual subordinated debt

3,133

3,126

– term subordinated debt

13,944

18,418– property revaluation reserves1

27,84729,043– impairment allowances and regulatory reserve eligible for inclusion in tier 2 capital

16,254

15,724

Regulatory deductions to tier 2 capital(5,501)(13,651)– significant capital investments in unconsolidated financial sector entities(5,501)(13,651)

Total tier 2 capital

55,67754,223

Total capital

557,180522,2441

Includes the revaluation surplus on investment properties which is reported as part of retained earnings and adjustments made in accordance with the Banking (Capital) Rules issued
by the HKMA.

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 2018, which will be available in the Regulatory Disclosures section of our website www.hsbc.com.hk.

44

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

The following table shows the pro-forma Basel III end point basis
position once all transitional arrangements have been phased out.
It should be noted that the pro-forma Basel III end point basis
position takes no account of, for example, any future profits or
management actions. In addition, the current regulations or theirapplication may change before full implementation. Given this, thefinal impact on the group’s capital ratios may differ from the proforma position, which is a mechanical application of the current
rules to the balance sheet at 31 December 2018; it is not a
projection. On this pro-forma basis, the group’s CET1 ratio is16.5% (2017: 15.2%), which is above the Basel III minimum
requirement, plus expected regulatory capital buffer requirements.

Reconciliation of capital from transitional basis to a pro-forma Basel III end point basis(Unaudited)At
31 DecCET1 capital on a transitional basis
Transitional provisions: Significant capital investments in unconsolidated financial sector entities

31 Dec

2018

2017

HK$m

HK$m

463,774

438,693—(19,750)

CET1 capital end point basis463,774

418,943

AT1 capital on a transitional basis

37,72929,328Grandfathered instruments: Perpetual non-cumulative preference shares—(19,367)

Transitional provisions:

—

6,406

Allowable non-controlling interests in AT1 capital—(3,469)Significant capital investments in unconsolidated financial sector entities

—

9,875

AT1 capital end point basis

37,72916,367

Tier 2 capital on a transitional basis

55,67754,223

Grandfathered instruments:(3,133)(5,287)—(1,563)(3,133)(3,126)

Perpetual cumulative preference shares
Perpetual subordinated debt
Term subordinated debt

—

(598)

Transitional provisions: Significant capital investments in unconsolidated financial sector entities

—

9,875

52,54458,811

Tier 2 capital end point basis

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201845

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 47-51, is made with a view to distinguishing for shareholders the respective responsibilities of the Directors and of the Auditor
in relation to the 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 ‘the group’),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 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 theundertakings included in the consolidation taken as a whole; 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 and the undertakings included in the consolidation taken as a whole,
together with a description of the principal risks and uncertainties that the group faces.

On behalf of the Board

John Flint
Chairman
19 February 201946

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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 52 to 113, which comprise:• the consolidated balance sheet as at 31 December 2018;• 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 2018, rather than in the notes to the financial statements.
These are cross-referenced from the financial statements and are identified as audited.

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 2018, 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
section of our report.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Independence
We 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 judgment, 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• Alternative performance measure

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201847

Independent Auditor’s Report

IT access management
Nature of the Key Audit Matter

Matters discussed with the Audit Committee

The audit approach relies extensively on automated controls and therefore
on the effectiveness of controls over IT systems. In previous years, we
identified and reported that controls over access to applications, operating
systems and data in the financial reporting process required improvements.
Access management controls are critical to ensure that changes toapplications and underlying data are made in an appropriate manner.
Appropriate access controls contribute to mitigating the risk of potential
fraud or errors as a result of changes to applications and data. Management
has implemented remediation activities that have contributed to reducing
the risk over access management in the financial reporting process.
However, issues related to privileged access and business user accessremained unresolved on parts of the technology infrastructure, requiring our
audit approach to respond to the risks presented.

The status of management’s remediation, our audit response and theresults of our testing procedures was discussed at Audit Committee
meetings in 2018 and 2019.

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 applications and databases,
and that business users, developers and production support did not have access to change applications, the operating system or databases in the
production environment.
As a consequence of the deficiencies identified, a range of other procedures were performed:• where inappropriate access was identified, we understood the nature of the access, and obtained additional evidence on the appropriateness of theactivities performed;• additional substantive testing was performed on specific year-end reconciliations (i.e. custodian, bank account and suspense account reconciliations)and confirmations with external counterparties;• testing was performed on other compensating controls such as business performance reviews;• testing was performed over controls that prevent inappropriate combinations of access; and• a list of users’ access permissions was obtained and manually compared to other access lists where segregation of duties was deemed to be of higher
risk, for example users having access to both core banking and payments systems.
Relevant references in the Annual Report and Accounts 2018

Risk: Top and Emerging Risks, page 17; Operational Risk, page 36

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

Matters discussed with the Audit Committee

At 31 December 2018, the market value of the Bank's investment in BoCombased on the share price was HK$53,536 million lower than the carrying value.
This is 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$1,723 million in excess of carrying value at 31 December
2018. On this basis, no impairment was recorded and the share of BoCom’s
profits has been recognised in the consolidated income statement.

The VIU model is dependent on many assumptions, both short-term and longterm in nature. These assumptions are derived from a combination ofmanagement estimates, analysts’ forecasts and market data, and are highly
judgemental. Given the proximity of the carrying value and VIU, small changes
in some of these assumptions would lead to an impairment. We discussed theappropriateness of these assumptions with the Audit Committee, particularly
those with the greatest sensitivity related to short term cash flows and theminimum level of capital required by BoCom. We discussed whether the impactof China-US trade tensions and the impact of government policies on the China
banking market had been fully reflected. We also reviewed with the Audit
Committee the long term profit growth rate and loan impairment rate, andconsidered reasonably possible alternatives. In the discussion we specificallyconsidered whether the assumptions used captured the current levels of
uncertainty, both individually and considering the output of the model inaggregate.

How our audit addressed the Key Audit Matter• The conclusions on the appropriateness of the model were evaluated, with the assistance of our valuation expert.
• Inputs used in the determination of assumptions within the model were challenged and corroborating information was obtained with reference toexternal market information, third-party sources including analyst reports, and historical publicly available BoCom information.
• A reasonable range for the discount rate used within the model was independently calculated with the assistance of our valuation experts.
• The controls in place over the model, and its mathematical accuracy were tested.
• A meeting between management and senior BoCom executive management, held specifically to identify facts or circumstances impacting management
assumptions, was observed.
• Disclosures made in the Annual Report and Accounts 2018 in relation to BoCom were tested and assessed for appropriateness.
• Representations were obtained from the Bank that the assumptions used were consistent with information currently available to the Bank both asshareholder and to which the Bank is entitled through participation on BoCom's board of Directors.
Relevant references in the Annual Report and Accounts 2018

Financial Review, page 11
Note 1: Basis of preparation and significant accounting policies, page 59
Note 15: Interests in associates and joint ventures, page 86-88

48

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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$48,522 million and liabilities
under non-linked life insurance contracts of HK$433,668 million as at 31
December 2018. The determination of these balances requires the use of
appropriate actuarial methodologies and also highly judgemental
assumptions. Such assumptions include the long-term economic returns of
insurance contracts issued, assumptions over policyholder behaviour suchas longevity, mortality and persistency, and management assumptions overthe future costs of obtaining and maintaining the group’s insurance
business. Small movements in these assumptions 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,• assumption 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:• long-term economic returns of insurance contracts issued;• policyholder behaviour such as longevity, mortality 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, market information and formed a reasonable basis for setting the assumptions.
Relevant references in the Annual Report and Accounts 2018

Risk: Risks of insurance manufacturing operations, page 38-41
Note 1: Basis of preparation and significant accounting policies, page 65
Note 4: Liabilities under insurance contracts, page 77
Note 16: Goodwill and intangible assets, page 89

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

Matters discussed with the Audit Committee

As this is the first year of adoption of HKFRS 9, there is limited experienceavailable to back-test the expected credit loss ('ECL') charge and allowanceagainst actual results. There has been a significant increase in the number ofdata points required for the impairment calculation. The data is sourced
from a number of systems that have not been used previously for the
preparation of the accounting records. This increases the risk aroundcompleteness and accuracy of certain data used to create assumptions andoperate the models. The global credit environment has remained relatively
benign for an extended period of time, in part due to the low interest rateenvironment, and the relative strength of the global economy. However,there are a number of headwinds to the global economy as well as certain
regional and country specific risks. As a result, whilst the current levels ofdelinquencies and defaults remains low, the risk of impairment remains
significant.

At each Audit Committee meeting there was a discussion on changes to risk
factors and other inputs within the models, geopolitical risks, such as
escalating US-China trade tensions, as well as individually significant loan
impairments. The more judgemental interpretations of HKFRS 9 made bymanagement were discussed, in particular the application of forward
economic guidance, including the severity and magnitude of modelled
downside scenarios; and associated considerations of post model
adjustments. As the control environment for the calculation of ECL underHKFRS 9 continued to be strengthened following initial adoption, we
provided updates on the changes being made and the results of our testingprocedures.

How our audit addressed the Key Audit Matter• Model performance monitoring and validation controls were tested, including periodic policy and independent model reviews, back testing of
performance, and approval of model changes. We also performed risk based substantive testing of models, including independently re-building certain
assumptions.
• We tested the review and challenge of multiple economic scenarios by an expert panel and internal governance committee, and assessed thereasonableness of the multiple economic scenarios and variables using our economic experts.
• Controls over the inputs of critical data into source systems and the flow and transformation of data between source systems to the impairment
calculation system were tested. We also performed substantive testing over the critical data used in the year end ECL calculation.
• We assessed management’s user acceptance testing over the automated calculation of ECL to ensure it is performed in line with business requirements,
as well as independently reviewed the underlying system script to validate that the calculation operated as we would have expected.
• 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 supported the impairment provisions for a sample of significant
individually assessed loans.
Relevant references in the Annual Report and Accounts 2018

Risk: Credit Risk, page 18-31
Note 1: Basis of preparation and significant accounting policies, page 62-65
Note 3: Operating profit - Change in expected credit losses and other credit impairment charges, page 75

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201849

Independent Auditor’s Report

Alternative performance measure
Nature of the Key Audit Matter

Matters discussed with the Audit Committee

The group’s results are significant to HSBC Holdings plc (‘HSBC’), a listed
We communicated our risk assessment in November 2018, and designed acompany. The use of alternative performance measures is common by listed year end testing response as a result. The outcome of our testing wascommunicated to the Audit Committee in February 2019.
companies to help better explain performance to the established strategy.
HSBC use a number of alternative performance measures, including a Jaws
target. Jaws represents the difference between the rate of growth ofrevenue and the rate of growth of costs in a given financial period. During
the year we discussed with the Audit Committee the sensitivity of the jaws
metric of HSBC to small changes in revenue and costs. We concluded that
this increased the incentive for management to override controls to meettargets prompting us to perform a number of incremental procedures whichmight indicate that revenue or costs were intentionally misstated.
How our audit addressed the Key Audit Matter• We reassessed significant judgements in light of the enhanced incentives noted in the risk assessment.
• We performed additional tests on journals, specifically considering cutoff and unusual combinations that impact costs and revenue.
• We tested expenses booked post year end to assess if they were included in the correct period.
• We tested the clearance and appropriateness of classification of aged unreconciled items, considering if there was a trend towards only resolving issues
which would improve revenue or reduce costs.
• We performed additional tests on the completeness and accuracy of accruals and capitalised expenses.
Relevant references in the Annual Report and Accounts 2018

Report of the Directors: Asia Strategy, page 3
Risk: Operational Risk, page 36

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 2018 (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 2018 and the list of the directors of theBank’s subsidiary undertakings (consolidated in the financial statements) during the period from 1 January 2018 to 19 February 2019,
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.
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 2018 and the list of the directors of the Bank’s subsidiary undertakings (consolidated in
the financial statements) during the period from 1 January 2018 to 19 February 2019, 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.

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.

50

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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 of assurance, 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 orin 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 judgment 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, 19 February 2019

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201851

Consolidated Financial Statements

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

Net interest income

2018

2017

Notes

HK$m

HK$m

3a

126,463

110,237– interest income

170,065

138,081– interest expense(43,602)(27,844)

44,231

43,150– fee income

54,58552,312– fee expense(10,354)(9,162)

Net fee income

3b

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

3c

31,72323,098Net income/(expense) from assets and liabilities of insurance businesses, including related derivatives, measured at fairvalue through profit or loss

3c

(5,561)

15,607

Changes in fair value of long-term debt issued and related derivatives

3c

20

(115)

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

3c

(217)

N/A

Gains less losses from financial investments

3d

501

2,108

164

232

Net insurance premium income

4a60,67856,176

Other operating income

3eDividend income

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

4b

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

3f

Loan impairment charges and other credit risk provisions
Net operating income

10,306

4,740

268,308

255,233(57,839)(68,790)

210,469

186,443(4,720)

N/A

N/A(4,437)205,749

182,006

Employee compensation and benefits

5a(40,793)(40,095)

General and administrative expenses

3g(39,989)(34,786)

Depreciation and impairment of property, plant and equipment

17(4,686)(4,650)

Amortisation and impairment of intangible assets(1,956)(1,536)

Total operating expenses(87,424)(81,067)

Operating profit

118,325

100,939

Share of profit in associates and joint ventures

16,258

14,680

Profit before tax

134,583

115,619

Tax expense(22,467)(19,601)

Profit for the year

112,116

96,018

Profit attributable to shareholders of the parent company

103,01388,530

9,103

7,488

6

Profit attributable to non-controlling interests

52

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Consolidated statement of comprehensive income
for the year ended 31 December
2018

2017

HK$m

HK$m

112,116

96,018Available-for-sale investments

N/A

1,609

– fair value gains

N/A

3,346

– fair value gains reclassified to the income statement

N/A(1,667)– amounts reclassified to the income statement in respect of impairment losses

N/A5– income taxes

N/A

(75)

Debt instruments at fair value through other comprehensive income

826

N/A

– fair value gains

908

N/A

– fair value losses transferred to the income statement on disposal

142

N/A

(9)

N/A

– income taxes

(215)

N/A

Cash flow hedges

131

607

– fair value gains/(losses)

1,264(6,780)– fair value (gains)/losses reclassified to the income statement(1,125)

7,506

(8)

(119)

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 losses recognised in the income statement– income taxes
Share of other comprehensive expense of associates and joint ventures
Exchange differences

(146)

(852)

(18,098)

25,387

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

8,826

8,864

– fair value gains

10,626

10,442– income taxes(1,800)(1,578)Equity instruments measured at fair value through other comprehensive income

(581)

N/A

– fair value losses

(576)

N/A

– income taxes

(5)

N/A

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

(199)

(209)

– before income taxes

(241)

(250)

– income taxes
Remeasurement of defined benefit asset/liability– before income taxes– income taxes

42

41

(910)

1,371

(1,091)

1,640

181

(269)

Other comprehensive income for the year, net of tax(10,151)

36,777

Total comprehensive income for the year

101,965

132,795– shareholders of the parent company

92,796

123,739– non-controlling interests

9,169

9,056

101,965

132,795

Attributable to:Total comprehensive income for the year

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201853

Consolidated Financial Statements

Consolidated balance sheet
at 31 December
2018

2017

HK$m

HK$m

Cash and sight balances at central banks

205,660

208,073

Items in the course of collection from other banks

25,38025,714

Hong Kong Government certificates of indebtedness

280,854

267,174

Notes

AssetsTrading assets

8558,838

496,434

Derivatives

9292,869

300,243

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

10

132,859

N/A

Financial assets designated at fair value

10

N/A

122,646

Reverse repurchase agreements – non-trading

406,327

330,890

Placings with and advances to banks

338,151

433,005

Loans and advances to customers

11

3,528,702

3,328,980

Financial investments

12

1,871,026

1,720,873

Amounts due from Group companies

34

70,455

227,729

Interests in associates and joint ventures

15

142,885

144,717

Goodwill and intangible assets

16

65,104

59,865

Property, plant and equipment

17112,080

116,336

Deferred tax assets

6

2,315

2,156

Prepayments, accrued income and other assets

18

229,949

158,511

8,263,454

7,943,346

Hong Kong currency notes in circulation

280,854

267,174

Items in the course of transmission to other banks

33,80638,283

Repurchase agreements – non-trading

70,27947,170

Deposits by banks

164,664

201,697

Total assets
Liabilities

Customer accounts

19

5,207,666

5,138,272

Trading liabilities

20

81,194

231,365

Derivatives

9295,553309,353

Financial liabilities designated at fair value

21

161,143

49,278Debt securities in issue

22

58,23638,394Retirement benefit liabilities

5b

3,369

2,222

Amounts due to Group companies

34

396,487

265,688

Accruals and deferred income, other liabilities and provisions

23

196,665

110,687

Liabilities under insurance contracts

4468,589

438,017

Current tax liabilities

6

3,337

3,242

Deferred tax liabilities

6

24,51324,391

Subordinated liabilities

24

4,081

4,090

Preference shares

25

98

21,0377,450,534

7,190,360
151,360

Total liabilities
EquityShare capital

26

172,335

Other equity instruments

27

35,87914,737

Other reserves

114,949

123,417

Retained earnings

429,595

406,966

Total shareholders’ equity

752,758

696,480

Non-controlling interests

60,16256,506

Total equity

812,920752,986

8,263,454

7,943,346

Total liabilities and equity

54

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Consolidated statement of cash flows
for the year ended 31 December

Profit before tax

2018

2017

HK$m

HK$m

134,583

115,619

Adjustments for non-cash items:
Depreciation and amortisation

6,657

6,202

Net gain from investing activities(1,071)(3,564)

Share of profits in associates and joint ventures(16,258)(14,680)(Gain)/loss on disposal of subsidiaries, businesses, associates and joint ventures
Change in expected credit losses gross of recoveries and other credit impairment charges
Loan impairment losses gross of recoveries and other credit risk provisions

(38)

186

4,720

N/A

N/A

5,330

Provisions

51

(618)

Share-based payment expense

881

970

Other non-cash items included in profit before tax(3,861)510

Elimination of exchange differences

15,723(36,213)

Changes in operating assets and liabilities
Change in net trading securities and derivatives(65,937)(55,262)

Change in loans and advances to banks and customers(299,137)(491,235)

Change in reverse repurchase agreements – non-trading(61,887)(75,091)

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

1,176

N/A

N/A

(16,630)

Change in other assets

113,636

144,752

Change in deposits by banks and customer accounts

71,688247,486

Change in repurchase agreements – non-trading

23,10919,360Change in debt securities in issue

19,842

13,159Change in financial liabilities designated at fair value(8,605)(1,838)

166,634

63,627

Dividends received from associates

4,948

4,556

Contributions paid to defined benefit plans

(576)

(722)

(18,216)(14,674)

Change in financial assets designated at fair value

Change in other liabilities

Tax paid
Net cash from operating activities

88,062(88,770)

Purchase of financial investments(822,067)(721,925)

Proceeds from the sale and maturity of financial investments

756,630

749,277

Purchase of property, plant and equipment(1,646)(2,997)

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

11,8205,572

Proceeds from disposal of customer loan portfolios

2,542

2,004

Net investment in intangible assets(4,691)(2,831)

Cash outflow on purchase of subsidiaries
Net cash from investing activities—(1,757)(57,412)27,343Issue of ordinary share capital and other equity instruments

21,142

1,744

Redemption of preference shares and other equity instruments(20,975)(6,022)

Subordinated loan capital issued1

79,83476,433

Subordinated loan capital repaid1(42,986)(18,737)

Dividends paid to shareholders of the parent company and non-controlling interests(52,508)(60,892)

Net cash from financing activities(15,493)(7,474)

Net increase/(decrease) in cash and cash equivalents

15,157(68,901)

Cash and cash equivalents at 1 Jan2

718,038

752,705

Exchange differences in respect of cash and cash equivalents(11,586)

34,234

Cash and cash equivalents at 31 Dec

721,609

718,038– cash and balances at central banks

205,660

208,073– items in the course of collection from other banks

25,38025,714– loans and advances to banks of one month or less

179,952

293,499– reverse repurchase agreements with banks of one month or less

165,654

152,104– treasury bills, other bills and certificates of deposit less than three months

178,769

76,931– less: items in the course of transmission to other banks(33,806)(38,283)

Cash and cash equivalents at 31 Dec

721,609

718,038

Cash and cash equivalents comprise3

Interest received was HK$166,441m (2017: HK$136,539m), interest paid was HK$41,583m (2017: HK$28,324m) and dividends received
were HK$178m (2017: HK$175m).
1
2
3

Changes in subordinated liabilities (including those issued to Group companies) during the year included amounts from issuance and repayments as presented above, and non-cashchanges from foreign exchange losses (HK$ 280m) and fair value losses (HK$353m).
At 1 January 2018, the cumulative changes in cash and cash equivalents as a result of remeasurement upon the transition to HKFRS 9 ‘Financial Instruments’ was a loss of HK$1m.
At 31 December 2018 HK$ 122,899m (2017: HK$ 199,336m) was not available for use by the group, of which HK$ 71,783m (2017: HK$ 82,667m) related to mandatory deposits at
Central banks.

.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201855

Consolidated Financial Statements | Notes on the Consolidated Financial Statements

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

Sharecapital

At 31 Dec 2017
Impact on transition to HKFRS 9
At 1 Jan 2018
Profit for the year
Other comprehensive income/(expense) (net of tax)
– debt instruments at fair value
through other comprehensive
income– equity instruments designated atfair value through othercomprehensive income

Other
equityinstruments

Retainedearnings

Property
revaluation
reserve

Financialassets at
FVOCI
reserve7

Cashflow
Foreignhedge exchange
reserve
reserve

Other1
HK$m

HK$m

HK$m

HK$m

(6,948) 65,356

696,480

56,506752,986

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

151,360

14,737

406,966

58,381

6,825

(197)

HK$m

—

—

(7,478)—(4,512)—

151,360

14,737399,488

58,381

2,313

(197)

—

—

—

103,013

—

—

—

—

—

—

(890)

8,050

228

98

—

—

—

—

734

Total
shareNonholders’ controlling
equityinterests

Total
equity—(11,990)(323)(12,313)(6,948) 65,356

684,490

56,183740,673—

103,0139,103

112,116(17,701)(2)(10,217)66(10,151)

—

—

—

734

92

826

—

—

—

—

(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– exchange differences

—

—

(5)

—

(139)

—

—

(2)

(146)

—

(146)

—

—

—

—

—

—

(17,701)—(17,701)(397)(18,098)——

102,123

8,050

228

98

(17,701)(2)

92,796

9,169

101,965—

21,142

—

—

—

—

—

—

21,142—

21,142——(47,440)

—

—

—

—

—

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

Total comprehensive income/(expense) for the year
Other equity instruments issued

2

Dividends paid3
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) 78,830

752,758

60,162812,920

At 1 Jan 2017

114,359

14,737413,024

53,763

6,189

(793)

(31,861)

58,588628,006

51,130679,136

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

88,530

—

—

—

—

—

88,5307,488

96,018

—

—

976

8,144

636

596

24,913(56)

35,2091,568

36,777– available-for-sale investments

—

—

—

—

1,422

—

—

—

1,422

187

1,609

– cash flow hedges

—

—

—

—

—

596

—

—

596

11

607

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

—

—

(207)

—

—

—

—

—

(207)

(2)

(209)

– property revaluation

—

—

—

8,144

—

—

—

—

8,144

720

8,864

– remeasurement of defined benefit
asset/liability

—

—

1,193

—

—

—

—

—

1,193

178

1,371

– share of other comprehensive
expense of associates and joint
ventures– exchange differences

—

—

(10)

—

(786)

—

—

(56)

(852)

—

(852)

—

—

—

—

—

—

24,913—24,913474

25,387

Total comprehensive income/(expense) for the year
Shares issued
Dividends paid3
Movement in respect of sharebased payment arrangements——

89,506

8,144

636

596

24,913(56)

123,739

9,056

132,795

1,744
—

—
—

—
(56,260)

—
—

—
—

—
—

—
—

—
—

1,744
(56,260)—(4,632)

1,744(60,892)
(406)

—

—

(73)

—

—

—

—

(324)

(397)

(9)

Transfers and other movements4,5,6

35,257—(39,231)(3,526)

—

—

—

7,148

(352)

961

609

At 31 Dec 2017

151,360

14,737

406,966

58,381

6,825

(197)

(6,948)65,356

696,480

56,506752,986

1

2
3
4
5
6
7

56

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 share-based 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.
In 2018, there were US$2,700m additional tier 1 capital instruments issued.
Including distributions paid on perpetual subordinated loans classified as equity under HKFRS.
Ordinary share capital includes preference shares which have been redeemed or bought back via payment out of distributable profits. In 2018, the Bank redeemed HK$20,975m(2017: HK$35,257m) of preference shares.
The movement from retained earnings to other reserves includes the relevant transfers in associates according to local regulatory requirements.
The movement from property revaluation reserve to other reserves in 2018 included HK$7,169m (2017: HK$2,100m) relating to transfer of properties to a fellow subsidiary as part of
the Recovery and Resolution Plan as set out in the Report of Directors in the Annual Report and Accounts 2018.
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 2018

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
financial statements also comply with the requirements of the Hong Kong Companies Ordinance (Cap. 622) which are applicable to the
preparation of financial statements.

Standards adopted during the year ended 31 December 2018
The group has adopted the requirements of HKFRS 9 'Financial Instruments' from 1 January 2018, with the exception of the provisions
relating to the presentation of gains and losses on financial liabilities designated at fair value, which were adopted from 1 January 2017.
This includes the adoption of ‘Prepayment Features with Negative Compensation (Amendments to HKFRS 9)’ which is effective forannual periods beginning on or after 1 January 2019 with early adoption permitted. The effect of adopting the amendments to HKFRS 9
is not considered to be significant. HKFRS 9 includes an accounting policy choice to remain with HKAS 39 hedge accounting, which thegroup has exercised. The classification and measurement and impairment requirements are applied retrospectively by adjusting the
opening balance sheet at the date of initial application. As permitted by HKFRS 9, the group has not restated comparatives. Adoption
reduced net assets at 1 January 2018 by HK$12,313m as set out in note 2.
In addition, the group has adopted the requirements of HKFRS 15 ‘Revenue from Contracts with Customers’ and a number ofinterpretations and amendments to standards which have had an insignificant effect on the group's consolidated financial statements.

HKFRS 9 transitional requirements
The transition requirements of HKFRS 9 have necessitated a review of the designation of financial instruments at fair value. HKFRS 9
requires that the designation is revoked where there is no longer an accounting mismatch at 1 January 2018 and permits designations to
be revoked or additional designations created at 1 January 2018 if there are accounting mismatches at that date. As a result, fair value
designations for financial liabilities have been revoked where the accounting mismatch no longer exists, as required by HKFRS 9.
The results of these changes are included in the reconciliation set out in note 2.

Changes in accounting policy
While not necessarily required by the adoption of HKFRS 9, the following voluntary changes in accounting policy and presentation havebeen made as a result of reviews carried out in conjunction with its adoption. The effect of presentational changes at 1 January 2018 isincluded in the reconciliation set out in note 2 and comparatives have not been restated.
• We have considered market practices for the presentation of certain financial liabilities which contain both deposit and derivative
components. We have concluded that a change in accounting policy and presentation from ‘Trading liabilities' would be appropriate,
since it would better align with the presentation of similar financial instruments by peers and therefore provide more relevant
information about the effect of these financial liabilities on our financial position and performance. As a result, rather than beingclassified as held for trading, we designate these financial liabilities as at fair value through profit or loss since they are managed andtheir performance evaluated on a fair value basis. A further consequence of this change in presentation is that the effects of changes
in the liabilities’ credit risk will be presented in ‘Other comprehensive income’ with the remaining effect presented in profit or loss inaccordance with group's accounting policy adopted in 2017 (following the adoption of the requirements in HKFRS 9 relating to thepresentation of gains and losses on financial liabilities designated at fair value).
• Cash collateral, margin and settlement accounts have been reclassified from ‘Trading assets’, ‘Placings with and advances to banks'and 'Loans and advances to customers’ to ‘Prepayments, accrued income and other assets’ and from ‘Trading liabilities’ and ‘Deposits
by banks’ and ‘Customer accounts‘ to ‘Accruals and deferred income, other liabilities and provisions’. The change in presentation for
financial assets is in accordance with HKFRS 9 and the change in presentation for financial liabilities is considered to provide more
relevant information, given the change in presentation for the financial assets. The change in presentation for financial liabilities has
had no effect on measurement of these items and therefore on retained earnings or profit for any period.
• Certain stock borrowing assets have been reclassified from ‘Placings with and advances to banks' and 'Loans and advances tocustomers’ to ‘Trading assets’. The change in measurement is a result of the determination of the global business model for thisactivity and will align to the global presentation.

(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 2019. The group expects they
will have an insignificant effect, when adopted, on the consolidated financial statements.

Major new HKFRSs
The HKICPA has published HKFRS 16 ‘Leases’ and HKFRS 17 ‘Insurance contracts’.
HKFRS 16 ‘Leases’
HKFRS 16 ‘Leases’ has an effective date for annual periods beginning on or after 1 January 2019. HKFRS 16 results in lessees accounting
for most leases within the scope of the standard in a manner similar to the way in which finance leases are currently accounted for under
HKAS 17 ‘Leases’. Lessees will recognise a right of use (‘ROU’) asset and a corresponding financial liability on the balance sheet. The
asset will be amortised over the length of the lease, and the financial liability measured at amortised cost. Lessor accounting remains

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201857

Notes on the Consolidated Financial Statements

substantially the same as under HKAS 17. At 1 January 2019, the group expects to adopt the standard using a modified retrospective
approach where the cumulative effect of initially applying the standard is recognised as an adjustment to the opening balance of retained
earnings and comparatives are not restated. The implementation is expected to increase assets by approximately HK$9.2bn and increasefinancial liabilities by the same amount, with no effect on net assets or retained earnings.
As a consequence of HKFRS 16, properties currently reported under ‘Prepayments, accrued income and other assets’ as operating leases
and held at cost will be reclassified to ‘Property, plant and equipment’ and be measured at fair value. The implementation is expected toincrease ‘Property, plant and equipment’ by HK$16.3bn and increase deferred tax liabilities by HK$2.7bn, with the net impact taken to the'Property Revaluation Reserve'.
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 effective from 1 January 2021. However, the HKICPA
is considering delaying the mandatory implementation date by one year and may make additional changes to the standard. The groupis in the process of implementing HKFRS 17. Industry practice and interpretation of the standard is still developing and there may bechanges to the standard, therefore the likely impact of its implementation remains uncertain.
Amendment to HKAS 12 ‘Income Taxes’
An amendment to HKAS 12 was issued in February 2018 as part of the Annual Improvement Cycle. The amendment clarifies that anentity should recognise the tax consequences of dividends where the transactions or events that generated the distributable profits arerecognised. This amendment will be effective for annual periods beginning on or after 1 January 2019 and is applied to the income tax
consequences of distributions recognised on or after the beginning of the earliest comparative period. As a consequence, income tax
related to distributions on perpetual subordinated loans will be presented in profit or loss rather than equity.

(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 that are translated using the rate of exchange at the initial transaction date. Exchange differences are included in othercomprehensive 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 audited sections of the Annual Report and Accounts as follows:• 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 14 to 15, pages 18 to 29, page 32, page 33, page 34, page 35 and pages 38 to 41 as specified as "audited".
• Capital disclosures are included in the ‘Capital’ section on page 42.
In accordance with the group’s policy to provide disclosures that help other stakeholders to understand the group’s performance,
financial position and changes thereto, 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 good practicerecommendations issued from time to time by relevant regulators and standard setters and will assess the applicability and relevance ofsuch 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 2018 Financial Statements. Management’s selection of the group’s accounting policies whichcontain 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 financial statements are prepared on a going concern basis, as the Directors are satisfied that the group and parent company havethe resources to continue in business for the foreseeable future. In making this assessment, the Directors have considered a wide range
of information relating to present and future conditions, including future projections of profitability, cash flows and capital resources.

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The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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.
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 of financial statements 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
Impairment testing of investments in associates involves significant judgement in determining the value in use, and in particular estimating the present
values of cash flows expected to arise from continuing to hold the investment. The most significant judgements relate to the impairment testing of ourinvestment in Bank of Communications (‘BoCom’). Key assumptions used in estimating BoCom’s value in use, the sensitivity of the value in use calculation
to different assumptions and a sensitivity analysis that shows the changes in key assumptions that would reduce the excess of value in use over the
carrying amount (the ‘headroom’) to nil are described in note 15.

(b)

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 securities issued by the group that are designated under the fair value option and derivatives managed
in conjunction with those debt securities are included in interest expense.
Interest on impaired financial assets is recognised using the rate of interest used to discount the future cash flows for the purpose ofmeasuring 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 provide 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 element is comprised of the net trading
income, which includes all gains and losses from changes in the fair value of financial assets and financial liabilities held for trading,
together with the related interest income, expense and dividends; and it also includes all gains and losses from changes in the fairvalue of derivatives that are managed in conjunction with financial assets and liabilities measured at fair value through profit or loss.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201859

Notes on the Consolidated Financial Statements• ‘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 which can be separately
identifiable from other trading derivatives.
• ‘Changes in fair value of long-term debt and related derivatives’. Interest paid on the external long-term debt and interest cash flows
on related derivatives is presented in interest expense.
• ‘Changes in fair value of other financial instruments mandatorily measured at fair value through profit or loss’. This includes interest
on instruments which fail the 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 (‘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 or 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 financial statements, unlessthey 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 valued on the basis of valuation
techniques that feature one or more significant market inputs that are unobservable, where the measurement of fair value is more judgemental. An
instrument in its entirety is classified as valued using significant unobservable inputs if, in the opinion of management, a significant proportion of the
instrument’s inception profit or greater than 5% of the instrument’s valuation is driven by unobservable inputs. ‘Unobservable’ in this context means that
there is little or no current market data available from which to determine the price at which an arm’s length transaction would be likely to occur. It
generally does not mean that there is no data available at all upon which to base a determination of fair value (consensus pricing data may, for example,
be used).

(d)Financial instruments measured at amortised cost

Financial assets that are held to collect the contractual cash flows and that contain contractual terms that give rise on specified dates tocash flows that are solely payments of principal and interest, such as most loans and advances to banks and customers and some debt
securities, are measured at amortised cost. In addition, most financial liabilities are measured at amortised cost. The group accounts forregular way amortised cost financial instruments using trade date accounting. The carrying value of these financial assets at initialrecognition includes any directly attributable transactions costs. If the initial fair value is lower than the cash amount advanced, such as
in the case of some leveraged finance and syndicated lending activities, the difference is deferred and recognised over the life of the loan
through the recognition of interest income.
The group may commit to underwrite 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 repurchase or repurchase agreements (such as sales or purchases of debt
securities entered into together with total return swaps with the same counterparty) are accounted for similarly to, and presented
together with, reverse repurchase or repurchase agreements.

(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 that 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.

(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.

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The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

(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 whenextinguished. Subsequent changes in fair values are recognised in the income statement in ‘Net income from financial instruments held
for trading or managed on a fair value basis’ or ‘Net income/(expense) from assets and liabilities of insurance businesses, including
related derivatives, measured at fair value through profit or loss’.
Under the above criterion, the main classes of financial instruments designated by the group are:•

Long-term debt issues

The interest and/or foreign exchange exposure on certain fixed rate debt securities issued has been matched with the interest and/or
foreign exchange exposure on certain swaps as part of a documented risk management strategy.
•

Financial assets and financial liabilities under unit-linked and non-linked investment contracts

A contract under which 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.

(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.

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.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201861

Notes on the Consolidated Financial Statements(i)

Impairment of amortised cost and FVOCI financial assets

Expected credit losses (‘ECL’) are recognised for placings with and advances to banks, loans and advances to customers, non-trading
reverse repurchase agreements, other financial assets held at amortised cost, debt instruments measured at fair value through othercomprehensive income, and certain loan commitments and financial guarantee contracts. At initial recognition, allowance (or provision in
the case of some loan commitments and financial guarantees) is required for ECL resulting from default events that are possible within
the next 12 months (or less, where the remaining life is less than 12 months) (’12-month ECL’). In the event of a significant increase incredit risk, allowance (or provision) is required for ECL resulting from all possible default events over the expected life of the financial
instrument (‘lifetime ECL’). Financial assets where 12-month ECL is recognised are considered to be ‘stage 1’; financial assets which areconsidered to have experienced a significant increase in credit risk are in ‘stage 2’; and financial assets for which there is objective
evidence of impairment so are considered to be in default or otherwise credit-impaired are in ‘stage 3’. Purchased or originated creditimpaired 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 that 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 which 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 purchased or originatedcredit-impaired (‘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 to 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.
However, unless identified at an earlier stage, all financial assets are deemed to have suffered a significant increase in credit risk when 30
days past due. In addition, wholesale loans that are individually assessed, typically corporate and commercial customers, and included
on a watch or worry list are included in stage 2.

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The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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 reporting date. The quantitative measure of significancevaries 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 which 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
mitigations 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 25.
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 incorporate all available
information about the customer. This PD is adjusted for the effect of macroeconomic forecasts for periods longer than 12 months and isconsidered 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 that which would have been
acceptable at origination. It therefore approximates a comparison of origination to reporting date PDs.

Unimpaired and without significant increase in credit risk – (stage 1)
ECL resulting from default events that are possible within the next 12 months (’12-month ECL’) are recognised for financial 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 information
which is relevant to the assessment including information about past events, current conditions and reasonable and supportable
forecasts of future events and economic conditions at the reporting date. In addition, the estimation of ECL should take into account thetime value of money.
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 Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201863

Notes on the Consolidated Financial Statements

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 follows.
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 recalibrated 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 its 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 three economic scenarios applied more generally by the group and the judgement of the credit risk officer in relation to the likelihoodof the workout strategy succeeding or receivership being required. For less significant cases, the effect of different economic scenarios
and work-out strategies is approximated and applied as an adjustment to the most likely outcome.

Period over which ECL is measured
Expected credit loss is measured from the initial recognition of the financial asset. The maximum period considered when measuring ECL(be it 12-month or lifetime ECL) is the maximum contractual period over which 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 will in general apply three forward-looking global economic scenarios determined with reference to external forecast
distributions representative of our view of forecast economic conditions, the consensus economic scenario approach. This approach isconsidered sufficient to calculate unbiased expected loss in most economic environments. They represent a most likely outcome (theCentral scenario) and two, less likely, outer scenarios referred to as an Upside and a Downside scenario. The Central scenario is used by
the annual operating planning process and, with regulatory modifications, will also be used in enterprise-wide stress tests. The Upsideand Downside are constructed following a standard process supported by a scenario narrative reflecting the group’s current top andemerging risks and by consulting external and internal subject matter experts. The relationship between the outer scenarios and Central
scenario will generally be fixed with the Central scenario being assigned a weighting of 80% and the Upside and Downside scenarios
10% each, with the difference between the Central and Outer scenarios in terms of economic severity being informed by the spread of
external forecast distributions among professional industry forecasts. The outer scenarios are economically plausible, internallyconsistent states of the world and will not necessarily be as severe as scenarios used in stress testing. The period of forecast is five years,
after which the forecasts will revert to a view based on average past experience. The spread between the central and outer scenarios isgrounded on consensus distributions of projected gross domestic product of the following economies: UK, France, Hong Kong, mainland
China, US and Canada. The economic factors include, but are not limited to, gross domestic product, unemployment, interest rates,
inflation and commercial property prices across all the countries and territories in which the group operates.
In general, the consequences of the assessment of credit risk and the resulting ECL outputs will be probability-weighted using thestandard probability weights. This probability weighting may be applied directly or the effect of the probability weighting determined on aperiodic basis, at least annually, and then applied as an adjustment to the outcomes resulting from the central economic forecast. The
central economic forecast is updated quarterly.
The group recognises that the consensus economic scenario approach using three scenarios will be insufficient in certain economic
environments. Additional analysis may be requested at management’s discretion, including the production of extra scenarios. If
conditions warrant, this could result in alternative scenarios and probability weightings being applied in arriving at the ECL.
64

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Critical accounting estimates and judgements
In determining ECL, management is required to exercise judgement in defining what is considered to be a significant increase in credit risk and in making
assumptions and estimates to incorporate relevant information about past events, current conditions and forecasts of economic conditions. Judgement
has been applied in determining the lifetime and point of initial recognition of revolving facilities.
The PD, LGD and EAD models which support these determinations are reviewed regularly in light of differences between loss estimates and actual loss
experience, but given that HKFRS 9 requirements have only just been applied, there has been little time available to make these comparisons. Therefore,
the underlying models and their calibration, including how they react to forward-looking economic conditions, remain subject to review and refinement.
This is particularly relevant for lifetime PDs, which have not been previously used in regulatory modelling and for the incorporation of ‘Upside scenarios’
which have not generally been subject to experience gained through stress testing.
The exercise of judgement in making estimations requires the use of assumptions which are highly subjective and very sensitive to the risk factors, inparticular to changes in economic and credit conditions across a large number of geographical areas. Many of the factors have a high degree ofinterdependency and there is no single factor to which loan impairment allowances as a whole are sensitive. Pages 20 to 29 set out the assumptions
underlying the Central scenario and information about how scenarios are developed in relation to the group’s top and emerging risks and its judgements,
informed by consensus forecasts of professional industry forecasters. The sensitivity of ECL to different economic scenarios is illustrated by recalculating
the ECL for selected portfolios as if 100% weighting had been assigned to each scenario.

(j)

Insurance contracts

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

Critical accounting estimates and judgements
The value of PVIF depends upon assumptions regarding future events. The PVIF is determined by discounting those expected future profits using appropriate
assumptions in assessing factors such as future mortality, lapse rates and levels of expenses, and a risk discount rate that reflects the risk premium attributable
to the respective contracts. The PVIF incorporates allowances for both non-market risk and the value of financial options and guarantees. The assumptions
are reassessed at each reporting date and changes in the estimates which affect the value of PVIF are reflected in the income statement.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201865

Notes on the Consolidated Financial Statements(k)

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.
Buildings held for own use which are situated on leasehold land where it is possible to reliably separate the value of the building from thevalue of the leasehold land at inception of the lease are revalued by professional qualified valuers, on a depreciated replacement costbasis or surrender value, with sufficient regularity to ensure that the net carrying amount does not differ materially from the fair value.
Leasehold land and buildings are depreciated over the shorter of the unexpired terms of the leases or the remaining useful lives.
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. At inception of the lease, where the cost of land is known or can be reliably determined and the term of the leaseis not less than 50 years, the group records its interests in leasehold land and land use rights as land and buildings held for own use.
Where the term is less than 50 years, the group records its interests as operating leases.
Where the cost of the land is unknown or cannot be reliably determined, and the leasehold land and land use rights are not clearly held
under an operating lease, they are accounted for as land and buildings held for own use.

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.

66

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

(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
Judgement is involved in determining whether a present obligation exists and in estimating the probability, timing and amount of any outflows.
Professional expert advice is taken on the assessment of litigation, property (including onerous contracts) and similar obligations. Provisions for legal
proceedings and regulatory matters typically require a higher degree of judgement than other types of provisions. When matters are at an early stage,accounting judgements can be difficult because of the high degree of uncertainty associated with determining whether a present obligation exists, andestimating the probability and amount of any outflows that may arise. As matters progress, management and legal advisers evaluate on an ongoing basis
whether provisions should be recognised, revising previous judgements and estimates as appropriate. At more advanced stages, it is typically easier tomake judgements and estimates around a better defined set of possible outcomes. However, the amount provisioned can remain very sensitive to theassumptions used. There could be a wide range of possible outcomes for any pending legal proceedings, investigations or inquiries. As a result, it is often
not practicable to quantify a range of possible outcomes for individual matters. It is also not practicable to meaningfully quantify ranges of potential
outcomes in aggregate for these types of provisions because of the diverse nature and circumstances of such matters and the wide range of uncertainties
involved. Provisions for customer remediation also require significant levels of estimation and judgement. The amounts of provisions recognised depend on
a number of different assumptions, such as the volume of inbound complaints, the projected period of inbound complaint volumes, the decay rate ofcomplaint volumes, the population identified as systemically mis-sold and the number of policies per customer complaint.

Contingent liabilities, contractual commitments and guarantees
Contingent liabilities
Contingent liabilities, which include certain guarantees and letters of credit pledged as collateral security, and contingent liabilities related
to legal proceedings or regulatory matters, are not recognised in the financial statements but are disclosed unless the probability ofsettlement is remote.
Financial guarantee contracts
Liabilities under financial guarantee contracts which are not classified as insurance contracts are recorded initially at their fair value,
which is generally the fee received or present value of the fee receivable.
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.

(o)Accounting policies applicable prior to 1 January 2018

Financial instruments measured at amortised cost
Loans and advances to banks and customers, held-to-maturity investments and most financial liabilities are measured at amortised cost.
The carrying value of these financial assets at initial recognition includes any directly attributable transactions costs. If the initial fair value
is lower than the cash amount advanced, such as in the case of some leveraged finance and syndicated lending activities, the difference
is deferred and recognised over the life of the loan (as described in note 1.2(c) above) through the recognition of interest income, unlessthe loan becomes impaired.
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, a provision on the loan commitment is only recorded where it is probable that the group will incur a loss.
Impairment of loans and advances
Losses for impaired loans are recognised when there is objective evidence that impairment of a loan or portfolio of loans has occurred.
Losses which may arise from future events are not recognised.
Individually assessed loans and advances
The factors considered in determining whether a loan is individually significant for the purposes of assessing impairment include the sizeof the loan, the number of loans in the portfolio, the importance of the individual loan relationship and how this is managed. Loans thatare determined to be individually significant will be individually assessed for impairment, except when volumes of defaults and losses are
sufficient to justify treatment under a collective methodology.
Loans considered as individually significant are typically to corporate and commercial customers, are for larger amounts and aremanaged on an individual basis. For these loans, the group considers on a case-by-case basis at each balance sheet date whether there
is any objective evidence that a loan is impaired.
The determination of the realisable value of security is based on the most recently updated market value at the time the impairment
assessment is performed. The value is not adjusted for expected future changes in market prices, though adjustments are made to reflect
local conditions such as forced sale discounts.
Impairment losses are calculated by discounting the expected future cash flows of a loan, which include expected future receipts ofcontractual interest, at the loan’s original effective interest rate or an approximation thereof, and comparing the resultant present value
with the loan’s current carrying amount.
Collectively assessed loans and advances
Impairment is assessed collectively to cover losses which have been incurred but have not yet been identified on loans subject toindividual assessment or for homogeneous groups of loans that are not considered individually significant, which are generally retaillending portfolios.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201867

Notes on the Consolidated Financial Statements

Incurred but not yet identified impairment
Individually assessed loans for which no evidence of impairment has been specifically identified on an individual basis are grouped
together according to their credit risk characteristics for a collective impairment assessment. This assessment captures impairment
losses that the group has incurred as a result of events occurring before the balance sheet date that the group is not able to identify on
an individual loan basis, and that can be reliably estimated. When information becomes available that identifies losses on individual loans
within a group, those loans are removed from the group and assessed individually.
Homogeneous groups of loans and advances
Statistical methods are used to determine collective impairment losses for homogeneous groups of loans not considered individuallysignificant. The methods used to calculate collective allowances are set out below:• When appropriate empirical information is available, the group utilises roll-rate methodology, which employs statistical analyses ofhistorical data and experience of delinquency and default to reliably estimate the amount of the loans that will eventually be written
off as a result of events occurring before the balance sheet date. Individual loans are grouped using ranges of past due days, andstatistical estimates are made of the likelihood that loans in each range will progress through the various stages of delinquency andbecome irrecoverable. Additionally, individual loans are segmented based on their credit characteristics, such as industry sector, loan
grade or product. In applying this methodology, adjustments are made to estimate the periods of time between a loss event occurring,for example because of a missed payment, and its confirmation through write-off (known as the loss identification period). Current
economic conditions are also evaluated when calculating the appropriate level of allowance required to cover inherent loss. In certain
highly developed markets, models also take into account behavioural and account management trends as revealed in, for example
bankruptcy and rescheduling statistics.
• When the portfolio size is small or when information is insufficient or not reliable enough to adopt a roll-rate methodology, the group
adopts a basic formulaic approach based on historical loss rate experience, or a discounted cash flow model. Where a basic formulaic
approach is undertaken, the period between a loss event occurring and its identification is estimated by local management, and istypically between six and 12 months.
Write-off of loans and advances
Loans and the related impairment allowance accounts are normally written off, either partially or in full, when there is no realistic
prospect of recovery. Where loans are secured, this is generally after receipt of any proceeds from the realisation of security. In
circumstances where the net realisable value of any collateral has been determined and there is no reasonable expectation of further
recovery, write-off may be earlier.
Reversals of impairment
If the amount of an impairment loss decreases in a subsequent period, and the decrease can be related objectively to an event occurring
after the impairment was recognised, the excess is written back by reducing the loan impairment allowance account accordingly. The
write-back is recognised in the income statement.

Assets acquired in exchange for loans
When non-financial assets acquired in exchange for loans as part of an orderly realisation are held for sale, these assets are recorded as‘Assets held for sale.’
Renegotiated loans
Loans subject to collective impairment assessment whose terms have been renegotiated are no longer considered past due, but aretreated as up-to-date loans for measurement purposes once a minimum number of required payments has been received. Where
collectively assessed loan portfolios include significant levels of renegotiated loans, these loans are segregated from other parts of theloan portfolio for the purposes of collective impairment assessment to reflect their risk profile. Loans subject to individual impairment
assessment, whose terms have been renegotiated, are subject to ongoing review to determine whether they remain impaired. The
carrying amounts of loans that have been classified as renegotiated retain this classification until maturity or derecognition.
A loan that is renegotiated is derecognised if the existing agreement is cancelled and a new agreement made on substantially different
terms or if the terms of an existing agreement are modified such that the renegotiated loan is substantially a different financial
instrument. Any new loans that arise following derecognition events will continue to be disclosed as renegotiated loans and are assessed
for impairment as above.
Non-trading reverse repurchase, repurchase and similar agreements
When debt securities are sold subject to a commitment to repurchase them at a predetermined price (‘repos’), they remain on 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 repurchase or repurchase agreements (such as sales or purchases of debt
securities entered into together with total return swaps with the same counterparty) are accounted for similarly to, and presented
together with, reverse repurchase or repurchase agreements.

Financial instruments measured at fair value
Available-for-sale financial assets
Available-for-sale financial assets are recognised on the trade date when the group enters into contractual arrangements to purchase
them, and are normally derecognised when they are either sold or redeemed. They are subsequently remeasured at fair value, andchanges therein are recognised in other comprehensive income until the assets are either sold or become impaired. Upon disposal, thecumulative gains or losses in other comprehensive income are recognised in the income statement as ‘Gains less losses from financial
investments’.

68

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Impairment of available-for-sale financial assets
Available-for-sale financial assets are assessed at each balance sheet date for objective evidence of impairment. Impairment losses arerecognised in the income statement within ‘Loan impairment charges and other credit risk provisions’ for debt instruments and within‘Gains less losses from financial investments’ for equities.
Available-for-sale debt securities
In assessing objective evidence of impairment at the reporting date, the group considers all available evidence, including observable data
or information about events specifically relating to the securities which may result in a shortfall in the recovery of future cash flows. A
subsequent decline in the fair value of the instrument is recognised in the income statement when there is objective evidence ofimpairment as a result of decreases in the estimated future cash flows. Where there is no further objective evidence of impairment, thedecline in the fair value of the financial asset is recognised in other comprehensive income. If the fair value of a debt security increases ina subsequent period, and the increase can be objectively related to an event occurring after the impairment loss was recognised in theincome statement, or the instrument is no longer impaired, the impairment loss is reversed through the income statement.
Available-for-sale equity securities
A significant or prolonged decline in the fair value of the equity below its cost is objective evidence of impairment. In assessing whether it
is significant, the decline in fair value is evaluated against the original cost of the asset at initial recognition. In assessing whether it isprolonged, the decline is evaluated against the continuous period in which the fair value of the asset has been below its original cost atinitial recognition.
All subsequent increases in the fair value of the instrument are treated as a revaluation and are recognised in other comprehensive
income. Subsequent decreases in the fair value of the available-for-sale equity security are recognised in the income statement to theextent that further cumulative impairment losses have been incurred. Impairment losses recognised on the equity security are notreversed through the income statement.
Financial instruments designated at fair value
Financial instruments, other than those held for trading, are classified in this category if they meet one or more of the criteria set out
below, and are so designated irrevocably at inception:• the use of the designation removes or significantly reduces an accounting mismatch;• when a group of financial assets, liabilities or both is managed and its performance is evaluated on a fair value basis, in accordancewith a documented risk management or investment strategy; and• where financial instruments contain one or more non-closely related embedded derivatives.
Designated financial assets are recognised when the bank enters into contracts with counterparties, which is generally on trade date, andare normally derecognised when the rights to the cash flows expire or are transferred. Designated financial liabilities are recognised
when the bank enters into contracts with counterparties, which is generally on settlement date, and are normally derecognised whenextinguished. Subsequent changes in fair values are recognised in the income statement in ‘Net income/(expense) from financial
instruments designated at fair value’. Under this criterion, the main classes of financial instruments designated by the group are:
Long-term debt issues
The interest and/or foreign exchange exposure on certain fixed rate debt securities issued has been matched with the interest and/or
foreign exchange exposure on certain swaps as part of a documented risk management strategy.
Financial assets and financial liabilities under unit-linked and non-linked investment contracts
A contract under which 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. See note
1.2(j) for investment contracts with DPF and contracts where the group accepts significant insurance risk. Customer liabilities underlinked and certain non-linked investment contracts issued by insurance subsidiaries and the corresponding financial assets aredesignated at fair value. Liabilities are at least equivalent to the surrender or transfer value which is calculated by reference to the valueof the relevant underlying funds or indices. Premiums receivable and amounts withdrawn are accounted for as increases or decreases in
the liability recorded in respect of investment contracts. The incremental costs directly related to the acquisition of new investment
contracts or renewing existing investment contracts are deferred and amortised over the period during which the investment
management services are provided.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201869

Notes on the Consolidated Financial Statements

2

Effects of reclassification upon adoption of HKFRS 9

Reconciliation of consolidated balance sheet at 31 December 2017 and 1 January 2018
HKFRS 9 reclassification to
HKAS 39
carrying
amount at
31 Dec2017

Otherchangesin classification

Fair
value
through
profitand loss

Fair value
throughothercomprehensive
incomeAmortised
cost

Carrying
amount post
reclassification

HKFRS 9remeasurement
includingHKFRS 9expectedcarrying
credit amount at
losses4 1 Jan 2018

HKAS 39
measurement
categoryHKFRS 9measurement
category

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Cash and sightbalances at
central banks

Amortised
cost

Amortised
cost

208,073

—

—

—

—

208,073(1)

208,072

Items in thecourse ofcollection fromother banks

Amortised
cost

Amortised
cost

25,714————25,714—25,714

Hong Kong
Government
certificates ofindebtedness

Amortised
cost

Amortised
cost

267,174

—

—

—

—

267,174—

267,174

FVPL

FVPL

496,434

36,282——(26,572)

506,1449506,153

FVPL

FVPL

300,243

—

—

—

—

300,243—

300,243

FVPL

FVPL

122,646—

12,130—(899)

133,877

158

134,035

Amortised
cost

Amortised
cost

330,890

—

—

—

—

330,890—

330,890(53)

391,190

Footnotes

AssetsTrading assets

1, 3

Derivatives
Financial assets
designated andotherwise
mandatorily
measured at fairvalue

2,5,6,7

Reverserepurchaseagreements –non-trading
Placings withand advances tobanks

1, 2, 3

Amortised
cost

Amortised
cost

433,005(37,095)(4,667)——391,243

Loans andadvances tocustomers

1, 2, 3, 4

Amortised
cost

Amortisedcost

3,328,980(35,406)(2,654)——3,290,920

5

FVOCI(Available
for sale –debt
instruments)

FVOCI

1,410,655

—

(47)

—

(50,699)

1,359,909—

1,359,909

6

FVOCI(Available
for sale –equityinstruments)

FVOCI

9,275

—

(3,093)

297

—

6,479

6

6,485

5

Amortised
cost

Amortised
cost

300,943———

51,598352,541(4,457)

348,084

Amortisedcost / FVPL

Amortisedcost / FVPL

227,729

—

—

—

—

227,729(26)

227,703

Financialinvestments

Amounts duefrom Group
companies(3,492) 3,287,428

Interests inassociates andjoint ventures

8

N/A

N/A

144,717

—

—

—

—

144,717(6,029)138,688

Goodwill andintangible assets

9

N/A

N/A

59,865————59,865(616)

59,249Property, plantand equipment

N/A

N/A

116,336

—

—

—

—

116,336—

116,336

Deferred tax
assets

N/A

N/A

2,156

—

—

—

—

2,156

383

2,539

N/A

N/A

158,511

36,219(1,669)(297)

26,572

219,336(32)

219,304

7,943,346

—

—

—

—

7,943,346

Prepayments,
accrued income
and other assets

1, 7

Total assets
For footnotes, see page 73.

70

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

(14,150) 7,929,196

Reconciliation for consolidated balance sheet at 31 December 2017 and 1 January 2018 (continued)
HKFRS 9 reclassification to
HKAS 39
carrying
amount at
31 Dec2017

Otherchangesin classification

Fair
value
through
profitand loss

Fair value
throughothercomprehensive
incomeAmortised
cost

Carrying
amount post
reclassification

HKFRS 9remeasurement
includingHKFRS 9expectedcarrying
credit amount at
4losses 1 Jan 2018

HKAS 39
measurement
categoryHKFRS 9measurement
category

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Hong Kong
currency notes incirculation

Amortised
cost

Amortised
cost

267,174

—

—

—

—

267,174—

267,174

Items in thecourse oftransmission toother banks

Amortised
cost

Amortised
cost

38,283————38,283—38,283

Repurchaseagreements –non-trading

Amortised
cost

Amortisedcost

47,170————47,170—47,170

Deposits by
banks

1

Amortised
cost

Amortisedcost

201,697(24,023)———

177,674—

177,674

1

Amortised
cost

Amortised
cost

5,138,272(15,303)———

5,122,969—

5,122,969

FVPL

FVPL

231,365(147,654)———

83,711—

83,711

FVPL

FVPL

309,353

—

—

—

—

309,353—309,353

Footnotes

Liabilities

Customer
accounts
Trading liabilities

1, 10

Derivatives
Financialliabilities
designated at fair
value

FVPL

FVPL

49,278120,397———

169,67573

169,748

Debt securities in
issue

Amortised
cost

Amortised
cost

38,394————38,394—38,394Retirement
benefit liabilities

N/A

N/A

2,222

—

—

—

—

2,222

—

2,222

Amounts due toGroupcompanies

Amortisedcost / FVPL

Amortisedcost / FVPL

265,688

—

—

—

—

265,688—265,688

9, 10

Accruals anddeferred income,other liabilities
and provisions

1, 4

N/A

N/A

110,687

66,583———

177,270487

177,757

Liabilities underinsurance
contracts

9

N/A

N/A

438,017

—

—

—

—

438,017(536)

437,481

N/A

N/A

3,242

—

—

—

—

3,242

—

3,242

Current tax
liabilities
Deferred tax
liabilities
Subordinatedliabilities

N/A

N/A

24,391————

24,391(1,861)

22,530

Amortised
cost

Amortised
cost

4,090

—

—

—

—

4,090

—

4,090

Preference
sharesAmortised
cost

Amortisedcost

21,037————

21,037—

21,037

7,190,360

—

—

—

—

7,190,360

Total liabilities(1,837) 7,188,523

HKAS 39 carrying
amount at 31 Dec
2017

HKFRS 9reclassification

Carrying amountpost
reclassification

HKFRS 9remeasurement
including
expected credit
losses

HK$m

HK$m

HK$m

HK$m

HK$m

Called up share capital

151,360—

151,360—

151,360

Other equity instruments

14,737—

14,737—

14,737

123,417(4,569)118,848

57

118,905

Retained earnings

406,966

4,569

411,535(12,047)

399,488

Total shareholders' equity

696,480—

696,480(11,990)

684,490

Non-controlling interests

56,506—56,506(323)

56,183

Total equity

752,986—

752,986(12,313)740,673

Footnotes

Carrying amountat 1 January 2018

EquityOther reserves

11

For footnotes, see page 73.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201871

Notes on the Consolidated Financial Statements

Reconciliation of impairment allowance under HKAS 39 and provision under HKAS 37 to expected credit losses under HKFRS 9
Reclassification to

Remeasurement

Fair value
through profit
and loss

Fair value
through othercomprehensive
incomeAmortised cost

Stage 3

Stage 1 & Stage 2

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HKAS 39 measurement
category

Financial assets at
amortised cost
HKAS 39 impairment
allowance at 31 Dec 2017

—

—

—

—

—

13,046

Cash and sight balances at
central banks

Amortised cost
(Loans and receivables)

—

—

—

—

1

1

Items in the course ofcollection from other banks

Amortised cost
(Loans and receivables)

—

—

—

—

—

—

Hong Kong Government
certificates of indebtedness

Amortised cost
(Loans and receivables)

—

—

—

—

—

—

Reverse repurchaseagreements – non-trading

Amortised cost
(Loans and receivables)

—

—

—

—

—

—

Placings with and advances
to banks

Amortised cost
(Loans and receivables)

—

—

—

—

53

53

Loans and advances tocustomers

Amortised cost
(Loans and receivables)

—

—

—

827

2,665

3,492

Financial investments

Amortised cost
(Held to maturity)

—

—

23

—

99

122

Amortised cost
(Loans and receivables)

—

—

—

—

32

32

—

—

—

—

—

16,746

—

—

—

—

—

54

N/A

N/A

N/A

1

486

487

—

—

—

—

—

541

Prepayments, accrued
income and other assets
Expected credit loss
allowance at 1 Jan 2018
Loan commitments andfinancial guarantee
contracts
HKAS 37 provisions at 31
Dec 2017
Provisions (loancommitments and financial
guarantees)

N/A

Expected credit loss
provision at 1 Jan 2018

The pre-tax net asset impact of additional impairment allowances on adoption of HKFRS 9 is HK$4,187m; HK$3,700m in respect offinancial assets at amortised cost and HK$487m related to loan commitments and financial guarantee contracts. Total expected credit
loss allowance at 1 January 2018 is HK$16,746m in respect of financial assets at amortised cost and HK$541m related to loan
commitments and financial guarantee contracts.
Effects of reclassification upon adoption of HKFRS 9
Assuming no reclassification

Carrying
amount at 31
Dec 2018

Fair value at
31 Dec 2018

Gains/(losses)
recognised in
profit or loss

Gains/(losses)
recognised inothercomprehensive
income

HK$m

HK$m

HK$m

HK$m

41,70442,448N/A(3,427)

Reclassified from available-for-sale to amortised cost
Debt instruments measured at amortised cost

The majority of the assets reclassified from fair value through profit and loss to amortised cost matured during the year.

72

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Footnotes to Effects of reclassification upon adoption of HKFRS 9
1

Settlement accounts of HK$26,572m have been reclassified from ‘Trading assets’ to ‘Prepayments, accrued income and other assets’ as a result of the assessment of businessmodel in accordance with HKFRS 9. Cash collateral, margin and settlement accounts previously presented as ‘Placings with and advances to banks' of HK$28,032m and 'Loans
and advances to customers’ of HK$8,187m have been represented in ‘Prepayments, accrued income and other assets’ to ensure consistent presentation of all such balances. Cashcollateral, margin and settlement accounts previously presented as ‘Trading liabilities’ of HK$27,257m, ‘Deposits by banks' of HK$24,023m and 'Customer accounts' of
HK$15,303m have been represented in 'Accruals and deferred income, other liabilities and provisions’. This change in presentation for financial liabilities is considered to provide
more relevant information, given the change in presentation for the financial assets. These changes in presentation for financial assets and liabilities have had no effect on
measurement of these items and therefore on 'Retained earnings'.

2'Loans and advances to customers' of HK$2,654m and 'Placings with and advances to banks' of HK$4,667m did not meet the 'solely payments of principal and interest' (‘SPPI’)requirement for amortised cost classification under HKFRS 9. As a result, these financial assets were reclassified to ‘Financial assets designated and otherwise mandatorily
measured at fair value'.

3

Stock borrowing assets of HK$36,282m have been reclassified from ‘Placings with and advances to banks' and 'Loans and advances to customers’ to ‘Trading assets’. The change
in measurement is a result of the determination of the global business model for this activity and to align the presentation throughout the group.

4

HKFRS 9 expected credit losses have decreased net assets by HK$4,187m principally comprising of HK$3,492m reduction in the carrying value of assets classified as 'Loans andadvances to customers' and HK$487m increase in 'Provisions' relating to expected credit losses on loan commitments and financial guarantee contracts.

5

Debt instruments of HK$47m previously classified as available-for-sale under HKAS 39 did not meet the SPPI requirement for FVOCI classification. As a result, these financial assets
were classified as ‘Financial assets designated and otherwise mandatorily measured at fair value’ upon adoption of HKFRS 9. Debt instruments of HK$50,699m previouslyclassified as available-for-sale under HKAS 39, have been reclassified to amortised cost as a result of ‘hold to collect’ business model classification under HKFRS 9. This resulted ina HK$4,335m downward remeasurement of the financial assets now measured at amortised cost excluding expected credit losses.

6

HK$3,093m of available-for-sale equity instruments have been reclassified as ‘Financial assets designated and otherwise mandatorily measured at fair value’ in accordance withHKFRS 9. The group has elected to apply the FVOCI option under HKFRS 9 for the remaining HK$6,182m.

7

HK$1,669m of other financial assets, representing default fund contributions which were measured at amortised cost under HKAS 39, did not meet the SPPI requirement foramortised cost classification under HKFRS 9. As a result, these financial assets were classified as ‘Financial assets designated and otherwise mandatorily measured at fair value’.

8'Interests in associates and joint ventures' includes the consequential downward remeasurement of our interests in associates and joint ventures as a result of these entities
applying HKFRS 9 of HK$6,029m.

9

Changes in the classification and measurement of financial assets held in our insurance business and the recognition of ECL under HKFRS 9 has resulted in secondary impacts on
the present value of in-force long-term insurance business ('PVIF') and liabilities to holders of insurance and investment contracts. The gross carrying value of PVIF reported in‘Goodwill and intangible assets’ and liabilities reported in ‘Liabilities under insurance contracts’ has decreased by HK$616m and HK$536m respectively. Liabilities reported under‘Financial liabilities designated at fair value’ have increased by HK$73m.

10

We have considered market practices for the presentation of HK$120,397m of financial liabilities which contain both deposit and derivative components. We have concluded that achange in accounting policy and presentation from ‘Trading liabilities’ would be appropriate, since it would better align with the presentation of similar financial instruments bypeers and therefore provide more relevant information about the effect of these financial liabilities on our financial position and performance. As a result, rather than being classified
as held for trading, we have designated these financial liabilities as at fair value since they are managed and their performance evaluated on a fair value basis.

11

While HKFRS 9 ECL has no effect on the carrying value of FVOCI financial assets, which remain measured at fair value, the adoption of HKFRS 9 results in a transfer from the
FVOCI reserve (formerly AFS reserve) to retained earnings to reflect the cumulative impairment recognised in profit or loss in accordance with HKFRS 9 (net of impairment losses
previously recognised in profit or loss under HKAS 39). The resulting cumulative expected credit losses recognised in ‘Retained earnings’ on financial assets measured at FVOCI on
adoption of HKFRS 9 is HK$55m. In addition, the cumulative AFS reserve relating to financial investments reclassified to 'Financial assets designated and otherwise mandatorily
measured at fair value’ in accordance with HKFRS 9 has been transferred to retained earnings.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201873

Notes on the Consolidated Financial Statements

3

Operating profit(a)

Net interest income

Net interest income includes:

Interest income recognised on impaired financial assets

2018

2017

HK$m

HK$m

276

277

Interest income recognised on financial assets measured at amortised cost

143,709

N/A

Interest income recognised on financial assets measured at FVOCI

26,412

N/A

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

N/A(b)

Net fee income

Net fee income by global business
2018

2017

RetailBanking and
WealthManagement

Commercial
BankingGlobalBanking andMarkets

Global Private
Banking

Corporate
Centre1

Total

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Account services

1,434

979

337

55

3

2,808

2,863

Funds under management

4,122

724

1,749

910

1

7,506

7,000

Cards

6,552

1,788

74

—

—

8,414

7,622

Credit facilities

242

1,568

1,360

9

1

3,180

2,886

Broking income

3,397

73

702

507

—

4,679

4,386

Imports/exports

—

2,909

723

—

—

3,632

3,627

6,381

172

—

558

(4)

7,107

6,987

Underwriting

5

3

1,111

—

(7)

1,112

1,477

Remittances

333

2,183

625

3

(6)

3,138

3,316

Global custody

713

51

3,025

95

(18)

3,866

3,626

Insurance agency commission 2

1,510

142

4

94

(9)

1,741

1,528

Other

1,816

2,020

5,087

719

(2,240)

7,402

6,994

Fee income

26,505

12,612

14,7972,950(2,279)54,58552,312

Unit trusts

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

(300)

2,381

(10,354)(9,162)

Net fee income

21,087

10,598

9,794

2,650

102

44,231

43,1501
2Includes inter-segment elimination
Re-insurance fees (previously reported under ‘insurance agency commission’) were reclassified under ‘Other’ to align with the Group's presentation. Comparatives have been
represented to conform to the current year’s presentation.

Net fee income includes:
2018

2017

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)

11,583

11,031– fee income

16,36815,443– fee expense(4,785)(4,412)

Fee earned on trust and other fiduciary activities

9,653

8,904

– fee income

10,7879,843– fee expense(1,134)(939)

Net fee income includes the following:74

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

(c)Net income from financial instruments measured at fair value
2018

2017

HK$m

HK$m

32,56723,432

Net income/(expense) arising on:
Trading activities
Gain on termination of hedges
Other trading income - hedging ineffectiveness

—

38

(122)

(14)

– on cash flow hedges—

1– on fair value hedges

(122)

(15)

Fair value movement on non-qualifying hedges

(209)

(246)

Other instruments designated at fair value and related derivatives1

(513)

(112)

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

31,72323,098Financial assets held to meet liabilities under insurance and investment contracts(6,104)

18,162543(2,555)(5,561)

15,60720(115)

Liabilities to customers under investment contracts
Net income/(expense) from assets and liabilities of insurance businesses, including related derivatives, measured atfair value through profit or loss1
Changes in fair value of long-term debt issued and related derivatives
Changes in fair value of other financial instruments mandatorily measured at fair value through profit or loss
Year ended 31 Dec
1

(217)

N/A

25,96538,590The presentation has been updated to show the net income/(expense) from assets and liabilities backing insurance and investment contracts separately. Comparatives have been
represented to conform to the current year's presentation.

(d)Gains less losses from financial investments
2018

2017

HK$m

HK$m

Gains on disposal of debt instruments measured at fair value through other comprehensive income

501

N/A

Gains on disposal of available-for-sale securities

N/A

2,113

Impairment of available-for-sale equity investments

N/A

(5)

Year ended 31 Dec

501

2,108

The decrease in gains on disposal of financial investments was mainly due to the non-recurrence of disposal of the investment in
Techcom Bank in 2017.

(e)

Other operating income

Movement in present value of in-force insurance business

2018

2017

HK$m

HK$m

4,629

305

Gains on investment properties

639

416

Gains/(losses) on disposal of property, plant and equipment and assets held for sale

(69)

77

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

38

(186)

Rental income from investment properties

416

426

Other

4,653

3,702

Year ended 31 Dec

10,306

4,740

There was a loss on disposal of loans and receivables of HK$5m in the year (2017: loss of HK$75m). There were no gains or losses on
disposal of financial liabilities measured at amortised cost in the year (2017: nil).

(f)Change in expected credit losses and other credit impairment charges
2018

2017

HK$m

HK$m

Loans and advances to banks and customers

4,611

4,330

– new allowances net of allowance releases

5,551

5,224

– recoveries of amounts previously written off

(940)

(894)

– modification losses and other movements—

N/A

Loan commitments and guarantees

123

107

Other financial assets

(14)

—

Year ended 31 Dec

4,720

4,437

Change in expected credit losses/ loan impairment charges

Change in expected credit losses as a percentage of average gross customer advances was 0.13% for 2018 (2017: 0.14%).

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201875

Notes on the Consolidated Financial Statements(g)General and administrative expenses
2018

2017

HK$m

HK$m

Premises and equipment

8,208

7,814

– rental expenses

4,134

3,717

– other premises and equipment expenses

4,074

4,097

Marketing and advertising expenses

2,940

2,785

Other administrative expenses

28,841

24,187

Year ended 31 Dec

39,98934,786

Included in operating expenses were direct operating expenses of HK$35m (2017: HK$32m) 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$3m (2017: HK$4m).
Included in operating expenses were minimum lease payments under operating leases of HK$3,550m (2017: HK$3,598m).

(h)

Auditors’ remuneration

Auditors’ remuneration amounted to HK$125m (2017: HK$122m).

4

Insurance business(a) Net insurance premium Income
Non-linked

Unit-linked

Total

HK$m

HK$m

HK$m

Gross insurance premium income

63,462

1,586

65,048

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

1,565

60,678Gross insurance premium income

61,577

1,669

63,246

Reinsurers’ share of gross insurance premium income(7,052)(18)(7,070)At 31 Dec 2017

54,525

1,651

56,176

Non-linked

Unit-linked

Total

HK$m

HK$m

HK$m

Gross 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)

At 31 Dec 2018

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

65,671

8,841

74,512– claims, benefits and surrenders paid

19,765

7,239

27,004– movement in liabilities

45,906

1,602

47,508

Reinsurers’ share of claims and benefits paid and movement in liabilities(6,894)

1,172(5,722)– claims, benefits and surrenders paid

(1,727)(1,715)(3,442)– movement in liabilities(5,167)2,887(2,280)At 31 Dec 2017

58,777

10,013

68,790(b) Net insurance claims and benefits paid and movement in liabilities to policyholders

76

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Liabilities under insurance contracts

2017

2018
Gross

Reinsurers’
share2Net

Gross

Reinsurers’
share2

Net

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

391,348(15,624)

375,724

342,134(10,077)

332,057

(535)

—

(535)

—

—

—

At 1 Jan

390,813(15,624)

375,189

342,134(10,077)

332,057

Claims and benefits paid

(27,086)

1,930(25,156)(19,765)

1,727(18,038)

Increase/(decrease) in liabilities to policyholders

65,002(4,155)60,84765,671(6,894)

58,777

Exchange differences and other movements1

4,939

91

5,030

3,308

(380)

2,928

433,668(17,758)

415,910391,348(15,624)

375,724

42,745

Non-linked insurance contracts
At 31 Dec
Impact on transition to HKFRS 9

At 31 Dec
Linked insurance contracts
At 1 Jan

46,669(110)

46,55944,036(1,291)Claims and benefits paid

(7,598)1,394(6,204)(7,239)1,715(5,524)

Increase/(decrease) in liabilities to policyholders(3,080)72(3,008)

8,841

1,172

10,013

Exchange differences and other movements1(1,070)(1,390)(2,460)1,031(1,706)(675)

At 31 Dec

34,921(34)

34,887

46,669(110)

46,559Total liabilities to policyholders

468,589(17,792)

450,797

438,017(15,734)

422,283

1
2

Exchange differences and other movements’ includes movements in liabilities arising from net unrealised investment gains recognised in other comprehensive income.
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 death claims, surrenders, lapses, liabilities topolicyholders created at the initial inception of the policies, the declaration of bonuses and other amounts attributable to policyholders.

5

Employee compensation and benefits(a) Employee compensation and benefits
2018

2017

HK$m

HK$m

Wages and salaries

36,972

36,485Social security costs

1,249

1,110

Retirement benefits costs

2,572

2,500

– defined contribution plans

1,804

1,685

– defined benefit plans
Year ended 31 Dec

768

815

40,79340,095

Share-based payments‘Wages and salaries’ include the effect of share-based payments arrangements of HK$968m (2017: HK$1,052m).

(b) Retirement benefit pension plans
The group operates a number of retirement 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 thelargest plan is The HSBC Group Hong Kong Local Staff Retirement Benefit Scheme (‘the Principal Plan’).

The Principal Plan
In Hong Kong, the Principal Plan covers employees of the Bank and certain other local employees of the Group. The Principal Plan
comprises a funded defined benefit scheme (which provides a lump sum benefit on retirement but is now closed to new members) and adefined contribution scheme. The latter was established on 1 January 1999 for new employees, and the 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 investment strategy of the defined benefit scheme of the Principal Plan is to hold the majority of assets in bonds, with a smaller
portion in equities and each investment manager has been assigned a benchmark applicable to their respective asset class. The target
asset allocation for the portfolio is as follows: Bonds 65% and Equity 35%. The Principal Plan is predominantly a funded plan with assets
which are held in trust funds separate from the group. The actuarial funding valuation of the Principal Plan is reviewed 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 assumes the overall responsibility for the Principal Plan and the group has established a management committee and anumber of sub-committees to broaden the governance and manage the concomitant issues.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201877

Notes on the Consolidated Financial Statements

Defined benefit pension plans
Net asset/(liability) under defined benefit pension plans
Fair value of plan
assetsPresent value of
defined benefit
obligations

Net defined
benefit liability

HK$m

HK$m

HK$m

15,167(17,308)(2,141)Service cost

—

(697)

(697)

– current service cost

—

(684)

(684)

– past service cost and gains from settlements1

—

(13)

(13)

Net interest expense on the net defined benefit liability

289

(338)

(49)

Re-measurement effects recognised in other comprehensive income

(692)

(399)

(1,091)– return on plan assets (excluding interest income)At 1 Jan 2018

(692)

—

(692)

– actuarial losses

—

(399)

(399)

Exchange differences and other movements

(80)

74

(6)

Contributions by the group

576

—

576

Benefits paid

(1,404)

1,471

67

At 31 Dec 201813,856(17,197)(3,341)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

Present value of defined benefit obligation relating to:– actives(16,848)– deferreds(19)– pensioners(330)

At 1 Jan 2017

14,755(18,552)(3,797)

Service cost

—

(722)

(722)

– current service cost

—

(748)

(748)

– past service cost and gains from settlements1

—

26

26

281

(362)

(81)

Net interest expense on the net defined benefit liability
Re-measurement effects recognised in other comprehensive income

1,633

7

1,640

– return on plan assets (excluding interest income)

1,633

–

1,633

—

7

7

(450)

482

32
722

– actuarial gains
Exchange differences and other movements2
Contributions by the group722—

Benefits paid

(1,774)

1,839

65

At 31 Dec 201715,167(17,308)(2,141)Retirement benefit liabilities recognised on the balance sheet(2,222)Retirement benefit assets recognised on the balance sheet (within ‘Prepayment, accrued income and otherassets’)81

Present value of defined benefit obligation relating to:– actives(17,044)– pensioners
1
2

(264)

Gains from settlements arise as the difference between assets distributed and liabilities extinguished on settlements.
Other movements in 2017 included the impact from transfer of certain employees to a fellow subsidiary.

The group expects to make HK$581m of contributions to defined benefit pension plans during 2019. Benefits expected to be paid fromthe Principal Plan to retirees over each of the next five years, and in aggregate for the five years thereafter, are as follows:
Benefits expected to be paid from the Principal Plan

HSBC Group Hong Kong Local Staff Retirement
Benefit Scheme1

2019

2020

2021

2022

2023

2024-2028

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

612

988

1,090

1,051

825

3,783

1 The duration of the defined benefit obligation is 7 years for the Principal Plan under the disclosure assumptions adopted (2017: 7 years).

Fair value of plan assets by asset classes
At 31 Dec 2018

At 31 Dec 2017

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

13,856

13,856454

15,167

15,167321– equities

4,390

4,390

—

4,791

4,791

—

– bonds

8,448

8,448

—

9,539

9,539

—

– other1

1,018

1,018

454

837

837

321

1

Other mainly consists of cash and deposits.

.

78

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

The Principal Plan’s principal actuarial financial assumptions
The group determines the discount rate to be applied to its obligations under the defined benefit scheme as prescribed by HKAS 19 andin consultation with the Principal Plan’s local actuary, on the basis of the current average yields of Hong Kong Government bonds andHong Kong Exchange Fund Notes, with maturities consistent with that of the defined benefit obligation.
The present value of the Principal Plan’s obligation was HK$9,739m (2017: HK$10,086m). The principal actuarial assumptions used to
calculate the group’s obligations for the Principal Plan for the year, and used as the basis for measuring the expenses in relation to the
Principal Plan, were as follows:
Key actuarial assumptions for the principal plan
2018

2017

% p.a.

% p.a.

Discount rate

1.95

1.70

Rate of pay increase

3.0

3.0

HKLT20171

HKLT20162

Mortality table
1
2

HKLT2017- Hong Kong Life Tables 2017
HKLT2016- Hong Kong Life Tables 2016

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 Principal Plan at year end:
The effect of changes in key assumptions on the principal plan
Impact on pension obligation
Financial impact of increase

Financial impact of decrease

2018

2017

2018

2017

HK$m

HK$m

HK$m

HK$m

Discount rate – increase/decrease of 25bps

(167)

(183)

172

189

Rate of pay increase – increase/decrease of 25bps

176

193

(172)

(188)

(c) 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$115m (2017: HK$108m). This comprises fees of HK$10m (2017: HK$9m) and other
emoluments of HK$105m (2017: HK$99m) which includes contributions to pension schemes of HK$1m (2017: HK$1m). Non-cash
benefits which are included in other emoluments mainly relate to share-based payment awards, and the provision of housing andfurnishing. 2017 balances have been represented to align to the 2018 presentation. Details on loans to directors are set out in note 34.

6Tax

The Bank and its subsidiaries in Hong Kong have provided for Hong Kong profits tax at the rate of 16.5% (2017: 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 2018. Deferred taxation is provided for in accordance with the group’s accounting policy
in note 1.2(m).
Tax expense
2018

2017

HK$m

HK$m

Current tax

20,41318,801– Hong Kong taxation – on current year profit

12,155

10,489– Hong Kong taxation – adjustments in respect of prior years

(11)

(3)

8,471

8,588

– overseas taxation – adjustments in respect of prior years

(202)

(273)

Deferred tax

2,054

800

– origination and reversal of temporary differences

1,938

805

– overseas taxation – on current year profit– effect of changes in tax rates

62

3– adjustments in respect of prior years

54

(8)

22,467

19,601

Year ended 31 Dec

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201879

Notes on the Consolidated Financial Statements

Tax reconciliation
The tax charged to the income statement differs from the tax charge that would apply if all profits had been taxed at the applicable tax
rates in the countries concerned as follows:
Reconciliation between taxation charge and accounting profit at applicable tax rates
2018

2017

HK$m

HK$m

Profit before tax

134,583

115,619

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

25,232

21,915

Effects of profits in associates and joint ventures(2,683)(2,333)

Non-taxable income and gains(3,412)(2,623)

Local taxes and overseas withholding taxes

1,470

810

Permanent disallowables

1,132

1,001

OthersYear ended 31 Dec

728

831

22,467

19,601

Movements of deferred tax assets and liabilities
Accelerated
capitalallowances

Insurancebusiness

Expenseprovisions

Impairment
allowance on
financial
instruments

Revaluationof properties

Other

Total

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Assets

93

—

1,296

491

—

2,154

4,034

Liabilities(751)(7,417)——(13,667)(4,435)(26,270)

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)

Assets1

108

—

961

674

—

2,415

4,158

Liabilities1(626)(7,323)——(12,768)(3,339)(24,056)

At 1 Jan 2017

(518)

(7,323)961

674(12,768)(924)(19,898)

9

(44)

84

18

396

(15)

448

(149)

(50)

251

(201)

283

(934)

(800)

Exchange and other adjustments
Charge/(credit) to income statement
Charge/(credit) to other comprehensive
incomeAt 31 Dec 2017

—

—

—

—

(1,578)(408)(1,986)(658)(7,417)

1,296

491

(13,667)(2,281)(22,236)

Assets1

93

—

1,296

491

—

2,154

4,034

Liabilities1(751)(7,417)——(13,667)(4,435)(26,270)1

After netting off balances within countries, the balances as disclosed in the accounts are as follows: deferred tax assets HK$2,315m (2017: HK$2,156m); and deferred tax liabilities HK$24,513m (2017: HK$24,391m).

The amount of unused tax losses for which no deferred tax asset is recognised in the balance sheet is HK$3,626m (2017: HK$2,572m). Of
this amount, HK$1,950m (2017: HK$1,898m) has no expiry date and the remaining will expire within 10 years.
Deferred tax of HK$2,261m (2017: HK$2,321m) 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.

80

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

7

Dividends

Dividends to ordinary shareholders of the parent company
2018

2017

HK$ per share

HK$m

HK$ per share

HK$m

0.36

16,5590.56

25,438– first interim dividend paid

0.22

10,0000.22

10,000– second interim dividend paid

0.22

10,0000.22

10,000– third interim dividend paid

0.22

10,0000.22

10,000

Total

1.02

46,5591.22

55,438Dividends paid on ordinary shares
In respect of previous year:– fourth interim dividend in respect of the previous financial year approved and paid
during the year
In respect of current year:

The Directors have declared a fourth interim dividend in respect of the financial year ended 31 December 2018 of HK$0.47 per ordinary
share (HK$21,958m) (2017: HK$0.36 per ordinary share (HK$16,559m)).
Distributions on other equity instruments

US$1,900m floating rate perpetual subordinated loans (interest rate at one year US dollar LIBOR plus 3.84%)

8

2018

2017

HK$m

HK$m

881

822

Trading assets
2018

2017

HK$m

HK$m

Treasury and other eligible bills

140,050

100,566

Debt securities

283,506

250,730

Equity securities

119,475

107,301

Other1,2

15,807

37,837

At 31 Dec

558,838

496,434

1
2'Other' includes reverse repos, stock borrowing and other accounts with banks and customers.
Settlement accounts were reclassified from 'Trading assets' to 'Other assets' on 1 January 2018 in accordance with HKFRS 9.

9

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

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

Foreign Exchange

18,928,664

132,198

198,4832,449

200,932

201,8293,575

205,404

Interest rate

26,655,864

298,036

145,5692,431

148,000

147,460

702

148,162

Equity762,895—

22,116—

22,11625,106—25,106

Credit659,200

—

5,591

—

5,591

5,970

—

5,970

Commodity and other82,181

—

1,228

—

1,228

2,335

—

2,335

47,088,804

430,234

372,987

4,880

377,867

382,700

4,277

386,977

Gross total
Offset(77,624)(77,624)

At 31 Dec 2017

300,243

309,353

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 Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201881

Notes on the Consolidated Financial Statements

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.

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.

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

10

2018

Treasury and other eligible bills

2017

Designated atfair value

Mandatorily
measured atfair value

Total

HK$m

HK$m

HK$m

Designated atfair value

Mandatorily
measured atfair value

Total

HK$m

HK$m

HK$m

107

220

327

514

N/A

514

13,3806,134

19,514

18,142

N/A

18,142Equity securities1—

99,836

99,836

103,990

N/A

103,990

Other2—

13,182

13,182

N/A

N/A

N/A

13,487

119,372

132,859

122,646

N/A

122,646

Debt securities

At 31 Dec1282

Equity securities have been reclassified from ‘Financial assets designated at fair value’ to ‘Financial assets mandatorily measured at fair value through profit or loss’ in accordancewith HKFRS 9.
‘Other’ primarily includes loans and advance to banks and customers.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201811

Loans and advances to customers

Gross loans and advances to customers
Expected credit losses/Impairment allowances
At 31 Dec

2018

2017

HK$m

HK$m

3,545,258

3,342,025(16,556)(13,045)3,528,702

3,328,980

The following table provides an analysis of loans and advances to customers by industry sector.
Analysis of gross loans and advances to customers
2018

2017

HK$m

HK$m

Residential mortgages

937,666

855,788

Credit card advances

93,20089,368Other personal

236,133

230,119

Total personal

1,266,999

1,175,275

Real estate

626,120563,921

Wholesale and retail trade433,734

460,347

Manufacturing

424,813411,225

Transportation and storage

95,773

95,834

Other

484,186

429,800

Total corporate and commercial1

2,064,626

1,961,127

Non-bank financial institutions

213,633

205,623

3,545,258

3,342,025

Hong Kong

2,282,909

2,107,700

Rest of Asia Pacific

1,262,349

1,234,325

At 31 Dec
By geography2

12With effect from 2018, the industry sector is based on the Statistical Classification of economic activities in the European Community (‘NACE’) codes. Comparatives figures have been
represented to conform to the current year presentation.
The geographical information shown above has been classified by the location of the principal operations of the subsidiary and by the location of the branch responsible for advancing
the funds.

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
2018

2017

Total future
minimum
payments

Unearnedfinance
incomeTotal future
minimum
Unearnedpayments finance income

Present value

HK$m

HK$m

HK$m

HK$m

Present value

HK$m

HK$m

1,968

Amounts receivable– within one year

2,990

(640)

2,350

2,552

(584)

– after one year but within five years

8,622(2,097)

6,525

8,504

(1,922)

6,582– after five years

23,346(3,819)19,527

22,823(3,594)

19,22934,958(6,556)28,40233,879(6,100)27,779

Expected credit losses/Impairment allowances
Net investment in finance leases and hire purchase contracts
at 31 Dec

(117)

(82)

28,285

27,697

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201883

Notes on the Consolidated Financial Statements

12

Financial investments

Financial investments measured at fair value through other comprehensive income

2018

2017

HK$m

HK$m

1,503,625

N/A– treasury and other eligible bills

660,871

N/A– debt securities

836,896

N/A– equity securities

5,858

N/A

367,401

N/A

3,624

N/A

Debt instruments measured at amortised cost– treasury and other eligible bills– debt securities

363,777

N/A

Available-for-sale securities at fair value

N/A

1,419,930– treasury and other eligible bills

N/A

539,014– debt securities

N/A

871,641– equity securities

N/A

9,275

Held-to-maturity securities at amortised cost

N/A

300,943– treasury and other eligible bills

N/A

699

– debt securities

N/A

300,244

1,871,026

1,720,873

At 31 Dec1
1

Categories of financial instruments are disclosed under HKFRS 9 at 31 December 2018. These are not directly comparable with 31 December 2017, where the instruments werecategorised in accordance with HKAS 39.

Equity instruments measured at fair value through other comprehensive income
Instruments held at year end
Fair value

Dividends
recognised

Type of equity instruments

HK$m

HK$m

Business facilitation

5,137

155

Investments required by central institutions356

3

Others

365

5

5,858

163

At 31 Dec 201813

Assets pledged, assets transferred and collateral received

Assets pledged
Financial assets pledged to secure liabilities
2018

2017

HK$m

HK$m

Treasury bills, debt securities, equities and deposits

195,688

225,590

Amount of liabilities secured

162,036

169,722

Financial assets pledged as collateral

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.

Assets transferred
Transferred financial assets not qualifying for full derecognition and associated financial liabilities
2018

2017

Carrying amount of:Carrying amount of:TransferredassetsRepurchase agreements
Securities lending agreements

Associatedliabilities

Transferredassets

Associatedliabilities

HK$m

HK$m

HK$m

HK$m

70,492

59,11877,15145,778

6,702

870

3,209

63

77,19459,98880,36045,841

The 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.

84

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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
2018

2017

HK$m

HK$m

Fair value of collateral permitted to sell or repledge in the absence of default

512,242642,318

Fair value of collateral actually sold or repledged

112,832

102,382

14

Investments in subsidiaries

Principal subsidiaries of the Bank

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%

Hang Seng Bank Limited
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 principal 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
2018

2017

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

9,144

7,579

Accumulated non-controlling interests of the subsidiary

58,75054,919Dividends paid to non-controlling interests

5,066

4,632

– total assets

1,571,297

1,478,418– total liabilities

1,409,190

1,326,339– net operating income before loan impairment

41,49335,498– profit for the year

24,18820,003

Summarised financial information (before intra-group eliminations):– other comprehensive income for the year

400

3,969

– total comprehensive income for the year

24,58823,972

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201885

Notes on the Consolidated Financial Statements

15Interests in associates and joint ventures

Associates

Share of net assets
Goodwill

2018

2017

HK$m

HK$m

139,052

140,670

3,857

4,071

Impairment

(24)

(24)

At 31 Dec

142,885

144,717

The above balance represented the group’s interests in associates.

Principal associate
The group’s interest in issued
share capital

Place of incorporation

Bank of Communications Co., Limited

People’s Republic of China

19.03%

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$86,086m at 31 December 2018(2017: HK$81,987m).

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 2018, the fair value of the group’s investment in BoCom had been below the carrying amount for approximately
80 months. As a result, the group performed an impairment test on the carrying amount, which confirmed that there was no impairment
at 31 December 2018 as the recoverable amount as determined by a value-in-use (‘VIU’) calculation was higher than the carrying value.
At
31 Dec 2018

BoCom

31 Dec 2017

VIU

Carrying
value

Fair
value

VIU

Carrying
value

Fair
value

HK$bn

HK$bn

HK$bn

HK$bn

HK$bn

HK$bn

141.3

139.6

86.1

143.2

141.7

82.0

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 management's explicit forecasts over the short to medium term. This results in forecast earnings growth thatis lower than recent historical actual growth and also reflects the uncertainty arising from the current economic outlook. Earnings beyond
the short to medium term are then extrapolated in perpetuity using a long-term growth rate to derive a terminal value, which comprises
the majority of the VIU. The second component is the capital maintenance charge (‘CMC’) which is management’s forecast of theearnings that need to be withheld in order for BoCom to meet regulatory capital requirements over the forecast period (i.e. CMC isdeducted 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 other factors (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% (2017: 3%) for periods after 2022, which does not exceed forecast GDP growth in mainland China
and is consistent with forecasts by external analysts.
• Long-term asset growth rate: 3% (2017: 3%) for periods after 2022, which is the rate that assets are expected to grow to achieve longterm profit growth of 3%.

86

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

• Discount rate: 11.82% (2017: 11.85%) 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 10.4% to 15.0% (2017: 10.2% to 13.4%) indicated by external sources.
• Loan impairment charge as a percentage of customer advances: ranges from 0.73% to 0.79% (2017: 0.66% to 0.82%) in the short tomedium-term and reflect increases due to the US-China trade tensions. For periods after 2022, the ratio is 0.7% (2017: 0.7%) which isslightly higher than the historical average.
• Risk-weighted assets as a percentage of total assets: 62% (2017: 62%) for all forecast periods. This is slightly higher than BoCom’s
actual results and slightly lower than the forecasts disclosed by external analysts.
• Cost-income ratio: ranges from 38.7% to 39.0% (2017: 37.1% to 38%) in the short-to medium-term. This is consistent with theforecasts disclosed by external analysts.
• Effective tax rate: ranges from 13.8% to 22.3% (2017: 18.2% to 22.5%) in the short to medium-term reflecting an expected increase
towards the long-term assumption. For periods after 2022, the rate is 22.5% (2017: 22.5%) which is slightly higher than the historical
average.
• Regulatory capital requirements: Capital adequacy ratio: 11.5% (2017: 11.5%) and Tier 1 capital adequacy ratio: 9.5% (2017: 9.5%),
based on the minimum regulatory requirements.
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
Loan impairment charge as a percentage of customer advances
Risk-weighted assets as a percentage of total assets
Cost-income ratio
Long-term effective tax rate
Regulatory capital requirements - capital adequacy ratio
Regulatory capital requirements - tier 1 capital adequacy ratio

Decrease by 10 basis points
Increase by 9 basis points
Increase by 12 basis points
Increase by 2 basis point
Increase by 58 basis points
Increase by 37 basis points
Increase by 92 basis points
Increase by 11 basis points
Increase by 69 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 is largely based on external analysts’ forecasts
which can change period to period.
Favourable change

Unfavourable change

Increase in VIU

VIU

bps

HK$bn

HK$bn

Long-term profit growth rate

+100

20.2

161.5

Long-term asset growth rate

-10

2.0

143.3

Discount rate

-142

25.4

166.7

Decrease in VIU

VIU

HK$bn

HK$bn

-10

(1.7)

139.6

+100

(21.7)

119.6

+28

(4.0)

137.3

bps

At 31 December 20182018 to
2022:
0.70%
2023
onwards:
0.65%

7.0

148.3

2018 to
2022:
0.83%
2023
onwards:
0.77%

(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

+204

12.2

153.5

-366

(19.9)

121.4

Regulatory capital requirements - capital adequacy ratio

-

—

141.3

+258

(39.4)

101.9

Regulatory capital requirements - tier 1 capital adequacy ratio

-

—

141.3

+243

(25.2)

116.1

Long-term profit growth rate

+200

51.5

194.7

–

–

143.2

Long-term asset growth rate

-20

4.2

147.4

+200

(55.4)

87.8

Discount rate

-35

5.7

148.9

+65

(9.5)

133.7

Loan impairment charge as a percentage of customer advances

At 31 December 20172017 to2020: 0.71%
2021
onwards:
0.70%

1.1

144.3

2017 to
2020:
0.90%
2021
onwards:
0.77%(10.0)

133.2

Risk-weighted assets as a percentage of total assets

-60

1.9

145.1

+30

(1.0)

142.2

Cost-income ratio

-173

11.7

154.9

–

–

143.2

Long term effective tax rate

-120

2.5

145.7

+250

(5.2)

138.0

Earnings in short to medium term - compound annual growth rate1

+288

22.0

165.2

-311

(28.1)

115.1

Regulatory capital requirements - capital adequacy ratio

-

-

143.2

+248

(43.8)

99.4

Regulatory capital requirements - tier 1 capital adequacy ratio

-

-

143.2

+234

(27.9)

115.3

Loan impairment charge as a percentage of customer advances

1 - Based on management’s explicit forecasts over the short to medium-term.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201887

Notes on the Consolidated Financial Statements

Considering the interrelationship of the changes set out in the table above, management estimates that the reasonably possible range of
VIU is HK$121.4bn to HK$153.5bn (2017: HK$115.1bn to HK$165.2bn). In 2018, the range is based on the favourable/unfavourable
change in the earnings in the short to medium-term and long-term LICs set out in the table above. All other long-term assumptions, thediscount rate and the basis of the CMC have been kept unchanged when determining the reasonably 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 2018, the group included theassociate’s results on the basis of financial statements made up for the 12 months to 30 September 2018, but taking into account thefinancial effect of significant transactions or events in the period from 1 October 2018 to 31 December 2018.
Selected balance sheet information of BoComAt 30 Sep
2018

2017

HK$m

HK$m

Cash and balances at central banks

982,268

1,141,256

Loans and advances to banks and other financial institutions

806,561

940,983

Loans and advances to customers

5,380,339

5,179,210

Other financial assets

3,196,602

3,017,209

Other assets

332,795

458,039

Total assets

10,698,565

10,736,697

Deposits by banks and other financial institutions

2,384,086

2,868,142

Customer accounts

6,497,116

5,844,883

Other financial liabilities

743,278

967,143

Other liabilities

284,560

254,525

Total liabilities

9,909,040

9,934,693

Total equity1

789,525

802,004

1 Due to the adoption of HKFRS 9, the equity balance of BoCom as at 1 January 2018 was reduced by HKD31,672m.

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

2018

2017

HK$m

HK$m

135,871

137,769

3,753

3,958

139,624

141,727

Selected income statement information of BoCom
For the 12 months ended 30 Sep
2018

2017

HK$m

HK$m

Net interest income

151,223

148,688

Net fee and commission income

48,94944,401

Change in expected credit losses/ loan impairment charges(43,907)(33,400)

Depreciation and amortisation(6,012)(10,460)

Tax expense(12,178)(17,411)– profit for the year

87,12280,172– other comprehensive income

1,490(4,860)Total comprehensive income

88,61275,312

Dividends received from BoCom

4,792

4,401

Other associates
Summarised aggregate financial information for all associates excluding BoComAt
31 Dec31 Dec

2018

2017

HK$m

HK$m

3,261

2,990

– total assets

7,618

7,465

– total liabilities

4,461

4,588

– profit or loss from continuing operations

327

160

– total comprehensive income

327

160

24

24

Carrying value
The group’s share of:

Other expense related to investment in an associate:– Impairment of an associate

At 31 December 2018, the group’s share of associates’ contingent liabilities was HK$319,469m (2017: HK$303,541m).

88

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

16

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.
2018

2017

HK$m

HK$m

Goodwill

5,932

7,128

Present value of in-force long-term insurance business

48,522

44,621Other intangible assets

10,6508,116

At 31 Dec

65,104

59,865The present value of in-force long-term insurance business
When calculating the present value of in-force insurance business (‘PVIF’), expected cash flows are projected after adjusting for a varietyof assumptions made by each insurance operation to reflect local market conditions and management’s judgement of future trends, anduncertainty 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 PVIF

PVIF at 31 Dec
Impact on transition to HKFRS 9

2018

2017

HK$m

HK$m

44,62144,077(616)—

PVIF at 1 Jan

44,00544,077

Changes in PVIF of long-term insurance business

4,629

305

– value of new business written during the year

8,138

6,597

– expected return(4,650)(3,687)– experience variances

(165)

(180)

– changes in operating assumptions(1,877)(1,685)– investment return variances

3,052

(638)

– changes in investment assumptions

143

(178)

– other adjustments

(12)

76

Exchange differences and other

(112)

239

48,522

44,621

PVIF at 31 Dec

Key assumptions used in the computation of PVIF for main life insurance operations
Economic assumptions are set in a way that is consistent with observable market values. The following are the key long-term
assumptions used in the computation of PVIF for Hong Kong, being the main life insurance operations:
2018

2017

%

%

Weighted average risk free rate

2.29

2.02

Weighted average risk discount rate

5.90

6.20

Expense inflation

3.00

3.00

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201889

Notes on the Consolidated Financial Statements

17

Property, plant and equipment

Movement in property, plant and equipment
2018

2017

Land andbuildings

Investment
properties

Equipment

Land andbuildings

Investment
properties

HK$m

Equipment

HK$m

HK$m

HK$m

HK$m

HK$m

22,092

Cost or valuation
At 1 Jan

97,61912,617

22,617

95,134

10,629Exchange and other adjustments

(497)

1

(342)

621

2

585

Additions

271

278

1,097

765

—

2,232

Disposals

(361)

—

(644)

(312)

—

(2,292)

Transfers1(11,126)(464)—(5,106)——

Elimination of accumulated depreciation on revalued landand buildings(2,613)——(2,353)——

Surplus on revaluation

10,626

639

—

9,479

1,379

—

118

(196)

—

(609)

607

—

94,037

12,87522,72897,61912,617

22,617210—

16,307169—

16,046

(2)

—

(251)

22

—

469

Charge for the year

2,643

—

2,043

2,678

—

1,972

Disposals

(165)

—

(612)

(306)

—

(2,180)(2,613)——(2,353)

—

—

73

—

17,487210—

16,307

93,964

12,875

5,241

97,40912,617

Reclassifications
At 31 Dec
Accumulated depreciation
At 1 Jan
Exchange and other adjustments

Elimination of accumulated depreciation on revalued landand buildings
At 31 Dec
Net book value at 31 Dec
Total at 31 Dec
1112,080

6,310
116,336

During 2017 and 2018, certain properties have been transferred to a fellow subsidiary as part of the Recovery and Resolution Plan as set out in the Report of Directors on page 10-11.
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

2018

2017

HK$m

HK$m

16,281

19,358Valuation of land and buildings and investment properties
The group’s land and buildings and investment properties were revalued in November 2018 and updated for any material changes at
31 December 2018. The basis of valuation for land and buildings and investment properties was open market value, depreciatedreplacement cost or surrender value as noted in note 1.2(k). The resultant values are Level 3 in the fair value hierarchy. The fair values forland and buildings are determined by using 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$8,374m (2017: HK$8,853m) in respect of properties which werevalued using the depreciated replacement cost method or surrender value.
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.

90

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

18

Prepayments, accrued income and other assets
2018

2017

HK$m

HK$m

Prepayments and accrued income

27,897

24,541

Bullion50,05844,555

Acceptances and endorsements

44,40136,720

Reinsurers’ share of liabilities under insurance contracts (note 4)

17,792

15,734Current tax assets

1,517

2,485

Settlement accounts1, 2

23,683

N/A

Cash collateral and margin receivables1,2

30,378

N/A

Other assets

34,223

34,476

At 31 Dec1,2

229,949

158,5111
2

Settlement accounts were reclassified from 'Trading assets' to 'Other assets' on 1 January 2018 in accordance with HKFRS 9.
Settlement accounts, cash collateral and margin receivables were reclassified from 'Placings with and advances to Banks' and 'Loans and advances to customers' to 'Other assets' on
1 January 2018. This reclassification is to better reflect the nature of these balances and ensure consistency of presentation. Comparatives have not been restated.

Prepayments, accrued income and other assets included HK$159,483m (2017: HK$93,610m) of financial assets, the majority of whichwere measured at amortised cost.

19

Customer accounts

Customer accounts by country

Hong Kong

2018

2017

HK$m

HK$m

3,797,807

3,728,687

Mainland China

358,026

359,428

Singapore

331,479

321,548

Australia

161,726

157,959

India

111,297103,264

Malaysia

108,899

109,626

Taiwan106,537

105,189

Indonesia

29,84332,907

Other

202,052

219,664

5,207,666

5,138,272

At 31 Dec1
1

Settlement accounts, cash collateral and margin payables were reclassified from 'Customer accounts' to 'Other liabilities' on 1 January 2018. This reclassification is to better reflect thenature of these balances and ensure consistency of presentation. Comparatives have not been restated.

20

Trading liabilities
2018

2017

HK$m

HK$m

Deposits by banks1,2

1,162

9,984

Customer accounts1,2,3

773

117,602—20,755

Debt securities in issue3
Net short positions in securities

79,25983,024

At 31 Dec

81,194

231,36512
3‘Deposits by banks’ and ‘Customer accounts’ include repos, stock lending and other amounts.
Settlement accounts, cash collateral and margin payable included within 'Deposits by banks' and 'Customer accounts' were reclassified from 'Trading liabilities' to 'Other liabilities' on
1 January 2018. This reclassification is to better reflect the nature of these balances and ensure consistency of presentation. Comparatives have not been restated.
Financial liabilities which contain both deposit and derivative components were reclassified from 'Trading liabilities' to 'Financial liabilities designated at fair value' on 1 January 2018.
This reclassification is to better align with the presentation of similar financial instruments by peers and therefore provide more relevant information about the effect of these financial
liabilities on the group's financial position and performance.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201891

Notes on the Consolidated Financial Statements

21

Financial liabilities designated at fair value
2018

2017

HK$m

HK$m

Deposits by banks and customer accounts1

82,136

N/A

Debt securities in issue

42,36911,010Liabilities to customers under investment contracts

36,63838,268At 31 Dec

161,143

49,2781

Financial liabilities which contain both deposit and derivative components were reclassified from 'Trading liabilities' to 'Financial liabilities designated at fair value' on 1 January 2018.
This reclassification is to better align with the presentation of similar financial instruments by peers and therefore provide more relevant information about the effect of these financial
liabilities on the group's financial position and performance.

The carrying amount of financial liabilities designated at fair value was HK$2,232m lower than the contractual amount at maturity(2017: HK$27m higher). The cumulative gain in fair value attributable to changes in credit risk was HK$177m (2017: HK$8m loss).

22

Debt securities in issue
2018

2017

HK$m

HK$m

Bonds and medium-term note

75,98059,266

Other debt securities in issue

24,625

10,893

Total debt securities in issue

100,605

70,159Included within:– trading liabilities (note 20)—(20,755)– financial liabilities designated at fair value (note 21)(42,369)(11,010)

At 31 Dec

58,23638,39423

Accruals and deferred income, other liabilities and provisions
2018

2017

HK$m

HK$m

Accruals and deferred income

26,932

25,880Acceptances and endorsements

44,43836,720

Settlement accounts1

37,833

N/A

Cash collateral and margin payables1

36,613

N/A

Share-based payment liability to HSBC Holdings plc

1,923

2,268

Other liabilities

47,52145,193

Provisions for liabilities and charges

1,405

626

196,665

110,687

At 31 Dec1
1

Settlement accounts, cash collateral and margin payables were reclassified from ‘Trading liabilities’, ‘Deposits by banks’ and ‘Customer accounts’ to ‘Other liabilities’ on 1 January
2018. This reclassification is to better reflect the nature of these balances and ensure consistency of presentation. Comparatives have not been restated.

Accruals and deferred income, other liabilities and provisions included HK$184,221m (2017: HK$102,902m) of financial liabilities whichwere measured at amortised cost.
Movement in provisions
Restructuring
costs

Other

Total

HK$m

HK$m

HK$m

At 31 Dec 2017

192

380

572

Additions

11

469

480

Amounts utilised

(97)

(91)

(188)

Unused amounts reversed(120)

Provisions (excluding contractual commitments)

(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 provision150

At 31 Dec 2018
Total Provisions at 31 Dec 2018
1

92

691
1,405

The contractual commitments provision at 31 December 2017 represented HKAS 37 provisions on off-balance sheet loan commitments and guarantees, 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 2018

Movement in provisions (continued)
Restructuring
costs

Other

Total

HK$m

HK$m

HK$m

At 1 Jan 2017

786

381

1,167

Additions

110

232

342

Amounts utilised

(728)

(84)

(812)

Unused amounts reversed

(14)

(109)

(123)

Exchange and other movements

38

14

52

At 31 Dec 2017

192

434

626

24

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
1

2018

2017

HK$m

HK$m

3,133

3,126

948

964

4,081

4,090

The interest rate on the MYR500m 5.05% callable subordinated bonds due 2027 will increase by 1% from November 2022.

25

Preference shares

Irredeemable preference shares, issued and fully paid
2018

2017

HK$m

HK$m

At 1 Jan

21,037

26,879Redeemed / bought back during the year

(20,975)(6,022)

Exchange and other movements

36

180

At 31 Dec

98

21,037

The preference shares were issued at the then nominal value, and may be redeemed subject to 30 days’ notice in writing to shareholders
and with the prior consent of the Hong Kong Monetary Authority. In the event of redemption, holders of the shares shall be entitled toreceive the issue price of US$1 per share held together with any unpaid dividends for the period since the annual dividend payment date
immediately preceding the date of redemption, subject to the Bank having sufficient distributable profits. The holders of the preference
shares are entitled to one vote per share at shareholders’ meetings of the Bank.
2,478m of issued non-cumulative irredeemable preference shares were fully bought back during the year (2017: 775m) and there were no
remaining balance of issued non-cumulative irredeemable preference shares at 31 December 2018 (2017: 2,478m). The preference sharesare no longer in issue.
200m of issued cumulative irredeemable preference shares were fully bought back during the year (2017: nil) and there were no
remaining balance of issued cumulative preference shares at 31 December 2018 (2017: 200m). The preference shares are no longer inissue.
There was INR870m (2017: 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. These shares may be converted into fully
paid equity shares of HSBC InvestDirect at any time after one year to 10 years from the date of allotment of the CCPS by written notice.
The conversion shall be made at par or premium as may be determined by the Board of HSBC InvestDirect at the time of the conversion.
The CCPS shall carry a fixed dividend of 0.001% of the face value per annum. After 10 years following the allotment of the CCPS, alloutstanding CCPS shall be converted at par or premium as may be determined by the Board of HSBC InvestDirect at the time of theconversion. HSBC InvestDirect did not convert any CCPS during 2018 (2017: nil). The number of issued CCPS at 31 December 2018 was
8.7m (2017: 8.7m). No CCPS were issued during the year (2017: nil).

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201893

Notes on the Consolidated Financial Statements

26

Share capital

2018

Paid up share capital in HK$

2017

HK$m

HK$m

116,103

116,103

Paid up share capital in US$ 1

56,23235,257

At 31 Dec

172,335

151,360

Ordinary shares issued and fully paid2018

At 1 Jan
Shares issued during the year

2017

HK$m

Number

HK$m

Number151,360

46,440,991,798

114,359

45,743,491,798
697,500,000

—

—

1,744

Redemption / bought back of preference shares

20,975—35,257—

At 31 Dec

172,335

46,440,991,798

151,360

46,440,991,798

1. Paid up share capital in US$ represents preference shares which have been redeemed or bought back via payment out of distributable profits and for which the amount was transferredfrom retained earnings to share capital in accordance with the requirements of the Companies Ordinance.

During 2018, no new ordinary shares were issued (2017: 698m). The holders of the ordinary shares are 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.

27

Other equity instruments

Other equity instruments comprise additional tier 1 capital instruments in issue which are accounted for in equity.
2018

2017

HK$m

HK$m

US$1,000m Floating rate perpetual subordinated loan, callable from Dec 20191

7,756

7,756

US$900m

Floating rate perpetual subordinated loan, callable from Dec 20191

6,981

6,981

US$900m

Floating rate perpetual subordinated loan, callable from Nov 20232

7,048

—

US$500m

Floating rate perpetual subordinated loan, callable from Nov 20232

3,915

—

US$700m

Floating rate perpetual subordinated loan, callable from Dec 20233

5,481

—

US$600m

Floating rate perpetual subordinated loan, callable from Nov 20244

4,698

—

35,87914,737

At 31 Dec
12
34Interest rate at one year US dollar LIBOR plus 3.84%
Interest rate at three months US dollar LIBOR plus 3.51%
Interest rate at three months US dollar LIBOR plus 4.98%
Interest rate at three months US dollar LIBOR plus 3.62%

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.

28

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.

94

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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 over6 months
but notmorethan 9monthsDue over9 months
but notmorethan 1year

Due over1 yearbut notmorethan 2years

Due over2 years
but not
more than
5 years

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 sight balances at central banks

205,660

—

—

—

—

—

—

—

205,660

Items in the course of collection from otherbanks

25,380

—

—

—

—

—

—

—

25,380Hong Kong Government certificates ofindebtedness

280,854

—

—

—

—

—

—

—

280,854

Trading assets

554,886

1,359

1,723

—

—

870

—

—

558,838

Derivatives

291,515

83

117

247

17

324

318

248

292,869

615

1,121

3,839

11,210105,634

132,859
406,327

Financial assets

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

9,308

24

1,108

Reverse repurchase agreements – nontrading

250,550

87,93915,059

4,326

7,771

37,682

3,000—

Placings with 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 liabilities2

—

—

—

—

—

—

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

Total 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

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201895

Notes on the Consolidated Financial Statements

Maturity analysis of assets and liabilities1 (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 sight balances at central banks

208,073———

Items in the course of collection from other
banks

—

—

—

—

208,073

25,714——

Hong Kong Government certificates ofindebtedness

—

—

—

—

—

25,714

267,174—

Trading assets

492,178

4,121

—

—

—

—

—

—

267,174

135

—

—

—

—

—

Derivatives

295,653827

496,434

503

644

178

768

1,487

183

1,145

300,243

294

1,515

1,156

446

3,150

7,893

107,047

Reverse repurchase agreements – non-trading

122,646

212,556

62,050

5,381

3,437

7,654

6,972

32,840—330,890

Placings with and advances to banks

282,259

74,04320,088

10,3986,724

14,877

15,9978,619

433,005

Loans and advances to customers

656,101

315,163

227,683

149,786

156,397334,895

676,249

812,706

3,328,980

Financial investments

205,553

351,781

197,723

75,11991,276

186,116

303,034

310,271

1,720,873

Amounts due from Group companies

74,484

151,749

100

318

442

446

110

80

227,729

Accrued income and other financial assets

49,384

27,632

10,733

1,810

809

446

382

2,414

93,6102,770,274

987,660

463,861

242,668

263,926

547,670

1,037,992

1,241,320

7,555,371(Represented)

Due over 9
Due over 1
months but year but not
not more more than 2than 1 year
years

Financial assets

Financial assets designated at fair value

Financial assets at 31 Dec 2017
Non-financial assets

—

—

—

—

—

—

—

387,975

387,975

2,770,274

987,660

463,861

242,668

263,926

547,670

1,037,992

1,629,295

7,943,346

Hong Kong currency notes in circulation

267,174

—

—

—

—

—

—

—

267,174

Items in the course of transmission to otherbanks

38,283

—

—

—

—

—

—

—

38,283

Repurchase agreements – non-trading

45,000

2,170

—

—

—

—

—

—

47,170

Deposits by banks

192,187

2,840

5,079

1,045

313

94

139

—

201,697

Customer accounts

4,727,204

217,307

94,791

42,20740,152

9,456

6,881

274

5,138,272

Trading liabilities

212,618

2,493

2,321

2,722

841

2,491

7,857

22

231,365

Derivatives

305,014

361

950

368

636

1,333

343

348

309,353

199

—

2,621

—

—

6,182

1,940

38,33649,278

1,189

2,677

5,331

301

3,363

3,963

17,151

4,419

38,394

Amounts due to Group companies

119,364

1,919

168

27

324

34

47,60996,243

265,688

Accruals and other financial liabilities

100,741

Total assets at 31 Dec 2017
Financial liabilities

Financial liabilities designated at fair value
Debt securities in issue

43,61735,43012,236

3,502

2,625

2,071

1,016

244

Subordinated liabilities2

—

—

—

—

—

—

964

3,126

4,090

Preference shares

—

—

—

—

—

—

—

21,037

21,037

5,951,849

265,197

123,497

50,172

48,25425,624

83,900

164,049

6,712,542

—

—

—

—

—

—

—

477,818

477,818

5,951,849

265,197

123,497

50,172

48,25425,624

83,900641,867

7,190,360

Financial liabilities at 31 Dec 2017
Non-financial liabilities
Total liabilities at 31 Dec 2017
1
2

The table has been revised to align with the Group’s presentation and comparatives have been represented to conform to the current year’s presentation.
The maturity for subordinated liabilities is based on the earliest date on which the group is required to pay, i.e. the callable date.

96

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

29 Analysis of cash flows payable under financial liabilities by remaining contractual
maturities

On demand

Due within
3 months

Due 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

280,854

—

—

—

—

280,854—

33,806———33,806

Repurchase agreements – non-trading

12,492

51,591

6,464

—

—

70,547

Deposits by banks

146,159

12,019

7,221

137

—

165,536

Customer accounts

5,217,864

At 31 Dec 2018
Hong Kong currency notes in circulation
Items in the course of transmission to other banks

3,941,160

953,242

289,185

34,19780

Trading liabilities

81,194————

81,194

Derivatives

293,073

1,679

403

1,754

—

296,909463

46,39440,49839,72339,474

166,552—

9,329

12,02837,1403,521

62,018Amounts due to Group companies

38,093

176,357

885

88,418137,417441,170

Other financial liabilities

81,63368,51522,377

2,850

1,194

176,569

Subordinated liabilities

—

22

65

1,294

3,995

5,376

Preference shares

—

—

98

—

—

98

4,875,121

1,352,954

379,224

205,513

185,6816,998,493

Loan commitments

1,950,956

612,015237——

2,563,208

Financial guarantees

57,964————57,964

6,884,041

1,964,969

379,461

205,513

185,6819,619,665

267,174

—

—

—

—

267,174—

38,283———38,283

Repurchase agreements – non-trading

11,82935,554———47,383

Deposits by banks

163,030

32,048

6,467

267

—

201,812

Customer accounts

4,229,543

717,651

179,389

17,795281

5,144,659

Trading liabilities

231,365

—

—

—

—

231,365

Derivatives

304,970

412

1,820

1,253

411

308,866

Financial liabilities designated at fair value

199

32

2,724

8,524

38,06949,548Debt securities in issue

40

4,026

9,521

22,421

4,753

40,761

Amounts due to Group companies

40,004

82,614

4,495

67,306113,635

308,054

Other financial liabilities

8,870

69,01016,515

3,287

218

97,900Subordinated liabilities

—

25

74

1,361

3,634

5,094

Preference shares

—

283

412

2,781

27,99031,466

Financial liabilities designated at fair value
Debt securities in issue

At 31 Dec 2017
Hong Kong currency notes in circulation
Items in the course of transmission to other banks

5,257,024

979,938

221,417

124,995

188,991

6,772,365

Loan commitments

1,821,774

640,726

14,4374,678

97

2,481,712

Financial guarantees

57,353————57,353

7,136,151

1,620,664

235,854

129,673

189,0889,311,430

The balances in the above tables incorporates 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 trading liabilities 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 designated at 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 (assumingthat all surrender and 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 the earliest date they can be called. Cash flows payable in respect of customer accounts are primarily contractually
repayable on demand or at short notice.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201897

Notes on the Consolidated Financial Statements

30

Contingent liabilities, contractual commitments and guarantees

Off-balance sheet contingent liabilities and commitments
2018

2017

HK$m

HK$m

Contingent liabilities and financial guarantee contracts:– financial guarantees1

57,964

57,124– Performance & other guarantee2

234,265

231,709– other contingent liabilities

3,416

1,059

295,645289,892– documentary credits and short-term trade-related transactions

23,25828,045– forward asset purchases and forward forward deposits placed

14,087

8,198– undrawn formal standby facilities, credit lines and other commitments to lend

2,525,863

2,445,468

At 31 Dec

2,563,208

2,481,711

At 31 Dec
Commitments3:

1
2
3

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 the above table are nominal principal amounts.
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 toretain title to the underlying shipment, performance bonds, bid bonds, standby letters of credit and other transaction-related guarantees.
Includes HK$1,490,711m of commitments at 31 December 2018 to which the impairment requirements in HKFRS 9 are applied where the group has become party to an irrevocablecommitment.

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 theloan commitments shown above reflects, where relevant, the expected level of take-up of pre-approved facilities. As a significant portionof guarantees and commitments is expected to expire without being drawn upon, the total of the contractual amounts is not
representative of future liquidity requirements.
It also reflect 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 Dec 2018 included provisions made in relation to legal and regulatory matters as set out in note 39.

31

Other commitments

Capital commitments
At 31 December 2018, capital commitments, mainly related to the commitment for purchase of premises, were HK$7,912m(2017: HK$7,097m).

Operating lease commitments
The group leases certain properties and equipment under operating leases. The leases normally run for a period of one to 10 years andmay include an option to renew. Lease payments are usually adjusted annually to reflect market rentals. None of the leases include
contingent rentals. Future minimum lease payments under non-cancellable operating leases for premises and equipment are as follows:
2018

2017

HK$m

HK$m

– one year or less

2,925

2,948

– five years or less but over one year

3,967

4,277

– over five years

1,391

874

At 31 Dec

8,283

8,099

Amounts payable within

98

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

32

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.
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

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

420,178—

Financial
instruments

Non-cashcollateralCashcollateralNet
amountAmounts not
subject toenforceablenettingarrangements1

Balance
sheet
total

At 31 Dec 2018
Financial assets2

Loans and advances to customers at
amortised cost

—

—

—

—

—

—

—

—

825,650(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

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—

Financial liabilities3– trading liabilities– non-trading liabilities
Customer accounts at amortised cost

—

—

—

—

—

—

—

—

537,090(151,692)

385,398(208,893) (124,106)(18,758)

33,641

51,458436,856

Derivatives

353,713(77,624)

276,089(234,555)(4,926)(28,992)

7,616

24,154300,243

Reverse repos, stock borrowing and similar
agreements classified as:

550,165(12,689)

537,476—(537,348)

(62)

66

23,487560,963

8,966

—

8,966

—

(8,966)

—

—

—

8,966

541,199(12,689)

528,510—(528,382)

(62)

66

23,487551,997

At 31 Dec 2017
Financial assets2– trading assets– non-trading assets
Loans and advances to customers at
amortised cost

—

—

—

—

—

—

—

—

—

903,878(90,313)

813,565(234,555)(542,274)(29,054)

7,682

47,641

861,206

Derivatives

366,456(77,624)

288,832(234,555)(4,738)(27,959)

21,58020,521

309,353

Repos, stock lending and similar agreements
classified as:

94,755(12,689)

82,066—(81,847)—

219

27,617

109,683

687

—

687

—

(686)

—

1

—

687

94,068(12,689)

81,379—(81,161)—

218

27,617

108,996

Financial liabilities3– trading liabilities– non-trading liabilities
Customer accounts at amortised cost

1
2
3

—

—

—

—

—

—

—

—

—

461,211(90,313)

370,898(234,555)(86,585)(27,959)

21,79948,138419,036

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.
Amounts presented in the balance sheet included balances due from Group companies of HK$103,358m (2017: HK$262,159m).
Amounts presented in the balance sheet included balances due to Group companies of HK$139,410m (2017: HK$132,091m).

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 201899

Notes on the Consolidated Financial Statements

33

Segmental analysis

The group’s operating segments are organised into four global businesses and a Corporate Centre. The group’s chief operating decisionmaker, the Executive Committee (‘EXCO’), regularly reviews operating activities on a number of bases, including by global businesses
and by countries. Although the chief operating decision-maker reviews information on a number of bases, business performance isassessed and capital resources are allocated by global business, and the segmental analysis is presented on that basis. The global
businesses are therefore considered our reportable segments under HKFRS 8.
Information provided to EXCO is measured in accordance with HKFRSs. The group’s 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 ofcertain support services and global functions to the extent that they can be meaningfully attributed to operational business lines andgeographical regions. While such allocations have been made on a systematic and consistent basis, they necessarily involve a degree ofsubjectivity. Costs which are not allocated to global businesses are included in the ‘Corporate Centre’. Where relevant, income andexpenses amounts presented include the results of inter-segment funding along with inter-company and inter-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.
The group provides a comprehensive range of banking and related financial services to its customers organised by global business:• Retail Banking and Wealth Management (‘RBWM’) serves personal customers. We take deposits and provide transactional banking
services to enable customers to manage their day to day finances and save for the future. We selectively offer credit facilities to assist
customers in their short or longer-term borrowing requirements; and we provide financial advisory, broking, insurance and investment
services to help them manage and protect their financial futures.
• Commercial Banking (‘CMB’) is segmented into Corporate, to serve both corporate and mid-market companies with moresophisticated financial needs, and Business Banking, to serve small- and medium-sized enterprises (‘SMEs’), enabling differentiatedcoverage of our target customers. This allows us to provide continuous support to companies as they grow both domestically andinternationally, and ensures a clear focus on internationally aspirant customers.
• Global Banking and Markets (‘GB&M’) provides tailored financial solutions to major government, corporate and institutional clientsworldwide. GB&M operates a long-term relationship management approach to build a full understanding of clients’ financial
requirements. Sector-focused client service teams comprising relationship managers and product specialists develop financial
solutions to meet individual client needs.
• Global Private Banking (‘GPB’) provides investment management and trustee solutions to high net worth individuals and their families.
We aim to meet the needs of our clients by providing excellent customer service, leveraging our global footprint and offering acomprehensive suite of solutions.
• Corporate Centre was established to align certain functions of the group. The Corporate Centre includes Balance Sheet Management,
certain interests in associates and joint ventures, as well as the results of our financing operations and central support costs withassociated 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

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

Total operating income

187,935

70,397(3,099)255,233

Profit before tax

73,57742,042—

115,619

Total assets

5,643,940

2,923,926(624,520)

7,943,346

Total liabilities

5,263,539

2,551,341(624,520)

7,190,360

Credit commitments and contingent liabilities (contract amounts)

1,500,456

1,271,147—

2,771,603

For the year ended 31 Dec 2018

At 31 Dec 2018

For the year ended 31 Dec 2017

At 31 Dec 2017100

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Information by country
Revenue1

Non-current assets2

For the year ended 31 Dec
2018
2017
HK$m
HK$m

At 31 Dec
2018
HK$m

2017
HK$m

Hong Kong

142,665

125,698

110,125

111,164

Mainland China

17,653

14,264147,444

150,778

Australia

7,658

6,636

825

871

India

7,880

8,372

1,934

2,108

Indonesia

3,702

4,395

3,566

3,851

Malaysia

6,330

5,663

962

833

Singapore

10,053

9,054

1,415

1,404

Taiwan

3,509

3,295

2,201

2,325

Other

11,019

9,066

3,075

2,963

Total

210,469

186,443

271,547

276,297

1
2

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.
Non-current assets consist of property, plant and equipment, goodwill, other intangible assets, interests in associates and joint ventures and certain other assets.

34

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 which arecontrolled or jointly controlled by KMP or their close family members.
Particulars of transactions with related parties are set out below.

(a)Inter-company

As part of recovery and resolution planning, the ownership of the group was transferred in November 2018 from HSBC Asia Holdings B.V.
(previously the group's immediate holding company) to HSBC Asia Holdings Limited, a newly incorporated intermediate holding
company in Hong Kong that is a wholly-owned subsidiary of HSBC Holdings plc (incorporated in England).
During the year, the group transferred another property to the service company, HSBC Global Services (Hong Kong) Limited (the‘ServCo’), which is a fellow subsidiary of the group set up in Hong Kong as part of recovery and resolution planning to provide functional
support services to the group. The transfer was made at market value with no impact to the profit and loss. The group recognised amanagement charge of HK$1,098m for services provided by ServCo for the year ended 31 Dec 2018 (2017: HK$238m), which is included
under ‘General and administrative expenses’.
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 Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018101

Notes on the Consolidated Financial Statements

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:
2018

2017

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

2,447

Income and expenses for the year
Interest income

—

—

1,220

—

—

1,563

5,545

1,681

2,739

1,709

625

Fee income

—

43

2,547

—

41

2,605

Fee expense

—

—

1,153

—

—

1,100

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

—

5

1,289

—

2

27

Other operating income

—

1,348

2,531

—

1,201

2,506

Other operating expenses2

—

3,405

13,682

2

2,879

9,632

Assets—327

149,1221713

306,099– trading assets3—

123

11,586

—

202

8,270

– derivative assets——

78,994——79,084– other assets3—

204

58,542

1

511

218,745

Liabilities—

254,547

212,358

71,70094,460190,831

Trading liabilities3

—

15

97

—

2

12,994

Financial liabilities designated at fair value3,4—

87,065298—

35,86615

Derivative liabilities——

70,320——70,266

Other liabilities3—

96,000120,551

515

1,067

107,449

Subordinated liabilities3,5—71,467

20,99450,25557,525—Preference shares

—

—

98

20,930—107

Guarantees——

17,763——

17,908Commitments——

14,319——14,372

Interest expense1

At 31 Dec

1
2
3
4
5

Interest expense included distribution on preference shares and interest on subordinated liabilities.
In 2018, payments were made of HK$459m (2017: HK$432m) for software costs which were capitalised as intangible assets in the balance sheet of the group.
These balances are presented under ‘Amounts due from/to Group companies’ in the consolidated balance sheet.
The balance included subordinated liabilities of HK$87,065m to meet Total Loss Absorbing Capacity (‘TLAC’) requirements (2017: HK$35,866m).
The balance included subordinated liabilities of HK$78,450m to meet TLAC requirements (2017: HK$89,889m).

(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 2018 amounted to
HK$3,147m and HK$1,923m respectively (2017: HK$2,901m and HK$2,268m respectively).

(c)Retirement benefit plans

At 31 December 2018, HK$12.3bn (2017: HK$15.1bn) of the group’s retirement benefit plan assets were under management by groupcompanies, earning management fees of HK$29m in 2018 (2017: HK$27m). At 31 December 2018, the group’s retirement benefit plans
had placed deposits of HK$486m (2017: HK$370m) with its banking subsidiaries, earning interest payable to the schemes of HK$2m(2017: HK$3m). The above outstanding balances arose from the ordinary course of business and on substantially the same terms,
including interest rates and security, as for 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 given in note 15. Transactions andbalances during the year with associates and joint ventures were as follows:
2018
Highest balance
during the year

2017
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 – unsubordinated30,411

23,487

24,17819,793

Amounts due to associates

15,821

2,141

20,454

9,632

1

1

1

1

Commitments

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.
The transactions resulting in outstanding balances arose in the ordinary course of business and on substantially the same terms,
including interest rates and security, as for comparable transactions with third party counterparties.

102

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

(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.
The following table shows the expense in respect of compensation for Key Management Personnel of the Bank for services rendered to
the Bank:
2018

2017

HK$m

HK$m

Salaries and other short-term benefits

337

308

Post employment benefits

10

10

Share-based payments1

92

94

Total1

439

412

1

2017 amounts have been represented.

Transactions, arrangements and agreements involving Key Management Personnel
2018

2017

HK$m

HK$m

Highest average assets1

47,132

36,413Highest average liabilities1

48,251

55,629936

899

Guarantees

7,060

10,249Commitments

3,841

2,961

During the year

Contribution to group‘s profit before tax
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 the year.

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.
Change in expected credit losses recognised for the year, and impairment allowances against balances outstanding at the end of theyear, in respect of Key Management Personnel were insignificant (2017: nil).

(f)Loans to directors

Directors are defined as the Directors of the Bank, its ultimate holding company, HSBC Holdings plc and intermediate companies. Loans
to directors also include loans to companies that are controlled by, and entities that are connected with these directors. Particulars ofloans 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 DecMaximum aggregate amountoutstanding during the year

2018

2017

2018

2017

HK$m

HK$m

HK$m

HK$m

By the Bank

857

1,090

7,986

1,213

By subsidiaries

8

—

10

1

865

1,090

7,996

1,214

These amounts include principal and interest, and the maximum liability that may be incurred under guarantees.

35

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.
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 Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018103

Notes on the Consolidated Financial Statements

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. These Committees are overseen by the Group's Valuation Committee Review Group, which considers all material
subjective valuations.

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.

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

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

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
At 31 Dec 2017
AssetsTrading assets1

300,646

195,575213

496,434—

496,434

Derivatives

4,773

215,869517

221,159

79,084300,243

Financial assets designated at fair value

90,641

23,567

8,438

122,646—

122,646

Financial investments

916,385

498,512

5,033

1,419,930—

1,419,930

Trading liabilities1

79,209141,972

10,184

231,365—

231,365

Derivatives

4,501

232,627

1,959

239,087

70,266309,353—

49,278—49,278—49,278

Liabilities

Financial liabilities designated at fair value1
1
2

Amounts with HSBC Group entities are not reflected here.
Derivatives balances with HSBC Group entities are largely under ‘Level 2’.

104

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

Transfers between Level 1 and Level 2 fair values
AssetsLiabilities

Financialinvestments

Trading
assets

HK$m

HK$m

Designatedandotherwise
mandatorily
measured atfair value
HK$m

Derivatives

Trading
liabilities

Designated atfair value

Derivatives

HK$m

HK$m

HK$m

HK$m

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

—

—

Available-forsale

Held fortrading

Designated atfair value

Derivatives Held for trading

Designated atfair value

Derivatives

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

Transfers from Level 1 to Level 2

5,424

9,402

—

—

—

—

—

Transfers from Level 2 to Level 1

63,280

—

—

—

—

—

—

AssetsLiabilities

At 31 Dec 2017

Transfers between levels of the fair value hierarchy are deemed to occur at the end of each quarterly reporting period. Transfers into andout of Level 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 from/to Level 1 and 2 as a result of change in observability of valuation inputs, settlement, nor gains/loss
recognised in the income statement/other comprehensive income during the year in relation to financial instruments carried at fair value
in Level 3 (2017: immaterial). The increase in Level 3 assets was mainly due to the purchase of financial assets of HK$12,200m (2017:
HK$4,577m) to support growth in insurance business. The increase in Level 3 liabilities was mainly due to increased financial liabilities
which contain both deposit and derivative components of HK$10,954m (2017: Nil), reflecting increase in customers' demand.

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.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018105

Notes on the Consolidated Financial Statements

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 of market comparables, andmultiple items for private equity and strategic investments. In the absence of an active market, the fair value of private equity andstrategic investments is estimated on the basis of an analysis of the investee’s financial position and results, risk profile, prospects andother factors, 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.

36

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

406,327—

396,061

10,723406,784

Placings with and advances to banks

338,151—

322,443

15,531

337,974

Loans and advances to customers

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 2018
AssetsFinancial 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

Reverse repurchase agreements – non-trading

330,890—318,849

11,927

330,776

Placings with and advances to banks

433,005—

418,652

14,561

433,213Loans and advances to customers

3,328,980—

92,1463,230,365

3,322,511

300,2446,244

303,240—

309,484

Repurchase agreements – non-trading

47,170—47,155—47,155

Deposits by banks

201,697—

201,456

233

201,689

Customer accounts

Preference shares
At 31 Dec 2017
AssetsFinancial investments – at amortised cost
Liabilities

5,138,272—

5,138,352—

5,138,352

Debt securities in issue

38,394—

38,279—38,279Subordinated liabilities

4,090

—

993

2,773

3,766

Preference shares

21,037——

21,53921,539The 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 reprice to current market rates frequently.
Accordingly, their carrying amount is a reasonable approximation of fair value. They include cash and sight 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.

106

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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.

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.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018107

Notes on the Consolidated Financial Statements

37

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

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 fair
value

—

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

0–4

36

39

92

25

192

4–15

4

16

75

1

96

15–39

—

8

36

—

44

39–196

2

2

29

—

33

196+

—

1

4

—

5

Number of entities at 31 Dec 2017

42

66

236

26

370

HK$m

HK$m

HK$m

HK$m

HK$m

101,793– loans and advances to customers

The group’s maximum exposure at 31 Dec 2018
Total asset values of the entities (HK$bn)

Total assets in relation to the group's interests in the unconsolidated
structured entities

20,201

28,16044,854

8,578– trading assets

—

874

—

—

874

– financial assets designated at fair value—

26,01644,463—70,479– derivatives

1

—

—

—

1

20,200

—

—

8,281

28,481– financial investments

—

1,270

391

—

1,661

– other assets

—

—

—

297

297

Total liabilities in relation to the group's interests in the unconsolidated
structured entities

—

—

—

—

—

Other off balance sheet commitments

18

—

6,265

3,120

9,403

20,21928,16051,119

11,698111,196– loans and advances to customers

The group's maximum exposure at 31 Dec 2017108

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 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 2018 and 2017 were not significant.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018109

Notes on the Consolidated Financial Statements

38

Bank balance sheet and statement of changes in equity

Bank balance sheet at 31 December 2018
2018

2017

HK$m

HK$m

Cash and sight balances at central banks

147,447

149,529

Items in the course of collection from other banks

18,021

19,172

Hong Kong Government certificates of indebtedness

280,854

267,174

Trading assets

439,155

354,114

Derivatives

276,558

281,552

6,298

N/A

AssetsFinancial assets designated and otherwise mandatorily measured at fair value through profit or loss
Financial assets designated at fair value
Reverse repurchase agreements – non-trading

N/A

463

243,203

203,031

Placings with and advances to banks

159,636

187,495

Loans and advances to customers

1,947,307

1,832,490

Financial investments

866,566

796,384

Amounts due from Group companies

347,652

486,744

Investments in subsidiaries

88,16989,418Interests in associates and joint ventures

39,83039,830Goodwill and intangible assets

8,419

5,542

Property, plant and equipment

75,897

83,520

Deferred tax assets

682

738

130,057

87,287

5,075,751

4,884,483

Hong Kong currency notes in circulation

280,854

267,174

Items in the course of transmission to other banks

22,78628,217

Repurchase agreements – non-trading

55,142

12,243

Deposits by banks

121,618

154,728

Customer accounts

Prepayments, accrued income and other assets
Total assets
Liabilities

3,186,542

3,179,845

Trading liabilities

47,491

101,529

Derivatives

279,056

289,649

Financial liabilities designated at fair value

42,545

7,838

Debt securities in issue

41,39827,865Retirement benefit liabilities

2,085

1,675

Amounts due to Group companies

439,262

337,344

Accruals and deferred income, other liabilities and provisions

98,98351,929Current tax liabilities

1,600

1,099

Deferred tax liabilities

8,836

8,758

Subordinated liabilities

3,133

3,126

—

20,9304,631,331

4,493,949

Share capital

172,335

151,360

Other equity instruments

35,87914,737

Other reserves

23,346

18,855Retained earnings

212,860

205,582

Preference shares
Total liabilities
EquityTotal equity
Total equity and liabilities

110

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018444,420

390,534

5,075,751

4,884,483

Bank statement of changes in equity for the year ended 31 December 2018
Other reserves

Sharecapital

At 31 Dec 2017
Impact on transition to HKFRS 9

Other
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

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)

–

–

–

–

At 1 Jan 2018

– property revaluation

–

8,410

(208)
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)

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

Foreignexchangereserve

Other1Total
equityOther reserves

Share capital

Other
equityinstruments

Retainedearnings

Property
revaluation
reserve

Availablefor-saleinvestment
reserve

Cash
flow
hedge
reserve

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

HK$m

114,359

14,737

232,782

35,816

2,262

(675)

(13,734)(15,226)

370,321

Profit for the year——

62,511

—

—

—

—

—

62,511Other comprehensive income/expense(net of tax)

—

—

707

7,252

(538)

557

4,261

—

12,239– available-for-sale investments

—

—

—

—

(538)

—

—

—

(538)

– cash flow hedges

—

—

—

—

—

557

—

—

557

At 1 Jan 2017

– changes in fair value of financial liabilities
designated at fair value upon initialrecognition arising from changes in own
credit risk

—

—

(205)

—

—

—

—

—

(205)

– property revaluation

—

—

—

7,252

—

—

—

—

7,252

– remeasurement of defined benefit asset/
liability

—

—

912

—

—

—

—

—

912

– exchange differences

—

—

—

—

—

—

4,261

—

4,261
74,750Total comprehensive income/(expense) for
the year
Shares issued
Dividends paid3
Movement in respect of share-based
payment arrangements——

63,218

7,252

(538)

557

4,261

—

1,744

—

—

—

—

—

—

—

1,744

—

—

(56,260)

—

—

—

—

—

(56,260)
(414)

—

—

(103)

—

—

—

—

(311)

Transfers and other movements4,6

35,257—(34,055)(3,269)

(36)

—

—

2,496

393

At 31 Dec 2017

151,360

14,737

205,582

39,799

1,688

(118)

(9,473)(13,041)

390,534

For footnotes, please refer to page 56.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018111

Notes on the Consolidated Financial Statements

39

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 2018. 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 2010, HSBC Bank USA entered into a consent cease and desist order with the Office of the Comptroller of the Currency (‘OCC’) andthe indirect parent of that company, HSBC North America Holdings Inc. (‘HNAH’), entered into a consent cease and desist order with the
US Federal Reserve Board (‘FRB’). In 2012, HSBC Bank USA further entered into an enterprise-wide compliance consent order with the
OCC (together the ‘Orders’). These Orders required improvements to establish an effective compliance risk management programme
across HSBC’s US businesses, including risk management related to the US Bank Secrecy Act (‘BSA’) and anti-money laundering (‘AML’)
compliance. In 2012, an additional consent order was entered into with the OCC that required HSBC Bank USA to correct thecircumstances noted in the OCC’s report and imposed restrictions on HSBC Bank USA acquiring control of, or holding an interest in, any
new financial subsidiary, or commencing a new activity in its existing financial subsidiary, without the OCC’s approval. Between June and
September 2018, following implementation of the required remediation actions by HNAH and HSBC Bank USA, the FRB and OCC
terminated each of these orders.
In December 2012, among other agreements, HSBC Holdings plc consented to a cease-and-desist order with the FRB and agreed to anundertaking with the UK Financial Conduct Authority (‘FCA’) to comply with certain forward-looking AML and sanctions-related
obligations and to retain an independent compliance monitor (who is, for FCA purposes, a ‘skilled person’ under section 166 of the
Financial Services and Markets Act) 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 ofForeign Assets Control (‘OFAC’) regarding historical transactions involving parties subject to OFAC sanctions. The Skilled Person/
Independent Consultant will continue to conduct country reviews and provide periodic reports for a period of time at the FCA’s and FRB’s
discretion.
Through his country-level reviews, the Skilled Person/Independent Consultant has identified potential AML and sanctions complianceissues that HSBC is reviewing further with the FRB and/or FCA. 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 investigations
The Bank continues to cooperate with the relevant US and other authorities, including with respect to clients of the Bank in India who
may have had US tax reporting obligations.
In addition, various tax administration, regulatory and law enforcement authorities around the world, including in India, are conducting
investigations and reviews of HSBC Swiss Private Bank and other HSBC companies in connection with allegations of tax evasion or tax
fraud, money laundering and unlawful cross-border banking solicitation. In February 2015, the Indian tax authority issued a summonsand request for information to the Bank in India.
The Bank and other HSBC companies are cooperating with these ongoing investigation. There are many factors that may affect the rangeof outcomes, and the resulting financial impact, of these investigations and reviews, which could be significant.
In light of the media attention regarding these matters, it is possible that other tax administration, regulatory or law enforcement
authorities will also initiate or enlarge similar investigations or regulatory proceedings.

Singapore Interbank Offered Rate (‘Sibor’), Singapore Swap Offer Rate (‘SOR’) and Australia Bank Bill
Swap Rate (‘BBSW’)
In July 2016 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 andracketeering laws, and state law. Following a decision in October 2018 on the defendants’ motion to dismiss in the SIBOR/SOR litigation,
the claims against a number of HSBC entities were dismissed and the Bank remains the only HSBC defendant in this action. In October
2018, the Bank filed a motion for reconsideration of the decision based on the issue of personal jurisdiction. The plaintiff filed a thirdamended complaint in October 2018 naming only the SIBOR panel members. In November 2018, the defendants moved to dismiss thethird amended complaint, and this motion remains pending.
In November 2018, the court granted in part and denied in part the defendants’ motion to dismiss the BBSW case and dismissed all
foreign defendants, including all the HSBC entities, on personal jurisdiction grounds. The plaintiff sought leave to file a second amended
complaint in January 2019.
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 Peru112

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018

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 will seek to dismiss the Trustee Complaint. Based on the facts currently known, it is not practicable at this time to predict theresolution of these matters, 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 DoJ (the‘FX DPA’), regarding fraudulent conduct in connection with two particular transactions in 2010 and 2011. This concluded the DoJ’s
investigation into HSBC’s historical foreign exchange activities. Under the terms of the FX DPA, HSBC has a number of ongoingobligations, 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.

Other regulatory investigations, reviews and litigation
HSBC Holdings plc and/or certain of its affiliates are subject to a number of other investigations and reviews by various regulators andcompetition and law enforcement authorities, as well as litigation, in connection with various matters relating to the firm’s businesses
and operations, including:• requests for information from various tax administration or regulatory authorities relating to Mossack Fonseca & Co.;• an investigation by the US Securities and Exchange Commission of multiple institutions, including HSBC, in relation to hiring practicesof candidates referred by or related to government officials or employees of state-owned enterprises in Asia-Pacific.
There are many factors that may affect the range of outcomes, and the resulting financial impact, of these matters, which could besignificant.

40

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.

41

Events after the balance sheet date

During 2018, the group also made progress to remove internal operational dependencies (for instance, where one group entity provides
critical services to another) to further facilitate the recovery and resolution planning of the group. In particular, the group transferredcritical shared services to a separate internal group of service companies (‘ServCo group’), which is outside of the group but remain
wholly-owned by HSBC Holdings plc. The transfer to the ServCo group of relevant employees, critical shared services and assets in Hong
Kong was substantially completed on 1 January 2019. The establishment of the ServCo group does not change how the group operates
and there were no changes to employment terms and conditions or pension benefits as a result of these transfers.

42

Approval of financial statements

The financial statements were approved and authorised for issue by the Board of Directors on 19 February 2019.

The Hongkong and Shanghai Banking Corporation Limited Annual Report and Accounts 2018113© The Hongkong and Shanghai Banking
Corporation Limited 2019
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The Hongkong and Shanghai Banking Corporation Limited
HSBC Main Building
1 Queen's Road Central, Hong Kong
Telephone: (852) 2822 1111
Facsimile: (852) 2810 1112
www.hsbc.com.hk