RNS Number : 0288H
HSBC Holdings PLC
07 March 2018
 

 




Risk

 

Page

Our conservative risk appetite

63

Top and emerging risks

63

Externally driven

63

Internally driven

65

Areas of special interest

66

Process of UK withdrawal from the European Union

66

Risk management

66

Our risk management framework

66

Our material banking and insurance risks

70

Credit risk management

72

Liquidity and funding risk management

73

Market risk management

74

Operational risk management

77

Regulatory compliance risk management

77

Financial crime risk management

78

Insurance manufacturing operations risk management

78

Other material risks

 

- Reputational risk management

79

- Sustainability risk management

80

- Pension risk management

80

Key developments and risk profile in 2017

81

Key developments in 2017

81

Credit risk profile

81

Liquidity and funding risk profile

101

Market risk profile

105

Operational risk profile

111

Insurance manufacturing operations risk profile

112



Our conservative risk appetite

Throughout its history, HSBC has maintained an evolving conservative risk profile. This is central to our business and strategy.

The following principles guide the Group's overarching risk appetite and determine how its businesses and risks are managed.

Enterprise-wide application



Our risk appetite encapsulates consideration of financial and non-financial risks and is expressed in both quantitative and qualitative terms.



It is applied at the global business level, at the regional level, and to material operating entities.

Financial position



Strong capital position, defined by regulatory and internal capital ratios.



Liquidity and funding management for each operating entity, on a stand-alone basis.

Operating model



Returns generated in line with risk taken.



Sustainable and diversified earnings mix, delivering consistent returns for shareholders.

Business practice



Zero tolerance for knowingly engaging in any business, activity or association where foreseeable reputational risk or damage has not been considered and/or mitigated.



No appetite for deliberately or knowingly causing detriment to consumers, or incurring a breach of the letter or spirit of regulatory requirements.



No appetite for inappropriate market conduct by a member of staff or by any Group business.

 

 



Top and emerging risks

Our approach to identifying and monitoring top and emerging risks is described on page 69. During 2017, there have been a number of developments in our top and emerging risks analysis to reflect our assessment of the issues facing HSBC. Our current top and emerging risks are as follows.

Externally driven

Economic outlook and capital flows

Although global economic activity strengthened in 2017, growth was weak in many countries and headwinds remain in both developed and emerging economies. Global central banks have initiated a gradual tightening of monetary policy that will likely continue into 2018. Sharper than expected interest rate rises, or economic and/or geopolitical shocks, could lead to an increase in capital flows volatility, especially for emerging markets, potentially impacting economic growth.

Protectionism is on the rise in many parts of the world, driven by both populist sentiment and structural challenges facing developed economies. This rise could contribute to weaker global trade, potentially affecting HSBC's traditional lines of business.

The ongoing uncertainty regarding the terms of the UK's exit from the EU, the UK's future relationship with the EU, and its trading relationship with the rest of the world, may lead to market volatility, which could affect both the Group and its customers.

The level of indebtedness in mainland China remains high. Any policy action to restrain credit growth could have wider ramifications for regional and global economic growth, trade and capital flows.

Increased tensions in the Middle East may have significant regional economic and political consequences which could impact the Group's operations within the region.

Oil prices have staged a partial recovery since mid-2017, returning to levels last seen in late 2014. Nevertheless, certain producers, exporters and oil services companies are still under financial strain, which could negatively affect their investment budgets and thus business prospects for HSBC.

Mitigating actions



We actively assess the impact of economic developments in key markets on specific customer segments and portfolios and take 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 and portfolios. Our approach to stress testing is described on page 69.



We have carried out detailed reviews and stress tests of our wholesale credit and trading portfolios to determine those sectors and customers most vulnerable to the UK's exit from the EU, in order to proactively manage and mitigate this risk.

Geopolitical risk

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.

Geopolitical risk remained heightened throughout 2017. While elections across the EU during 2017 have temporarily stemmed a populist tide, political uncertainty remains high in the UK as negotiations progress towards an exit from the EU (see 'Process of UK withdrawal from the European Union' in Areas of special interest on page 66). In addition, the threat of terrorism within the region remains high.

 




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In the Middle East, a number of countries severed diplomatic and transport ties with Qatar, a leading exporter of liquefied natural gas and a significant global investor. Further sanctions may be imposed on Iran outside the guidelines laid out in the Joint Comprehensive Plan of Action, which was decertified, rather than dismantled, by the Trump administration. The tensions between Saudi Arabia, the US and Iran may remain.

In Asia, tensions continue to rise between North Korea and the US as a result of North Korean progress in its missile and nuclear programmes. The stronger Chinese enforcement of UN sanctions on North Korea may not halt further missile and nuclear tests. Any escalation could have a significant impact on regional and global trade.

Mitigating actions



We continually monitor the geopolitical outlook, in particular in countries where we have material exposures and/or a physical presence. We have also established dedicated forums to monitor geopolitical developments.



We use internal stress tests and scenario analysis as well as regulatory stress test programmes, to adjust limits and exposures to reflect our risk appetite and mitigate risks as appropriate. Our internal credit risk ratings of sovereign counterparties take into account geopolitical developments that could potentially disrupt our portfolios and businesses.



Contingency planning for the UK's exit from the EU continues and we are assessing the potential impact on our portfolios, operations and staff.



We have taken steps to enhance physical security in those geographical areas deemed to be at high risk from terrorism and military conflicts.

The credit cycle

The credit environment remains benign as evidenced by the continued fall in loan impairment charges during 2017. However, there is a risk that the credit cycle could turn sharply as a result of shocks. These could occur as a result of political events in the US, UK and EU, or sentiment towards mainland China deteriorating amid concerns over increasing leverage in the financial system. Additionally, a renewed downward trend in oil prices could increase financial difficulties in the oil and gas sector.

Substantial amounts of external refinancing are due in emerging markets in 2018. Stress could appear in a wide array of credit segments and impairment allowances could increase if the credit quality of our customers is affected by less favourable global economic conditions in some markets.

Mitigating actions



We closely monitor economic developments in key markets and sectors and undertake scenario analysis. This enables 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, with management actions being taken to rebalance exposures and manage risk appetite where necessary.



Reviews of key portfolios are undertaken regularly to help ensure that individual customer or portfolio risks are understood and our ability to manage the level of facilities offered through any downturn is appropriate.

Cyber-threat and unauthorised access to systems

HSBC and other public and private organisations continue to be the targets of increasingly sophisticated cyber-attacks. Ransomware and distributed denial of service attacks appear to be an increasingly dominant threat to the financial industry, which may result in disruption to our operations and customer-facing websites or loss of customer data.

 

Mitigating actions



We continue to strengthen and significantly invest in our ability to prevent, detect and respond to the ever-increasing and sophisticated threat of cyber-attacks. Specifically, we continue to enhance our capabilities to protect against increasingly sophisticated malware, denial of service attacks and data leakage prevention, as well as enhancing our security event detection and incident response processes.



Cyber risk is a priority area for the Board and is regularly reported at Board level to ensure appropriate visibility, governance and executive support for our ongoing cybersecurity programme.



We participate in intelligence sharing with both law enforcement and industry schemes to help improve our understanding of, and ability to respond to, the evolving threats faced by us and our peers.

Regulatory, technological and sustainability developments including conduct, with adverse impact on business model and profitability

Financial service providers continue to face stringent regulatory and supervisory requirements, particularly in the areas of capital and liquidity management, conduct of business, financial crime, internal control frameworks, the use of models and the integrity of financial services delivery. The competitive landscape in which the Group operates may be significantly altered by future regulatory changes and government intervention. Regulatory changes, including any resulting from the UK's exit from the EU, may affect the activities of the Group as a whole, or of some or all of its principal subsidiaries.

In September 2017, 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 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 ongoing obligations, including continuing to cooperate with authorities and 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.

While we are actively engaging in opportunities, there is a risk that the rise of financial technology ('fintech') could disrupt the traditional business model of financial institutions.

The financial sector has also been subject to an increasing number of campaigns promoting environmental objectives, including climate change related risks (see page 27 ), as the sophistication of campaigns and research capabilities of non-governmental organisations ('NGOs') develop.

Mitigating actions



We are fully engaged with governments and regulators in the countries in which we operate to help ensure that new requirements are considered properly by regulatory authorities and the financial sector and can be implemented effectively. Significant regulatory programmes, such as Global Standards (see page13) and the establishment of the UK ring-fenced bank, are overseen by the Group Change Committee ('GCC').



We hold regular meetings with UK authorities to discuss strategic contingency plans covering a wide range of scenarios relating to the UK's exit from the EU.



We have invested significant resources and have taken, and will continue to take, a number of steps to improve our compliance systems and controls relating to global markets activities. For

 




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further details, see 'Regulatory compliance risk management' on page 77.



The HSBC Digital Solutions team is actively pursuing opportunities in the fintech space and is deploying solutions with a higher level of agility than our traditional model, helping to enable us to be more competitive in this area.



We continue to work with NGOs to enhance our policies to support sustainable finance.

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 tandem with geopolitical developments. The financial crime risks related to the use of innovative fintech are not yet fully understood, while the changing sanctions regulatory landscape presents execution challenges.

Recent terrorist attacks in Europe and the US may increase law enforcement and/or regulatory focus on bank controls to combat terrorist financing and timely reporting to authorities. This focus may also lead to conflicts between data demands from law enforcement and the data protections which HSBC is required to enforce.

HSBC Bank USA entered into a consent cease and desist order with the OCC in October 2010 and HSBC North America Holdings entered into a consent cease and desist order with the FRB. HSBC Bank USA further entered into an enterprise-wide compliance consent order in 2012. HSBC Holdings consented to a cease and desist order with the FRB in December 2012. Together, these orders required improvements to establish an effective compliance risk management programme across HSBC, including risk management related to the Bank Secrecy Act, AML and compliance with US sanctions laws. Failure to comply with these orders by HSBC could place further restrictions on the operations of HSBC entities, and therefore impact the achievement of our strategic objectives.

HSBC Bank USA, as the primary US dollar correspondent bank for the Group, is subject to heightened financial crime risk arising from business conducted on behalf of clients as well as its non-US HSBC affiliates. If HSBC Bank USA fails to conduct adequate due diligence on clients, including its affiliates, or otherwise inappropriately processes US dollar payments on behalf of non-US HSBC affiliates, it could be in breach of applicable US AML and sanctions laws and regulations and become subject to legal or regulatory enforcement actions by the Office of Foreign Assets Control and other US agencies.

Mitigating actions



We continued to enhance our Financial Crime Risk function which brings together all areas of financial crime risk management at HSBC (see page 78).



We strengthened governance processes during 2017 by establishing formal financial crime risk governance committees at region, global business and country levels of the organisation. This will help to ensure appropriate oversight and escalation of issues to the Financial Crime Risk Management Meeting of the Group Management Board.



We are working to develop enhanced risk management capabilities through better use of sophisticated analytical techniques.



We are working to ensure that the reforms we have put in place are both effective and sustainable over the long term. Work in these areas will continue to be consistent with the terms of the orders by which we are bound and the strategic objectives of the Group.

 

 

Internally driven

IT systems infrastructure and resilience

HSBC continues to invest in the reliability and resilience of our IT systems and critical services. We do so to help prevent disruption to customer services, which could result in reputational and regulatory damage.

Mitigating actions



Strategic initiatives are transforming how technology is developed, delivered and maintained, with a particular focus on providing high-quality, stable and secure services. As part of this, we are concentrating on materially improving system resilience and service continuity testing. In addition, we have enhanced the security of our development life cycle and improved our testing processes and tools.



During 2017, we continued to monitor and upgrade our IT systems, simplifying our service provision and replacing older IT infrastructure and applications. These enhancements led to a further improvement in service availability during the year for our customers and employees.

Impact of organisational change and regulatory demands on employees

Our success in delivering the Group's strategic priorities, as well as significant regulatory change programmes, depends in part on the retention of key members of our management team and wider employee base. The ability to continue to attract, train, motivate and retain highly qualified professionals in an employment market where expertise is often mobile and in short supply is critical. This may depend on factors beyond our control, including economic, market and regulatory conditions. In addition, the impact of the UK's exit from the EU on our employees and the scale of the resultant organisational change is yet to be fully understood.

Mitigating actions



Risks related to organisational change are subject to close management oversight. A range of actions are being developed to address the risks associated with the Group's major change initiatives, including recruitment, development and extensive relocation support to existing employees in the UK ring-fenced bank.



Through dedicated work streams, we continue to develop succession plans using a broad array of talent-sourcing channels for key management roles, which are reviewed on a regular basis.



Contingency planning to address the potential impacts of the UK's exit from the EU on our staff is underway with regular updates provided to the UK authorities.

Execution risk

In order to deliver our strategic objectives and meet mandatory regulatory requirements, it is important for HSBC to maintain a strong focus on execution risk. This requires robust management of significant resource-intensive and time-sensitive programmes. Risks arising from the magnitude and complexity of change may include regulatory censure, reputational damage or financial losses.

Mitigating actions



The GCC, chaired by the Group Chief Operating Officer, oversees these key regulatory and strategic initiatives, managing interdependencies and providing direction and support to help ensure their effective and timely delivery.



In 2017, we continued to manage execution risks through closely monitoring the punctual delivery of critical initiatives, internal and external dependencies, and key risks, to allow better portfolio management across Group. The GCC also monitors the ongoing completion of material deliverables across these programmes in order to address any resourcing challenges.



The GCC escalates any necessary issues to the Group Risk Management Meeting of the Group Management Board.

 




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Risks arising from the receipt of services from third parties

We utilise third parties for the provision of a range of services, in common with other financial service providers. Risks arising from the 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, including adequate control over the selection, governance and oversight of third parties, particularly for key processes and controls that could affect operational resilience. Any deficiency in our management of risks arising from the use of third parties could affect our ability to meet strategic, regulatory or client expectations.

Mitigating actions



In the fourth quarter, we commenced the deployment of our delivery model in the first line of defence by establishing a dedicated team and developing associated processes, controls and technology for undertaking assessments of third-party service providers against key criteria throughout the third-party life cycle. In addition, we started to roll out associated control monitoring, testing and assurance processes.



We established a dedicated oversight forum in the second line of defence to monitor the embedding of policy requirements and performance against risk appetite.

Enhanced model risk management expectations

We use models for a range of purposes in managing our business, including regulatory capital calculations, stress testing, credit approvals, financial crime risk management and financial reporting. Internal and external factors have had a significant impact on our approach to model risk management. Moreover, the adoption of more sophisticated modelling techniques and technology across the industry could also lead to increased model risk.

Mitigating actions



We have established a model risk management sub-function in the second line of defence to strengthen governance and oversight of this risk type.



We further strengthened our model risk management framework throughout 2017 by establishing additional global model oversight committees and implementing policies and standards in accordance with key regulatory requirements.



As we adopt new modelling technologies, we are updating our model risk management framework and governance standards to help address any new risks arising.

Data management

The Group uses a large number of systems and applications to support key business processes and operations. As a result, we often need to reconcile multiple data sources, including customer data sources, to reduce the risk of error. HSBC, along with other organisations, also needs to meet external/regulatory obligations such as the General Data Protection Regulation ('GDPR') which requires implementation of data privacy and protection capabilities across our customer data systems by May 2018.

Mitigating actions



We continue to improve data quality across a large number of systems globally. Our data management and aggregation continues to strengthen and enhance the effectiveness of internal systems and processes. We are implementing data controls for critical processes in the 'front-office' systems to improve our data capture at the point of entry.



We continue to proactively monitor customer and transaction data resolving any associated data issues. We have also implemented data controls and enhanced reconciliation in order to improve the reliability of data used by our customers and staff.

 



Our data culture is strengthening with ownership and accountability attributed to our businesses and increased focus on data as a Group asset.



We have deployed risk and finance data aggregation and advanced reporting capabilities to key markets in 2017. We are on track for completing actions for the remaining countries in scope by the end of 2018.



A dedicated programme of work has been mobilised to execute the GDPR requirements in order to enhance our customers' data protection and privacy.



Areas of special interest

During 2017, we considered a number of areas because of the effect they may have on the Group. While these areas have been identified and considered as part of our top and emerging risks, we have placed particular focus on the UK withdrawal from the European Union in this section.

Process of UK withdrawal from the European Union

The UK is due to formally leave the EU in March 2019. Before this can happen, the UK and the EU have to finalise the Article 50 Withdrawal Agreement, which will then need to be approved by their respective Parliaments. Concluding negotiations on a comprehensive trade deal within this time frame could be challenging. A period of transition is therefore possible but the scope and length of any such arrangement would need to be agreed between the UK and the EU. Uncertainty therefore continues and with it the risk of significant market volatility.

Our objective in all scenarios is to continue to meet customers' needs and minimise disruption. This is likely to require adjustments to our cross-border banking model, with impacted business transferring from the UK to our existing subsidiary in France or other European subsidiaries, as appropriate.

Given the tight time frame and the complexity of the negotiations, we have put in place a robust contingency plan. It is based on a scenario whereby the UK exits the EU in March 2019, without access to the single market or customs union, and without a transitional arrangement. When negotiation positions and timelines become clearer, we will update our contingency plan.



Risk management

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

Our risk management framework

We use an enterprise risk management framework across the organisation and across all risk types. It is underpinned by our risk culture and is reinforced by the HSBC Values and our Global Standards programme.

The framework fosters continuous monitoring of the risk environment, and an integrated evaluation of risks and their interactions. It also ensures a consistent approach to monitoring, managing and mitigating the risks we accept and incur in our activities.

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

 




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HSBC Values and risk culture












Key components of our risk management framework

 

 

 

 

 

 

 

 

 

 

 

Risk governance

 

Non-executive risk governance

 

The Board approves the Group's risk appetite, plans and performance targets. It sets the 'tone from the top' and is advised by the Group Risk Committee, the Financial System Vulnerabilities Committee, and the Conduct & Values Committee (see page 127).

 

 

 

 

 

 

 

 

 

Executive risk governance

 

Responsible for the enterprise-wide management of all risks, including key policies and frameworks for the management of risk within the Group (see pages 67 and 69).

 

 

 

 

 

 

 

 

 

 

Roles and responsibilities

 

Three lines of defence model

 

Our three lines of defence model defines roles and responsibilities for risk management. An independent Global Risk function helps ensure the necessary balance in risk/return decisions (see page 68).

 

 

 

 

 

 

 

 

 

 

Processes and tools

 

Risk appetite

 

Processes to identify/assess, monitor, manage and report risks to ensure we remain within our risk appetite (see pages 67 to 69).

 

 

 

 

Enterprise-wide risk management tools

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

Internal controls

 

Policies and procedures

 

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

 

 

 

 

 

Control activities

 

The operational risk management framework defines minimum standards and processes for managing operational risks and internal controls (see page 77).

 

 

 

 

 

Systems and infrastructure

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 the HSBC Values and our Global Standards programme. It is instrumental in aligning the behaviours of individuals with our attitude to assuming and managing risk, which helps to ensure that our risk profile remains in line with our risk appetite.

We use clear and consistent employee communication on risk to convey strategic messages and set the tone from senior management and the Board. We also deploy mandatory training on risk and compliance topics to embed skills and understanding in order to strengthen our risk culture and reinforce the attitude to risk in the behaviour expected of employees, as described in our risk policies.

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. For further details on whistleblowing, see page 23 and also our ESG reporting available on www.hsbc.com/our-approach/measuring-our-impact and for details on the governance of our whistleblowing policy, see pages 127 and 132.

Our risk culture is also reinforced by our approach to remuneration. Individual awards, including those for senior executives, are based on compliance with the HSBC Values and the achievement of financial and non-financial objectives, which are aligned to our risk appetite and global strategy.

For further information on remuneration, see the Directors' Remuneration Report on page 141.

 

Governance and structure

The Board has ultimate responsibility for the effective management of risk and approves HSBC's risk appetite. It is advised on risk-related matters by the Group Risk Committee ('GRC'), the Financial System Vulnerabilities Committee ('FSVC'), and the Conduct & Values Committee ('CVC') (see pages 130, 131 and 132 respectively).

Executive accountability for the ongoing monitoring, assessment and management of the risk environment and the effectiveness of the risk management framework resides with the Group Chief Risk Officer. He is supported by the Risk Management Meeting of the Group Management Board ('RMM').

The management of financial crime risk resides with the Group Head of Financial Crime Risk. He is supported by the Financial Crime Risk Management Meeting, as described under 'Financial crime risk management' on page 78.

Day-to-day responsibility for risk management is delegated to senior 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 described below.

We use a defined executive risk governance structure to help ensure appropriate oversight and accountability of risk, which facilitates reporting and escalation to the RMM. This structure is summarised in the following table.

 




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Governance structure for the management of risk


Authority
Membership
Responsibilities include:

 

 

 

 

Risk Management Meeting of the Group Management Board

 

Group Chief Risk Officer

Chief Legal Officer

Group Chief Executive

Group Finance Director

All other Group Managing Directors

Supporting the Group Chief Risk Officer in exercising Board-delegated risk management authority

Overseeing the implementation of risk appetite and the enterprise risk management framework

Forward-looking assessment of the risk environment, analysing possible risk impacts and taking appropriate action

Monitoring all categories of risk and determining appropriate mitigating action

Promoting a supportive Group culture in relation to risk management and conduct

Global Risk Management Board

Group Chief Risk Officer

Chief Risk Officers of HSBC's global businesses and regions

Heads of Global Risk sub-functions

Supporting the Group Chief Risk Officer in providing strategic direction for the Global Risk function, setting priorities and providing oversight

Overseeing a consistent approach to accountability for, and mitigation of, risk across the Global Risk function

Global business/regional risk management meetings

Global Business/Regional Chief Risk Officer

Global Business/Regional Chief Executive

Global Business/Regional Chief Financial Officer

Global Business/Regional Heads of global functions

Supporting the Chief Risk Officer in exercising Board-delegated risk management authority

Forward-looking assessment of the risk environment, analysing the possible risk impact and taking appropriate action

Implementation of risk appetite and the enterprise risk management framework

Monitoring all categories of risk and determining appropriate mitigating actions

Embedding a supportive culture in relation to risk management and controls

The Board committees with responsibility for oversight of risk-related matters are set out on page 127.

Our responsibilities

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

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 by clarifying responsibility, 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, and ensuring that the right controls and assessments are in place to mitigate them.



The second line of defence sets the policy and guidelines for managing specific risk areas, provides advice and guidance in relation 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 adequacy of the design and operational effectiveness of the Group's risk management framework and control governance process.

Global Risk function

We have a Global Risk function, headed by the Group Chief Risk Officer, which is responsible for the Group's risk management framework. This responsibility includes establishing global policy, monitoring risk profiles, and forward-looking risk identification and management. Global Risk is made up of sub-functions covering all risks to our operations. Global Risk forms part of the second 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

Our risk appetite encapsulates consideration of financial and non-financial risks and is expressed in both quantitative and qualitative terms. It is applied at the global business level, at the regional level, and to material operating entities.

The Group's risk appetite defines its desired forward-looking risk profile, and informs the strategic and financial planning process. Furthermore, it is integrated with other key risk management tools, such as stress testing and our top and emerging risk reports, to help ensure consistency in risk management practices.

The Group sets out the aggregated level and risk types it accepts in order to achieve its business objectives in a risk appetite statement ('RAS'). The RAS is reviewed on an ongoing basis, and formally approved by the Board every six months on the recommendation of the GRC.

The Group's actual performance is reported monthly against the approved RAS to the RMM, enabling senior management to monitor the risk profile and guide business activity to balance risk and return. This reporting allows risks to be promptly identified and mitigated, and informs risk-adjusted remuneration to drive a strong risk culture.

Global businesses, regions and strategically important countries are required to have their own RASs, which are monitored to ensure they remain aligned with the Group's. All RASs and business activities are guided and underpinned by qualitative principles (see page 131). Additionally, for key risk areas, quantitative metrics are defined along with appetite and tolerance thresholds.

Risk map

The Group risk map provides a point-in-time view of the risk profiles of countries, regions and global businesses across HSBC's risk taxonomy. It assesses the potential for these risks to have a material impact on the Group's financial results, reputation and the sustainability of its business. Risk stewards assign 'current' and 'projected' risk ratings, supported by commentary. Risks that have an 'amber' or 'red' risk rating require monitoring and mitigating action plans to be either in place or initiated to manage the risk down to acceptable levels.

Descriptions of our material banking and insurance risks are set out on page 70.

 




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Top and emerging risks

We use a top and emerging risks process to provide a forward-looking view of issues with the potential to threaten the execution of our strategy or operations over the medium to long term.

We proactively assess the internal and external risk environment, as well as review the themes identified across our regions and global 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 and crystallise in between six months and one year, and that has the potential to materially affect the Group's financial results, reputation or business model. It may arise across any combination of risk types, regions or global businesses. The impact may be well understood by senior management and some mitigating actions may already be in place. Stress tests of varying granularity may also have been carried out to assess the impact.

An 'emerging risk' is a thematic issue with large unknown components that may form and crystallise beyond a one-year time horizon. If it were to materialise, it could have a material effect on the Group's long-term strategy, profitability and/or reputation. Existing mitigation plans are likely to be minimal, reflecting the uncertain nature of these risks at this stage. Some high-level analysis and/or stress testing may have been carried out to assess the potential impact.

Our current top and emerging risks are discussed on page 63.

Stress testing

HSBC operates a comprehensive stress testing programme that supports our risk management and capital planning. It includes execution of stress tests mandated by our regulators. Our stress testing is supported by dedicated teams and infrastructure, and is overseen at the most senior levels 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. As well as undertaking regulatory-driven stress tests, we conduct our own internal stress tests.

Many of our regulators - including the BoE, the FRB and the HKMA - use stress testing as a prudential regulatory tool and the Group has focused significant governance and resources to meet their requirements.

Bank of England stress test results for 2017

The BoE's Annual Cyclical Scenario ('ACS') stress test in 2017 specified a global downturn with severe effects in the UK, US, Hong Kong and mainland China, which accounted for approximately two-thirds of HSBC's RWAs at the end of 2016. We estimated that the economic shock to global GDP in this scenario was about as severe as in the global financial crisis of 2007 to 2009, but with a greater impact on emerging markets: for example, the scenario featured a contraction of 1.2% of the Chinese economy in the first year. Additionally, and in contrast to 2016, the ACS featured a 32% depreciation of sterling in the first year and a rise of UK base rates to 4%. The assumed GDP growth rates are detailed in the following table.  











Assumed GDP growth rates in the 2017 Bank of England ACS

stress test

 

2016


2017


2018


2019


 

%


%


%


%


UK

2.2


(4.7

)

0.7


1.3


USA

1.9


(3.5

)

0.7


1.4


Mainland China

6.8


(1.2

)

3.7


5.0


Hong Kong

1.8


(7.9

)

1.1


2.3


Source: Bank of England.

PRA assumed GDP growth rates are shown in terms of fourth quarter on fourth quarter annual changes.

 

In 2017, the results for HSBC as published by the BoE showed that our capital ratios, after taking account of CRD IV restrictions and strategic management actions, exceeded the BoE's requirements.

This outcome reflected our strong capital position, conservative risk appetite and diversified geographical and business mix. It also reflected our ongoing strategic actions, including the sale of operations in Brazil, ongoing RWA reduction initiatives and continued sales from our US CML run-off portfolio.

The following table shows the results of the stress test for the past three years, and reflects HSBC's resilience. From a starting CET1 ratio of 13.6% at the end of 2016, the BoE's 2017 stress test results showed a projected minimum stressed CET1 ratio of 8.9% after the impact of strategic management actions.  






Results of Bank of England stress tests for the past three years

 

2017

2016

2015

 

%

%

%

CET1 ratio at scenario start point

13.6

11.9

10.9

Minimum stressed CET1 ratio after

strategic management actions

8.9

9.1

7.7

Fall in CET1 ratio

4.7

2.8

3.2

Source: Bank of England.

Data is presented in terms of the minimum CET1 ratio reached net of strategic management actions as per the results published by the PRA.

Internal stress tests are an important element in our risk management and capital management frameworks. Our capital plan is assessed through a range of stress scenarios which explore risks identified by management. They include potential adverse macroeconomic, geopolitical and operational risk events, and other potential events that are specific to HSBC. The selection of 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 to which the bank is exposed. Using this information, management decides whether risks can or should be mitigated through management actions or, if they were to crystallise, should be absorbed through capital. This in turn informs decisions about preferred capital levels.

We conduct reverse stress tests each year at Group and, where required, subsidiary entity level in order to understand which potential extreme conditions would make our business model non-viable. Reverse stress testing identifies potential stresses and vulnerabilities we might face, and helps inform early warning triggers, management actions and contingency plans designed to mitigate risks.

In addition to the Group-wide stress testing scenarios, each major HSBC subsidiary conducts regular macroeconomic and event-driven scenario analyses specific to its region. They also participate as required in the regulatory stress testing programmes of the jurisdictions in which they operate, such as the Comprehensive Capital Analysis and Review and Dodd-Frank Act Stress Test programmes in the US, and the stress tests of the HKMA. Global functions and businesses also perform bespoke stress testing to inform their assessment of risks in potential scenarios.

The Group stress testing programme is overseen by the GRC and results are reported, where appropriate, to the RMM and GRC.

 




HSBC Holdings plc  Annual Report and Accounts 2017

69

 

 

Report of the Directors | Risk

 

Our material banking and insurance risks

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





Description of risks - banking operations

 

Risks
Arising from
Measurement, monitoring and management of risk

Credit risk (see page 72)

 

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 and derivatives.

Credit risk is:

measured as the amount that could be lost if a customer or counterparty fails to make repayments;

monitored using various internal risk management measures and within limits approved by individuals within a framework of delegated authorities; and

managed through a robust risk control framework which outlines clear and consistent policies, principles and guidance for risk managers.

Liquidity and funding risk (see page 73)

 

Liquidity risk is the risk that we do not have sufficient financial resources to meet our obligations as they fall due or that we can only do so at an excessive cost.

Funding risk is the risk that funding considered to be sustainable, and therefore used to fund assets, is not sustainable over time.

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 when required.

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 ('ILAAP');

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.

Market risk (see page 74)

 

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

Exposure to market risk is separated into two portfolios: trading and
non-trading.
Market risk exposures arising from our insurance operations are discussed on page 114.

Market risk is:

measured using sensitivities, value at risk ('VaR') and stress testing, giving a detailed picture of potential gains and losses for a range of market movements and scenarios, as well as tail risks over specified time horizons;

monitored using VaR, stress testing and other measures including the sensitivity of net interest income and the sensitivity of structural foreign exchange; and

managed using risk limits approved by the RMM and the risk management meeting in various global businesses.

Operational risk (see page 77)

 

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.

Operational risk arises from day-to-day operations or external events, and is relevant to every aspect of our business.

Regulatory compliance risk and financial crime compliance risk are discussed below.

Operational risk is:

Measured using the risk and control assessment process, which assesses the level of risk and the effectiveness of controls, and measured for Economic Capital management using risk event losses and scenario analysis;

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 and monitor the effectiveness of these controls using the operational risk management framework.

Regulatory compliance risk (see page 77)

 

Regulatory compliance risk is the risk that we fail to observe the letter and spirit of all relevant laws, codes, rules, regulations and standards of good market practice, and incur fines and penalties and suffer damage to our business as a consequence.

Regulatory compliance risk is part of operational risk, and arises from the risks associated with breaching our duty to clients and other counterparties, inappropriate market conduct and breaching other regulatory requirements.

Regulatory compliance risk is:

measured by reference to identified metrics, incident assessments, regulatory feedback and the judgement and assessment of our regulatory 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 of internal 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.

Financial crime risk (see page 78)

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

Financial crime risk is part of operational risk and arises from day-to-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 and metrics, the results of the monitoring and control activities of the second line of defence functions, and the results of internal 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.

 

 

 

 




70

HSBC Holdings plc  Annual Report and Accounts 2017

 

 





 

 

 

Description of risks - banking operations (continued)

 

Other material risks

Reputational risk (see page 79)

Reputational risk is the risk of failure to meet stakeholder expectations as a result of any event, behaviour, action or inaction, either by HSBC itself, our employees or those with whom we are associated, that might cause stakeholders to form a negative view of the Group.

Primary reputational risks arise directly from an action or inaction by HSBC, its employees or associated parties that are not the consequence of another type of risk. Secondary reputational risks are those arising indirectly and are a result of a failure to control any other risks.

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 that is integrated into the Group's broader risk management framework; and

managed by every member of staff, and covered by a number of policies and guidelines. There is a clear structure of committees and individuals charged with mitigating reputational risk.

Pension risk (see page 80)

Pension risk is the risk of increased costs to HSBC from offering post-employment 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 also includes operational and reputational risk of sponsoring pension plans.

Pension risk is:

measured in terms of the scheme's ability to generate sufficient funds to meet the cost of their accrued benefits;

monitored through the specific risk appetite that has been developed at both Group and regional levels; and

managed locally through the appropriate pension risk governance structure and globally through the Global Pensions Oversight Forum and ultimately the RMM.

Sustainability risk (see page 80)

Sustainability risk is the risk that financial services provided to customers by the Group indirectly result in unacceptable impacts on people or the environment.

Sustainability risk arises from the provision of financial services to companies or projects which indirectly result in unacceptable impacts on people or on the environment.

Sustainability risk is:

measured by assessing the potential sustainability effect of a customer's activities and assigning a sustainability risk rating to all high-risk transactions;

monitored quarterly by the RMM and monthly by the Group's sustainability risk function; and

managed using sustainability risk policies covering project finance lending and sector-based sustainability policies for sectors and themes with potentially large environmental or social impacts.

Our insurance manufacturing subsidiaries are regulated separately from our banking operations. Risks in our insurance entities are managed using methodologies and processes that are subject to

 

Group oversight. Our insurance operations are also subject to some of the same risks as our banking operations, which are covered by the Group's risk management processes.





Description of risks - insurance manufacturing operations

Financial risk (see page 114)

 

Our ability to effectively match liabilities arising under insurance contracts with the asset portfolios that back them is contingent on the management of financial risks and the extent to which these are borne by policyholders.

Exposure to financial risk arises from:

market risk affecting the fair values of financial assets or their future cash flows;

credit risk; and

liquidity risk of entities being unable to make payments to policyholders as they fall due.

Financial risk is:

measured (i) for credit risk, in terms of economic capital and the amount that could be lost if a counterparty fails to make repayments; (ii) for market risk, in terms of economic capital, internal metrics and fluctuations in key financial variables; and (iii) for liquidity risk, in terms of internal metrics including stressed operational cash flow projections;

monitored through a framework of approved limits and delegated authorities; 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 (see page 116)

 

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

The cost of claims and benefits can be influenced by many factors, including mortality and morbidity experience, as well as lapse and surrender 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 delegated authorities; and

managed through a robust risk control framework which outlines clear and consistent policies, principles and guidance. This includes using product design, underwriting, reinsurance and claims-handling procedures.

 




HSBC Holdings plc  Annual Report and Accounts 2017

71

 

 

Report of the Directors | Risk

 

Credit risk management

Details of changes in our credit risk profile in 2017 can be found on page 81, in 'Key developments and risk profile in 2017'.

There were no material changes to the policies and practices for the management of credit risk in 2017.

Credit risk sub-function

(Audited)

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

The principal objectives of our credit risk management are:



to maintain across HSBC a strong culture of responsible lending, and robust risk policies and control frameworks;



to both partner and challenge our businesses in defining, implementing and continually re-evaluating our risk appetite under actual and scenario conditions; and



to ensure there is independent, expert scrutiny of credit risks, their costs and their mitigation.

Concentration of exposure

(Audited)

Concentrations of credit risk arise when a number of counterparties or exposures have comparable economic characteristics, or such counterparties are engaged in similar activities or operate in the same geographical areas or industry sectors so that their collective ability to meet contractual obligations is uniformly affected by changes in economic, political

 

or other conditions. We use a number of controls and measures to minimise undue concentration of exposure in our portfolios across industries, countries and global businesses. These include portfolio and counterparty limits, approval and review controls, and stress testing.

Credit quality of financial instruments

(Audited)

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

The customer risk rating ('CRR') 10-grade scale summarises a more granular underlying 23-grade scale of obligor probability of default ('PD'). All corporate customers are rated using the 10- or 23-grade scale, depending on the degree of sophistication of the Basel II approach adopted for the exposure.

Each CRR band is associated with an external rating grade by reference to long-run default rates for that grade, represented by the average of issuer-weighted historical default rates. This mapping between internal and external ratings is indicative and may vary over time.

The expected loss ('EL') 10-grade scale for retail business summarises a more granular underlying EL scale for this customer segment. This combines obligor and facility/product risk factors in a composite measure.

For the five credit quality classifications defined, each encompasses a range of granular internal credit rating grades assigned to wholesale and retail lending businesses, and the external ratings attributed by external agencies to debt securities.

For debt securities and certain other financial instruments, external ratings have been aligned to the five quality classifications based upon the mapping of related CRR to external credit rating.










Credit quality classification

 

 

Sovereign debt securities

and bills

Other debt

securities

and bills

Wholesale lending

and derivatives

Retail lending

 

Footnotes

External credit rating

External credit rating

Internal credit rating

12-month probability of default %

Internal credit rating

Expected loss %

Quality classification

 

 

 

 

 

 

 

Strong

1, 2

BBB and above

A- and above

CRR 1 to CRR 2

0 - 0.169

EL 1 to EL 2

0 - 0.999

Good

 

BBB- to BB

BBB+ to BBB-

CRR 3

0.170 - 0.740

EL 3

1.000 - 4.999

Satisfactory

 

BB- to B and unrated

BB+ to B and unrated

CRR 4 to CRR 5

0.741 - 4.914

EL 4 to EL 5

5.000 - 19.999

Sub-standard

 

B- to C

B- to C

CRR 6 to CRR 8

4.915 - 99.999

EL 6 to EL 8

20.000 - 99.999

Impaired

3

Default

Default

CRR 9 to CRR 10

100

EL 9 to EL 10

100+ or defaulted



1

Customer risk rating ('CRR').



2

Expected loss ('EL').



3

The EL percentage is derived through a combination of probability of default ('PD') and loss given default ('LGD'), and may exceed 100% in circumstances where the LGD is above 100% reflecting the cost of recoveries.



Quality classification definitions

'Strong' exposures demonstrate a strong capacity to meet financial commitments, with negligible or low probability of default and/or low levels of expected loss.

'Good' exposures require closer monitoring and demonstrate a good capacity to meet financial commitments, with low default risk.

'Satisfactory' exposures require closer monitoring and demonstrate an average-to-fair capacity to meet financial commitments, with moderate default risk.

'Sub-standard' exposures require varying degrees of special attention and default risk is of greater concern.

'Impaired' exposures have been assessed as impaired, as described on page 86. These also include retail accounts classified as EL 1 to EL 8 that are delinquent by more than 90 days, unless individually they have been assessed as not impaired, and renegotiated loans that have met the requirements to be disclosed as impaired and have not yet met the criteria to be returned to the unimpaired portfolio (see following page ) .

 




72

HSBC Holdings plc  Annual Report and Accounts 2017

 

 

Renegotiated loans and forbearance

(Audited)

'Forbearance' describes concessions made on the contractual terms of a loan in response to an obligor's financial difficulties.

A loan is classed as 'renegotiated' when we modify the contractual payment terms, on concessionary terms, because we have significant concerns about the borrowers' ability to meet contractual payments when due.

Non-payment related concessions (e.g. covenant waivers), while potential indicators of impairment, do not trigger identification as renegotiated loans.

Loans that have been identified as renegotiated retain this designation until maturity or derecognition. A loan that is renegotiated is derecognised if the existing agreement is cancelled and a new agreement is made on substantially different terms, or if the terms of an existing agreement are modified such that the renegotiated loan is substantially a different financial instrument. Loans arising as a result of derecognition events will continue to be disclosed as renegotiated loans.

Credit quality of renegotiated loans

On execution of a renegotiation, the loan will also be classified as impaired if it is not already so classified. In wholesale lending, all facilities with a customer, including loans which have not been modified, are considered impaired following the provision of a renegotiated loan.

Those loans that are considered impaired retain the impaired classification for a minimum of one year. Renegotiated loans will continue to be disclosed as impaired until there is sufficient evidence to demonstrate a significant reduction in the risk of non-payment of future cash flows (the evidence typically comprises a history of payment performance against the original or revised terms), and there are no other indicators of impairment.

Renegotiated loans and recognition of impairment allowances

(Audited)

For retail lending, renegotiated loans are segregated from other parts of the loan portfolio for collective impairment assessment to reflect the higher rates of losses typically encountered with renegotiated loans.

For wholesale lending, renegotiated loans are typically assessed individually. Credit risk ratings are intrinsic to the impairment assessments. The individual impairment assessment takes into account the higher risk of the non-payment of future cash flows inherent in renegotiated loans.

Impairment assessment

(Audited)

For details of our impairment policies on loans and advances and financial investments, see Note 1.2(d) on the Financial Statements.

Write-off of loans and advances

(Audited)

For details of our policy on the write-off of loans and advances, see Note 1.2(d) on the Financial Statements.

Unsecured personal facilities, including credit cards, are generally written off at between 150 and 210 days past due. The standard period runs until the end of the month in which the account becomes 180 days contractually delinquent. Write-off periods may be extended, generally to no more than 360 days past due. However, in exceptional circumstances, they may be extended further. For example, in a few countries where local regulation or legislation constrain earlier write-off, or where the realisation of collateral for secured real estate lending takes more time.

For secured personal facilities, final write-off should generally occur within 60 months of the default.

In the event of bankruptcy or analogous proceedings, write-off may occur earlier than the maximum periods stated above. Collection procedures may continue after write-off.

 

Impairment methodologies for available-for-sale asset-backed securities ('ABSs')

(Audited)

To identify objective evidence of impairment for available-for-sale ABSs, an industry standard valuation model is normally applied which uses data with reference to the underlying asset pools and models their projected future cash flows. The estimated future cash flows of the securities are assessed at the specific financial asset level to determine whether any of them are unlikely to be recovered as a result of loss events occurring on or before the reporting date.

The principal assumptions and inputs to the models are typically the delinquency status of the underlying loans, the probability of delinquent loans progressing to default, the prepayment profiles of the underlying assets and the loss severity in the event of default. However, the models utilise other variables relevant to specific classes of collateral to forecast future defaults and recovery rates. Management uses externally available data and applies judgement when determining the appropriate assumptions in respect of these factors. We use a modelling approach which incorporates historically observed progression rates to default to determine if the decline in aggregate projected cash flows from the underlying collateral will lead to a shortfall in contractual cash flows. In such cases, the security is considered to be impaired.

In respect of collateralised debt obligations ('CDOs'), expected future cash flows for the underlying collateral are assessed to determine whether there is likely to be a shortfall in the contractual cash flows of the CDO.

When a security benefits from a contract provided by a monoline insurer that insures payments of principal and interest, the expected recovery on the contract is assessed in determining the total expected credit support available to the ABS.

Liquidity and funding risk management

Details of HSBC's Liquidity and Funding Risk Management Framework ('LFRF') can be found in the Group's Pillar 3 Disclosures at December 2017 document.

Liquidity and funding risk management framework

The LFRF aims to allow us to withstand very severe liquidity stresses. It is designed to be adaptable to changing business models, markets and regulations. The Group Treasurer, who reports to the Group Finance Director, has responsibility for the oversight of the LFRF. Asset, Liability and Capital Management ('ALCM') teams are responsible for the application of the LFRF at a local operating entity level. This comprises of the following elements:



stand-alone management of liquidity and funding by operating entity;



operating entity classification by inherent liquidity risk ('ILR') categorisation;



minimum LCR requirement depending on ILR categorisation;



minimum NSFR requirement depending on ILR categorisation;



legal entity depositor concentration limit;



three-month and 12-month cumulative rolling term contractual maturity limits covering deposits from banks, deposits from non-bank financial institutions and securities issued;



annual individual liquidity adequacy assessment by principal operating entity;



minimum LCR requirement by currency;



management and monitoring of intra-day liquidity;



liquidity funds transfer pricing; and



forward-looking funding assessments.

 




HSBC Holdings plc  Annual Report and Accounts 2017

73

 

 

Report of the Directors | Risk

 

Risk governance and oversight

The elements of the LFRF are underpinned by a robust governance framework, the two major elements of which are:



Group, regional and entity level asset and liability management committees ('ALCOs').



Annual internal liquidity adequacy assessment process ('ILAAP') for principal operating entities used to validate risk tolerance and set risk appetite.

Liquidity and funding are predominantly managed at an entity level. Where appropriate, management may be expanded to cover a consolidated group of legal entities or narrowed to a principal office (branch) of a wider legal entity to reflect the management under internal or regulatory definitions.

The RMM reviews and agrees annually the list of countries, legal entities or consolidated groups it directly oversees and the composition of these entities ('principal operating entities'). This list forms the basis of liquidity and funding risk disclosures.

There were no material changes to the policies and practices for the management of liquidity and funding risk in 2017.

HSBC Holdings

HSBC Holdings' primary sources of liquidity are dividends received from subsidiaries, interest on and repayment of intra-group loans and securities, and interest earned on its own liquid funds. HSBC Holdings also raises ancillary funds in the debt capital markets through subordinated and senior debt issuances. Cash is primarily used for the provision of capital and subordinated funding to subsidiaries, payment of operating expenses, interest payments to debt holders and dividend payments to shareholders.

HSBC Holdings is also subject to contingent liquidity risk by virtue of credit-related commitments and guarantees and similar contracts issued relating to its subsidiaries. Such commitments and guarantees are only issued after due consideration of HSBC Holdings' ability to finance the commitments and guarantees and the likelihood of the need arising.

HSBC Holdings actively manages the cash flows from its subsidiaries to optimise the amount of cash held at the holding company level. During 2017, consistent with the Group's capital plan, the Group's subsidiaries did not experience any significant restrictions on paying dividends or repaying loans and advances. Also, there are no foreseen restrictions envisaged with regard to planned dividends or payments. However, the ability of subsidiaries to pay dividends or advance monies to HSBC Holdings depends on, among other things, their respective local regulatory capital and banking requirements, exchange controls, statutory reserves, and financial and operating performance.

 

Market risk management

Details of changes in our market risk profile in 2017 can be found on page 81, in ' Key developments and risk profile in 2017'.

There were no material changes to our policies and practices for the management of market risk in 2017.

Market risk in global businesses

The diagram below summarises the main business areas where trading and non-trading market risks reside, and the market risk measures used to monitor and limit exposures.








Trading risk

Non-trading risk

Foreign exchange and commodities

Interest rates

Credit spreads

Equities

Structural foreign exchange

Interest rates1

Credit spreads

GB&M and BSM2

GB&M, BSM2, GPB, CMB and RBWM

VaR | Sensitivity | Stress Testing



1

The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included in the Group VaR. The management of this risk is described on page 101.

 



2

BSM, for external reporting purposes, forms part of Corporate Centre while daily operations and risk are managed within GB&M.

Where appropriate, we apply similar risk management policies and measurement techniques to both trading and non-trading portfolios. Our objective is to manage and control market risk exposures to optimise return on risk while maintaining a market profile consistent with our established risk appetite.

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 the portfolio level.

Market risk governance

(Audited)

Market risk is managed and controlled through limits approved by the RMM for HSBC Holdings. These limits are allocated across business lines and to the Group's legal entities.







 

 

 

 

 

B&M manages market risk, where the majority of HSBC's total value at risk (excluding insurance) and almost all trading VaR resides, using risk limits approved by the GMB. VaR limits are set for portfolios, products and risk types, with market liquidity being a primary factor in determining the level of limits set. Global Risk is responsible for setting market risk management policies and measurement techniques.

Each major operating entity has an independent market risk management and control sub-function which is responsible for measuring market risk exposures, monitoring and reporting these exposures against the prescribed limits on a daily basis. The market risk limits are governed according to the framework illustrated to the left.

Each operating entity is required to assess the market risks arising on each 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 ALCO.

Model risk is governed through Model Oversight Committees ('MOCs') at the regional and global Wholesale Credit and Market Risk levels. They have direct oversight and approval responsibility for all traded risk models utilised for risk measurement and management and stress testing. We are committed to the ongoing development of our in-house risk models.

The Markets MOC reports into the Group MOC, which oversees all model risk types at Group level. The Group MOC informs the RMM about material issues at least two times a year. The RMM is the Group's 'Designated Committee' according to regulatory rules and has delegated day-to-day governance of all traded risk models to the Markets MOC.

Global Risk enforces trading in permissible instruments approved for each site, new product approval procedures, restricting trading in the more complex derivative products only to offices with appropriate levels of product expertise and robust control systems.

General
measures

 

HSBC Holdings Board

 

GB&M manages market risk, where the majority of HSBC's total value at risk (excluding insurance) and almost all trading VaR resides, using risk limits approved by the RMM. VaR limits are set for portfolios, products and risk types, with market liquidity being a primary factor in determining the level of limits set. Global Risk is responsible for setting market risk management policies and measurement techniques.

Each major operating entity has an independent market risk management and control sub-function which is responsible for measuring market risk exposures, monitoring and reporting these exposures against the prescribed limits on a daily basis. The market risk limits are governed according to the framework illustrated to the left.

Each operating entity is required to assess the market risks arising on each 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 ALCO.

Model risk is governed through Model Oversight Committees ('MOCs') at the regional and global Wholesale Credit and Market Risk levels. They have direct oversight and approval responsibility for all traded risk models used for risk measurement and management and stress testing. We are committed to the ongoing development of our in-house risk models.

The Markets MOC reports into the Group MOC, which oversees all model risk types at Group level. The Group MOC informs the RMM about material issues at least two times a year. The RMM is the Group's 'Designated Committee' according to regulatory rules and has delegated day-to-day governance of all traded risk models to the Markets MOC.

Global Risk enforces trading in permissible instruments approved for each site, new product approval procedures, restricting trading in the more complex derivative products only to offices with appropriate levels of product expertise and robust control systems.

q

Group Chairman/
Group Chief Executive

q

Risk Management Meeting of the GMB

q

Group traded risk

 

 

q

Specific
measures

 

Entity risk management committee

q

Principal office manager

q

 

Business/desk/trader

 

 

 

 

 




74

HSBC Holdings plc  Annual Report and Accounts 2017

 

 

Market risk measures

Monitoring and limiting market risk exposures

Our objective is to manage and control market risk exposures while 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, value at risk and stress testing.

Sensitivity analysis

Sensitivity analysis measures the impact of individual market factor movements on specific instruments or portfolios, including interest rates, foreign exchange rates and equity prices, such as the effect of a one basis point change in yield. We use sensitivity measures to monitor the market risk positions within each risk type. Sensitivity limits are set for portfolios, products and risk types, with the depth of the market being a principal factor in determining the level.

Value at risk

(Audited)

Value at risk ('VaR') is a technique for estimating potential losses on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence. The use of VaR is integrated into market risk management and calculated for all trading positions regardless of how we capitalise them. Where there is not an approved internal model, we use the appropriate local rules to capitalise exposures. In addition, we calculate VaR for non-trading portfolios to have a complete picture of risk. Where we do not calculate VaR explicitly, we use alternative tools as summarised in the 'Stress testing' section below.

Our models are predominantly based on historical simulation that incorporates the following features:



historical market rates and prices are calculated with reference to foreign exchange rates, commodity prices, interest rates, equity prices and the associated volatilities;

 



potential market movements utilised for VaR are calculated with 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 option features on the underlying exposures. The nature of the VaR models means that an increase in observed market volatility will lead to an increase in VaR without any changes in the underlying positions.

VaR model limitations

Although a valuable guide to risk, VaR should always be viewed in the context of its limitations. For example:



use of historical data as a proxy for estimating future events may not encompass all potential events, particularly extreme ones;

 



the use of a holding period assumes that all positions can be liquidated or the risks offset during that period, which may not fully reflect the market risk arising at times of severe illiquidity, when the holding period may be insufficient to liquidate or hedge all positions fully;

 



the use of a 99% confidence level does not take into account losses that might occur beyond this level of confidence; and

 



VaR is calculated on the basis of exposures outstanding at the close of business and therefore does not necessarily reflect intra-day exposures.

Risk not in VaR framework

The risks not in VaR ('RNIV') framework aims to capture and capitalise material market risks that are not adequately covered in the VaR model, such as the LIBOR tenor basis.

Risk factors are reviewed on a regular basis and 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. The outcome of the VaR-based RNIV is included in the VaR calculation and back-testing; a stressed VaR RNIV is also computed for the risk factors considered in the VaR-based RNIV approach.

Stress-type RNIVs include a gap risk exposure measure to capture risk on non-recourse margin loans and a de-peg risk measure to capture risk to pegged and heavily-managed currencies.

Stress testing

Stress testing is an important procedure that is integrated into our market 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 legal entity, regional and overall Group levels. A set of scenarios is used consistently across all regions within the Group. Scenarios are tailored to capture the relevant potential events or market movements at each level. The risk appetite around potential stress losses for the Group is set and monitored against referral limits.

Market risk reverse stress tests are undertaken on the premise 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 that are beyond normal business settings and could have contagion and systemic implications.

Stressed VaR and stress testing, together with reverse stress testing and the management of gap risk, provide management with insights regarding the 'tail risk' beyond VaR, for which HSBC's appetite is limited.

Trading portfolios

Back-testing

We routinely validate the accuracy of our VaR models by back-testing them against both actual and hypothetical profit and loss against the corresponding VaR numbers. Hypothetical profit and loss excludes non-modelled items such as fees, commissions and revenues of intra-day transactions.

We would expect, on average, to see two or three profits and two or three losses in excess of VaR at the 99% confidence level over a one-year period. The actual number of profits or losses in excess of VaR over this period can therefore be used to gauge how well the models are performing.

We back-test our Group VaR at various levels that reflect a full legal entity scope of HSBC, including entities that do not have local permission to use VaR for regulatory purposes.

Structural foreign exchange exposures

Structural foreign exchange exposures represent net investments in subsidiaries, branches and associates, the functional currencies of which are currencies other than the US dollar. An entity's functional 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'. We use the US dollar as our presentation currency in our consolidated financial statements because the US dollar and currencies linked to it form the major currency bloc in which we transact and fund our business. Our consolidated balance sheet is, therefore, affected by exchange differences between the US dollar and all the non-US dollar functional currencies of underlying subsidiaries.

Our structural foreign exchange exposures are managed with the primary objective of ensuring, where practical, that our consolidated capital ratios and the capital ratios of individual banking subsidiaries are largely protected from the effect of changes in exchange rates. We hedge structural foreign exchange exposures only in limited circumstances.

For further details of our structural foreign exchange exposures, please see page 108.

 




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Interest rate risk in the banking book

Overview

Interest rate risk in the banking book is the risk of an adverse impact to earnings or capital due to changes in market interest rates. It is generated by our non-traded assets and liabilities and is monitored and controlled at Group level by Group Treasury and at the entity level by Asset, Liability and Capital Management ('ALCM'). Group Treasury and ALCM functions are governed by RMM who approve risk limits used in the management of interest rate risk. Interest rate risk in the banking book is transferred to and managed by BSM, which is overseen by Wholesale Market Risk, Product Control and Group Treasury functions.

Key risk drivers

The bank's interest rate risk in the banking book can be segregated into the following drivers:



Managed rate risk - the risk that the pricing of products, which are dependent upon business line decisions, do not correlate to movements in market interest rates.

 



Re-investment risk - risk arising due to change in rates when behaviouralised balances are reinvested as per the transfer pricing policy.

 



Basis risk - the risk arising from assets and liabilities that are priced referencing different market indices creating a repricing mismatch.

 



Prepayment risk - the risk that the actual customer prepayment in different interest rate scenarios does not match the profile used to hedge the interest rate risk.

 



Duration risk - the risk that there are changes in the maturities of assets and liabilities due to changes in interest rate, which create or exacerbate a mismatch.

Governance and structure

Group Treasury and ALCM monitor and control non-traded interest rate risk. This includes reviewing and challenging the business prior to the release of new products and in respect of proposed behavioural assumptions used for hedging activities. ALCM are also responsible for maintaining and updating the transfer pricing framework, informing the Asset and Liability Committee ('ALCO') of the Group's overall banking book interest rate risk exposure and managing the balance sheet in conjunction with BSM.

The internal transfer pricing framework is constructed to ensure that structural interest rate risk, arising due to differences in the repricing timing of assets and liabilities, is transferred to BSM and business lines are correctly allocated income and expense based on the products they write, inclusive of activities to mitigate this risk. Contractual principal repayments, payment schedules, expected prepayments, contractual rate indices used for repricing and interest rate reset dates are examples of elements transferred for risk management by BSM.

The internal transfer pricing framework is governed by each entity's ALCO. The ALCO defines each operating entity's transfer pricing curve, reviews and approves the transfer pricing policy, including behaviouralisation assumptions used for products where there is either no defined maturity or customer optionality exists. The ALCO is also responsible for monitoring and reviewing each entity's overall structural interest rate risk position. Interest rate behaviouralisation policies have to be formulated in line with the Group's behaviouralisation policies and approved at least annually by local ALCOs.

Non-traded assets and liabilities are transferred to 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; the maximum average duration to which a portfolio of non-maturity defined customer balances or equity can be behaviouralised is five years. The maximum percentage of any portfolio that can be behaviouralised is 90% with the residual treated as overnight.

 

BSM manages the banking book interest rate positions transferred to it within the Market Risk limits approved by RMM. Effective governance of BSM is supported by the dual reporting lines it has to the Chief Executive Officer of GB&M and to the Group Treasurer. The global businesses can only transfer non-trading assets and liabilities to BSM provided BSM can economically hedge the risk they receive. Hedging is generally executed through vanilla interest rate derivatives or fixed rate government bonds. Any interest rate risk which BSM cannot economically hedge is not transferred and will remain within the global business where the risk is originated.

Measurement of interest rate risk in the banking book

ALCM uses a number of measures to monitor and control interest rate risk in the banking book, including:



non-traded VaR;

 



net Interest Income ('NII') sensitivity; and

 



economic value of equity ('EVE').

Non-traded VaR

Non-traded VaR uses the same models as those used in the trading book and excludes both HSBC Holdings and the elements of risk which are not transferred to BSM.

NII sensitivity

A principal part of our management of non-traded interest rate risk is to monitor the sensitivity of expected net interest income under varying interest rate scenarios (simulation modelling), where all other economic variables are held constant. This monitoring is undertaken at an entity level by local ALCOs, where entities forecast both one-year and five-year net interest income sensitivities across a range of interest rate scenarios.

Entities apply a combination of scenarios and assumptions relevant to their local businesses, and standard scenarios which are required throughout HSBC. The latter are consolidated to illustrate the combined pro forma effect on a hypothetical base case of our consolidated net interest income.

Projected net interest income sensitivity figures represent the effect of the pro forma movements in projected yield curves based on a static balance sheet size and structure, other than where the size of the balances or repricing is deemed interest rate sensitive, for example, non-interest bearing current account migration and fixed rate loan early prepayment. These sensitivity calculations do not incorporate actions which would be taken by BSM or in the business units to mitigate the effect of interest rate movements.

The net interest income sensitivity calculations assume that interest rates of all maturities move by the same amount in the 'up-shock' scenario. Rates are not assumed to become negative in the 'down-shock' scenario unless the central bank rate is already negative. In these cases, rates are not assumed to go further negative, which may, in certain currencies, effectively result in non-parallel shock. In addition, the net interest income sensitivity calculations take account of the effect on net interest income of anticipated differences in changes between interbank interest rates and internally determined interest rates over which the entity has discretion in terms of the timing and extent of rate changes.

Tables showing our calculations of net interest income sensitivity can be found on page 108.

Economic value of equity

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

 




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HSBC Holdings

HSBC Holdings is a financial services holding company. Its activities predominantly involve maintaining sufficient capital resources to support the Group's diverse activities; allocating these capital resources across our businesses; earning dividend and interest income on its investments in our businesses; payment of operating expenses; providing dividend payments to its equity shareholders and interest payments to providers of debt capital; and maintaining a supply of short-term liquid assets for deployment under extraordinary circumstances.

The main market risks to which HSBC Holdings is exposed are banking book interest rate risk and foreign currency risk. Exposure to these risks arises from short-term cash balances, funding positions held, loans to subsidiaries, investments in long-term financial assets and financial liabilities including debt capital issued. The objective of HSBC Holdings' market risk management strategy is to reduce exposure to these risks and minimise volatility in capital resources, cash flows and distributable reserves. Market risk for HSBC Holdings is monitored by Holdings ALCO in accordance with its risk appetite statement.

HSBC Holdings uses interest rate swaps and cross-currency interest rate swaps to manage the interest rate risk and foreign currency risk arising from its long-term debt issues.

Operational risk management

Details of our operational risk profile in 2017 can be found on page 111, in 'Operational risk exposures in 2017'.

Overview

The objective of our operational risk management is to manage and control operational risk in a cost-effective manner within targeted levels of operational risk consistent with our risk appetite, as defined by the GMB.

Key developments in 2017

During 2017 we implemented a new operational risk management framework ('ORMF') and group-wide risk management system. The new ORMF provides an end-to-end view of non-financial risks, enhancing focus on the risks that matter the most and associated controls. It provides a platform to drive forward-looking risk awareness and assist management focus. It also helps the organisation understand the level of risk it is willing to accept.

We also maintained activity to continually strengthen our risk culture. In particular, we focused on the use of the three lines of defence model to reinforce individual accountability. It sets our roles and responsibilities for managing operational risk on a daily basis.

Further information on the three lines of defence model can be found in the 'Our risk management framework' section on page 66.

Governance and structure

The ORMF defines minimum standards and processes, and the governance structure for the management of operational risk and internal control in our geographical regions, global businesses and global functions. The ORMF has been codified in a high-level standards manual, supplemented with detailed policies, which describes our approach to identifying, assessing, monitoring and controlling operational risk and gives guidance on mitigating action to be taken when weaknesses are identified.

We have a dedicated Global Operational Risk sub-function within our Global Risk function. It is responsible for leading the embedding of the ORMF, and assuring adherence to associated policies and processes across the first and second lines of defence. It supports the Group Chief Risk Officer and the Global Operational Risk Committee, which meets at least quarterly to discuss key risk issues and review implementation of the ORMF. The sub-function is also responsible for preparation of operational risk reporting at Group level, including reports for consideration by the RMM and Group Risk Committee. A formal governance structure provides oversight of the sub-function's management.

 

Key risk management processes

Business managers throughout the Group 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 to fulfil these responsibilities by defining a standard risk assessment methodology and providing a tool for the systematic reporting of operational loss data.

A group-wide risk management system is used to record the results of the operational risk management process. Operational risk and control self-assessments, along with issue and action plans, are entered and maintained by business units. Business and functional management monitor the progress of documented action plans to address shortcomings. To help ensure that operational risk losses are consistently reported and monitored at Group level, all Group companies are required to report individual losses when the net loss is expected to exceed $10,000, and to aggregate all other operational risk losses under $10,000. Losses are entered into the group-wide risk management system and reported to governance on a monthly basis.

Regulatory compliance risk management

Overview

The Regulatory Compliance sub-function ('RC') provides independent, objective oversight and challenge, and promotes a compliance-orientated culture that supports the business in delivering fair outcomes for customers, maintaining the integrity of financial markets and achieving HSBC's strategic objectives.

Key developments in 2017

There were no material changes to the policies and practices for the management of RC risk in 2017, except for the following:



We implemented a number of initiatives to raise our standards in relation to the conduct of our business, as described below under 'Conduct of business'.

 



Surveillance capabilities have been strengthened during the year with the deployment of an unauthorised trading detection tool in London, New York and Hong Kong, implementation of a foreign exchange trade analytics platform and expanded coverage of electronic communications surveillance. Infrastructure to support the effective delivery and reporting of surveillance activity continues to mature.

 



We continued to take steps to enhance our regulatory compliance risk management and controls, and to work with regulators in relation to their investigations into historical activities. This included, in September 2017, matters giving rise to a civil money penalty order with the Federal Reserve Board in connection with its investigation into HSBC's historical foreign exchange activities, and in January 2018, matters giving rise to HSBC's entry into a three-year deferred prosecution agreement with the US Department of Justice ('DoJ') regarding fraudulent conduct in connection with two particular transactions in 2010 and 2011 which concluded the DoJ's investigation into HSBC's historical foreign exchange activities. For further details, see Note 34 on the Financial Statements.

Governance and structure

The Global Head of RC reports to the Group Chief Risk Officer. To align with our global business structure and help ensure coverage of local regulatory requirements, RC is structured as a global function with regional and country RC teams, which support and advise each global business and global function.

Key risk management processes

We regularly review our policies and procedures. Global policies and procedures require the prompt identification and escalation of any actual or potential regulatory breach to RC. Reportable events are escalated to the RMM and the Group Risk Committee, as appropriate. Matters relating to the Group's regulatory conduct of business are reported to the Conduct & Values Committee.

 




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Conduct of business

In 2017, we focused on embedding conduct considerations in business-as-usual activity and decision making across the Group, reflecting our values and required behaviours, to deliver fair outcomes for customers and maintain market integrity. During the year, we continued to focus on work relating to potentially vulnerable customers, third parties, digital channels, markets trading surveillance and monitoring and testing. Other key activities in 2017 included:



Ongoing oversight of the breadth, depth and effectiveness of conduct management and governance at country level.

 



Identification and integration of conduct considerations in the enterprise-wide risk management framework and the Group's planning processes.

 



Expansion of conduct management information to identify actual or potential issues for resolution, in the global functions and HSBC Operations Services and Technology, complementing global business conduct management information.

 



Implementing new conduct-specific global mandatory training modules and an enhanced programme of conduct communications.

 



Enhancing the assessment of conduct in performance appraisal scorecards and remuneration decision-making processes.

The Board maintained oversight of conduct matters through the Conduct & Values Committee.

Further detail can be found under the Our conduct section of www.hsbc.com. For conduct-related costs relating to significant items, see page 61.

Financial crime risk management

Overview

HSBC continued its progress towards implementing an effective financial crime risk management capability across the Group. We completed the roll-out of major compliance systems and shifted our focus towards embedding a sustainable approach to financial crime risk management everywhere we operate. This was underpinned by the implementation of a target operating model for the Financial Crime Risk function and by the completion of a country-by-country assessment against our financial crime risk framework.

Key developments in 2017

During 2017, HSBC continued to increase its efforts to assist with keeping financial crime out of the financial system. We completed the roll-out of compliance systems to support our anti-money laundering and sanctions policies, having invested $1bn in new and upgraded IT systems since 2015.

To ensure we have a clear view of our progress, we completed an assessment of each country in which we operate against the capabilities set out in our financial crime risk framework.

We implemented a new target operating model for the Financial Crime Risk function which puts in place a sustainable structure at a global, regional and country level, and across all lines of business, and continued to build the function's leadership at the most senior levels.

An engaged and well-trained workforce is crucial and in 2017 we continued to invest significantly in this area. We relaunched and refreshed our global mandatory training for all employees and introduced targeted training for relationship managers and other key roles.

Working in partnership is vital to managing financial crime risk. HSBC is a strong proponent of public-private partnerships and information-sharing initiatives. During 2017 we joined three new partnerships - in Australia, Singapore and Hong Kong - and co-sponsored a major public report into the future of financial intelligence sharing. We also worked with, or invested in, a number of financial technology ('fintech') firms to help us continue to strengthen our analytical and innovative approach to financial crime risk management.

 

Key risk management processes

During 2017, HSBC introduced a strengthened financial crime risk management governance framework, mandating Financial Crime Risk Management Committees with a standardised agenda at country, region and global business line levels.

At a Group level, the Financial System Vulnerabilities Committee continues to report to the Board on matters relating to financial crime, and we introduced new members with significant external expertise in this area. Throughout the year the committee, which is attended by the Group Head of Financial Crime Risk, received regular reports on actions being taken to address issues and vulnerabilities.

We strengthened our approach to affiliate risk management, implementing an effective Group-level process to assess and remediate affiliate risk, and established a strong investigations and analytical capability to enable us to proactively identify emergent risk issues.

The Monitor

Under the agreements entered into with the US Department of Justice ('DoJ') and the UK Financial Conduct Authority ('FCA') in 2012, including the five-year deferred prosecution agreement ('AML DPA') and a Direction issued by the FCA, the Monitor (who is, for FCA purposes, a 'skilled person' under section 166 of the Financial Services and Markets Act) was appointed in July 2013 for an expected five-year period to produce annual assessments of the effectiveness of the Group's AML and sanctions compliance programme. Additionally, under the Cease and Desist Order issued by the US Federal Reserve Board ('FRB') in 2012, the Monitor also serves as an independent consultant to conduct annual assessments.

In December 2017, the AML DPA expired and the charges deferred by the AML DPA were dismissed. The Monitor will continue working in his capacity as a skilled person and independent consultant for a period of time at the FCA's and FRB's discretion.

In February 2018, the Monitor delivered his fourth annual follow-up review report based on various thematic and country reviews he had conducted during 2017. In his report, the Monitor concluded that, in 2017, HSBC made significant progress in developing a reasonably effective and sustainable AML and sanctions compliance programme and expressed confidence that HSBC can achieve its target end state within the next 18 months if it is able to maintain the concerted effort and focus it has demonstrated in remediating and enhancing its programme over the last five years. Nonetheless, the Monitor identified various challenges that HSBC faces in achieving this objective, noted deficiencies in HSBC's financial crime compliance controls and areas of HSBC's programme that require further work, and highlighted potential instances of financial crime and certain areas in which he believes that HSBC is not yet adequately managing financial crime risk.  As described on page 246 of note 34, the Monitor identified potential anti-money laundering and sanctions compliance issues that HSBC is reviewing further with the DoJ, FRB and/or FCA.

Throughout 2017, the FSVC received regular reports on HSBC's relationship with the Monitor and its compliance with the AML DPA. The FSVC received regular updates on the Monitor's review activity as part of the fourth annual review, and has received the Monitor's fourth annual review report.

Insurance manufacturing operations risk management

Details of changes in our insurance manufacturing operations risk profile in 2017 can be found on page 111, under 'Insurance manufacturing operations risk profile'.

There were no material changes to our policies and practices for the management of risks arising in our insurance manufacturing operations in 2017.

 




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Governance

(Audited)

Insurance risks are managed to a defined risk appetite, which is aligned to the Group's risk appetite and risk management framework, including its three lines of defence model. For details of the Group's governance framework, see page 66. The Global Insurance Risk Management Meeting oversees the control framework globally and is accountable to the RBWM Risk Management Meeting on risk matters relating to the insurance business.

The monitoring of the risks within our insurance operations is carried out by insurance risk teams. Specific risk functions, including Wholesale Credit & Market Risk, Operational Risk, Information Security Risk and Financial Crime Risk and Regulatory Compliance support Insurance Risk teams in their respective areas of expertise.

Stress and scenario testing

(Audited)

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, the European Insurance and Occupational Pensions Authority stress test, and individual country insurance regulatory stress tests.

These have highlighted that a key risk scenario for the insurance business is a prolonged low interest rate environment. In order to mitigate the impact of this scenario, the insurance operations have taken a number of actions including repricing some products to reflect lower interest rates, launching less capital intensive products, investing in more capital efficient assets and developing investment strategies to optimise the expected returns against the cost of economic capital.

Management and mitigation of key risk types

Market risk

(Audited)

All our insurance manufacturing subsidiaries have market risk mandates 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:



For products with discretionary participating features ('DPF'), adjusting bonus rates to manage the liabilities to policyholders. The effect is that a significant portion of the market risk is borne by the policyholder.

 



Asset and liability matching where asset portfolios are structured to support projected liability cash flows. The Group manages 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 the duration of the longest dated investments available. We use models to assess the effect of a range of future scenarios on the values of financial assets and associated liabilities, and ALCOs employ the outcomes in determining how best to structure asset holdings to support liabilities.

 



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

 



For new products with investment guarantees, considering the cost when determining the level of premiums or the price structure.

 



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

 



Designing new products to mitigate market risk, such as changing 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.

Credit risk

(Audited)

Our insurance manufacturing subsidiaries are responsible for the credit risk, quality and performance of their investment portfolios. Our assessment of the creditworthiness of issuers and counterparties is based primarily upon internationally recognised credit ratings and other publicly available information.

Investment credit exposures are monitored against limits by our insurance manufacturing subsidiaries, and are aggregated and reported to the Group Insurance Credit Risk and Group Credit Risk functions. Stress testing is performed on investment credit exposures using credit spread sensitivities and default probabilities.

We use tools to manage and monitor credit risk. These include a 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 are present in the investment portfolio. The report is circulated monthly to senior management in Group Insurance and individual country chief risk officers to identify investments that may be at risk of future impairment.

Liquidity risk

(Audited)

Risk is managed by cash flow matching and maintaining sufficient cash resources, investing in high credit-quality investments with deep and liquid markets, monitoring investment concentrations and restricting them where appropriate, and establishing committed contingency borrowing facilities.

Insurance manufacturing subsidiaries are required to complete quarterly liquidity risk reports for the Group Insurance Risk function and an annual review of the liquidity risks to which they are exposed.

Insurance risk

HSBC Insurance primarily uses the following techniques to manage and mitigate insurance risk:



formalised product approval process covering product design, pricing and overall proposition management (for example, management of lapses by introducing surrender charges);

 



underwriting policy;

 



claims management processes; and

 



reinsurance which cedes risks above our acceptable thresholds to an external reinsurer thereby limiting our exposure.

Reputational risk management

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 are associated. This might cause stakeholders to form a negative view of the Group and result in financial or non-financial effects and loss of confidence in the Group. Stakeholders' expectations change constantly, and so reputational risk is dynamic and varies between geographical regions, groups and individuals. We have an unwavering commitment to operating at the high standards we set for ourselves in every jurisdiction. Any material lapse in standards of integrity, compliance, customer service or operating efficiency may represent a potential reputational risk.

 




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Key developments in 2017

There were no material changes to the policies and practices for the management of reputational risk in 2017, except for the formation of a new Group Reputational Risk Committee which replaced the Group Reputational Risk Policy Committee and the Global Risk Resolution Committee, as described below.

Governance and structure

From December, the development of policies and an effective control environment for the identification, assessment, management and mitigation of reputational risk, are considered by the new Group Reputational Risk Committee ('GRRC') which is chaired by the Group Chief Risk Officer. It is the highest decision-making forum in the Group for dealing with matters arising from clients or transactions that either present a serious potential reputational risk to the Group or merit a Group-led decision to ensure a consistent risk management approach across 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, where appropriate, for making recommendations to the RMM to mitigate such risk.

Prior to December, these responsibilities were split between the Group Reputational Risk Policy Committee and the Global Risk Resolution Committee which were demised to create the GRRC.

Key risk management processes

The Global Communications function maintains policies and gives policy advice for the issues that might affect HSBC's reputation and standing with customers, employees, opinion formers and the public. It oversees the identification, management and control of reputational risk for all HSBC entities in the areas of media relations and engagement with non-governmental organisations and other external stakeholders.

Our Reputational Risk and Client Selection ('RRCS') team, which reports to both the Global Head of Financial Crime Compliance and the Global Head of Regulatory Compliance, oversees the identification, management and control of all other significant reputational risks across the Group. It is responsible for setting policies to guide the Group's reputational risk management, devising 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. It is led by a headquarters-based team. This is supported by teams in each business line and region, which help ensure that issues are directed to the appropriate forums, that decisions are made and implemented effectively, and that management information is generated to aid senior management in the businesses and regions in understanding where reputational risk exists. Each global business has established a governance process that empowers the RRCS's committees to address reputational risk issues at the right level, escalating decisions where appropriate. 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.

For further details of our financial crime risk management and regulatory compliance risk management, see 'Financial crime risk management' on page 78 and 'Regulatory compliance risk management' on page 77 respectively.

Further details can be found at www.hsbc.com.

Sustainability risk management

Overview

Assessing the environmental and social impacts of providing finance to our customers is integral to our overall risk management processes.

 

Key developments in 2017

We periodically review our sustainability risk policies. In 2017, we issued a revised Agricultural Commodities policy, requiring palm oil customers to make further commitments in line with recently enhanced sustainability standards in the industry. We are also currently conducting a review of our Energy Policy.

In 2017, we rolled out a training module for relevant relationship managers globally on our sustainability risk policies and their responsibilities, to ensure consistent implementation. By the end of the year, over 9,000 of our employees had completed this training.

Governance and structure

The Global Risk function is mandated to manage sustainability risk globally, working with the Global Businesses, Global Functions and local offices as appropriate. Sustainability risk managers have regional or national responsibilities for advising on and managing environmental and social risks.

Key risk management processes

The Global Risk function's responsibilities in relation to sustainability risk include:



Formulating sustainability risk policies. This includes work in several key areas: overseeing our sustainability risk standards; overseeing our application of the Equator Principles, which provide a framework for banks to assess and manage the social and environmental impact of large projects to which they provide financing; overseeing our application of our sustainability policies, covering agricultural commodities, chemicals, defence, energy, forestry, freshwater infrastructure, mining and metals, UNESCO World Heritage Sites and the Ramsar Convention on Wetlands; undertaking independent reviews of transactions where sustainability risks are assessed to be high; and supporting our operating companies to assess similar risks of a lesser magnitude.

 



Building and implementing systems-based processes to help ensure consistent application of policies, reduce the costs of sustainability risk reviews, and capture management information to measure and report on the effect of our lending and investment activities on sustainable development.

 



Providing training and capacity building within our operating companies to ensure sustainability risks are identified and mitigated consistently to appropriate standards.

Pension risk management

There were no material changes to our policies and practices for the management of pension risk in 2017.

Governance and structure

A global pension risk framework and accompanying global policies on the management of risks related to defined benefit and defined contribution plans are in place. Pension risk is managed by a network of local and regional pension risk forums. The Global Pensions Oversight Forum is responsible for the governance and oversight of all pension plans sponsored by HSBC around the world.

Key risk management processes

Our global pensions strategy is to move from defined benefit to defined contribution plans, where local law allows and it is considered competitive to do so.

In defined contribution pension plans, the contributions that HSBC is required to make are known, while the ultimate pension benefit will vary, typically with investment returns achieved by investment choices made by the employee. While the market risk to HSBC of defined contribution plans is low, the Group is still exposed to operational and reputational risk.

In defined benefit pension plans, the level of pension benefit is known. Therefore, the level of contributions required by HSBC will vary due to a number of risks, including:



investments delivering a return below that required to provide the projected plan benefits;

 




80

HSBC Holdings plc  Annual Report and Accounts 2017

 

 



the prevailing economic environment leading to corporate failures, thus triggering write-downs in asset values (both equity and debt);

 



a change in either interest rates or inflation expectations, causing an increase in the value of plan liabilities; and

 



plan members living longer than expected (known as longevity risk).

Pension risk is assessed using an economic capital model that takes into account potential variations in these factors. The impact of these variations on both pension assets and pension liabilities is assessed using a one-in-200-year stress test. Scenario analysis and other stress tests are also used to support pension risk management.

To fund the benefits associated with defined benefit plans, sponsoring Group companies, and in some instances employees, make regular contributions in accordance with advice from actuaries and in consultation with the plan's trustees where relevant. These contributions are normally set to ensure that there are sufficient funds to meet the cost of the accruing benefits for the future service of active members. However, higher contributions are required when plan assets are considered insufficient to cover the existing pension liabilities. Contribution rates are typically revised annually or once every three years, depending on the plan.

The defined benefit plans invest contributions in a range of investments designed to limit the risk of assets failing to meet a plan's liabilities. Any changes in expected returns from the investments may also change future contribution requirements. In pursuit of these long-term objectives, an overall target allocation of the defined benefit plan assets between asset classes is established. In addition, each permitted asset class has its own benchmarks, such as stock-market or property valuation indices. The benchmarks are reviewed at least once every three to five years and more frequently if required by local legislation or circumstances. The process generally involves an extensive asset and liability review.



Key developments and risk profile in 2017

Key developments in 2017

In 2017, HSBC undertook a number of initiatives to enhance its approach to the management of risk. These included:



Implementing a new operational risk management framework ('ORMF') and system of record (known as Helios), as described on page 77 of the 'Operational risk management' section.

 



We have completed the introduction of the major compliance IT systems, put in place our AML and sanctions policy framework, and assessed our current financial crime risk management capabilities to identify any gaps and enable integration into our day-to-day operations. All of the actions that we committed to in 2013 as part of the Global Standards programme have been completed or superseded. Further improvements are underway to make our reforms more effective and sustainable.

 



We continued to take steps to enhance our regulatory compliance risk management and controls, implementing a number of initiatives to raise our standards in relation to the conduct of our business and other regulatory compliance-related initiatives, as described on page 77 of the 'Regulatory compliance risk management' section.

 



The formation of a new Group Reputational Risk Committee which replaced the Group Reputational Risk Policy Committee and the Global Risk Resolution Committee, as described on page 79 under 'Reputational risk management'.

 

 




 

Page

Credit risk in 2017

81

Credit exposure

83

Wholesale lending

90

Personal lending

95

Supplementary information

99

HSBC Holdings

100

Securitisation exposures and other structured products

100

Credit risk in 2017

Credit risk is the risk of financial loss if a customer or counterparty fails to meet an obligation under a contract. It arises principally from direct lending, trade finance and leasing business, but also from other products, such as guarantees and credit derivatives and from holding assets in the form of debt securities. All amounts shown by geographical region or country are based on the location of the principal operations of the lending subsidiary or, in the case of the operations of The Hongkong and Shanghai Banking Corporation, HSBC Bank plc, HSBC Bank Middle East Limited and HSBC Bank USA, by the location of the lending branch.

For details on the adoption of IFRS 9, see Note 1.1(c) on the Financial Statements.

A summary of our current policies and practices regarding the management of credit risk is provided from page 72.

Gross loans and advances increased by $103bn to $1,060bn. This included foreign exchange movements increasing balances by $48bn.

Loan impairment charges and other credit provisions ('LICs') for the year were $1.8bn, which was $1.6bn lower than the prior year.

In wholesale lending, balances increased by $67bn to $684bn. This increase included foreign exchange movements of $30bn. Excluding foreign exchange movements, Asia grew strongly with loans and advances increasing by $34bn. In North America and Latin America, loans and advances increased by $2.3bn in each region, while Europe increased by $1.8bn. These increases were offset by a decrease in loans and advances in MENA of $3.2bn.

In personal lending, balances increased by $37bn to $376bn. This increase included foreign exchange movements of $19bn. Excluding foreign exchange movements, lending balances increased by $13bn in Asia and $9.0bn in Europe. Growth was partly offset by a $3.7bn fall in North America, due to the final loans sales of $5.0bn in our US CML run-off portfolio, which were sold through 2017. MENA and Latin America lending balances were broadly unchanged.

Information on constant currency movements is provided on page 32.

 




HSBC Holdings plc  Annual Report and Accounts 2017

81

 

 

Report of the Directors | Risk

 









Summary of credit risk

 

 

2017


2016


 

 

$bn


$bn


Page


At 31 Dec

 

 

 

Maximum exposure to credit risk

3,030


2,898


83


- total assets subject to credit risk

2,306


2,205


 

- off-balance sheet commitments subject to credit risk

724


693


 

Gross loans and advances

1,060


958


 

- personal lending

376


340


96


- wholesale lending

684


618


90


Impaired loans

15


18


86


- personal lending

5


6


 

- wholesale lending

10


12


 

 

%


%


 

Impaired loans as a % of gross loans and advances



 

 

Personal lending

1.3


1.8


 

Wholesale lending

1.5


1.9


 

Total

1.5


1.9


 

 

$bn


$bn


 

Impairment allowances

7.5


7.9


90


- personal lending

1.7


2.0


89


- wholesale lending

5.8


5.9


91


Loans and advances net of
impairment allowances

1,053


950


 

For year ended 31 Dec



 

 

Loan impairment charge

2.0


3.3


88


- personal lending

1.0


1.7


 

- wholesale lending

1.0


1.6


 

Other credit risk provisions

(0.2

)

0.1


 

 

1.8


3.4


 



Gross loans to customers and banks over five years ($bn)

 










 

 

Personal

 

 

 

Wholesale

 

 

 

 

 

 

 

 






 

Unimpaired

 

Impaired

 

 



Loan impairment charge over five years ($bn)

 






 

Personal

 

Wholesale



Loan impairment charges by geographical region ($bn)

 






 

2017

 

2016



Loan impairment charges by industry ($bn)

 






 

2017

 

2016

 

 




82

HSBC Holdings plc  Annual Report and Accounts 2017

 

 



Loan impairment allowances over five years ($bn)










 

 

Personal

 

 

 

Wholesale

 

 

 

 

 

 

 

 








-

w

-

Loan impairment allowances as

a percentage of impaired loans

 

Loan impairment allowances ($bn)

Credit exposure

Maximum exposure to credit risk

(Audited)

The table that follows provides information on balance sheet items, offsets, and loan and other credit-related commitments. Commentary on consolidated balance sheet movements in 2017 is provided on page 44.

 

The offset on derivatives remains in line with the movements in maximum exposure amounts.



'Maximum exposure to credit risk' table
The following table presents our maximum exposure before taking account of any collateral held or other credit enhancements (unless such enhancements meet accounting offsetting requirements). The table excludes financial instruments whose carrying amount best represents the net exposure to credit risk and it excludes equity securities as they are not subject to credit risk. For the financial assets recognised on the balance sheet, the maximum exposure to credit risk equals their carrying amount; for financial guarantees and similar contracts granted, it is the maximum amount that we would have to pay if the guarantees were called upon. For loan commitments and other credit-related commitments, it is generally the full amount of the committed facilities.
The offset in the table relates to amounts where there is a legally enforceable right of offset in the event of counterparty default and where, as a result, there is a net exposure for credit risk purposes. However, as there is no intention to settle these balances on a net basis under normal circumstances, they do not qualify for net presentation for accounting purposes. No offset has been applied to off-balance sheet collateral. In the case of derivatives the offset column also includes collateral received in cash and other financial assets.

Other credit risk mitigants

While not disclosed as an offset in the following 'Maximum exposure to credit risk' table, other arrangements are in place which reduce our maximum exposure to credit risk. These include a charge over collateral on borrowers' specific assets such as residential properties, collateral held in the form of financial instruments that are not held on balance sheet and short positions in securities. In addition, for financial assets held as part of linked insurance/investment contracts the risk is predominantly borne by the policyholder. See Note 29 and pages 190 and 193 on the Financial Statements for further details of collateral in respect of certain loans and advances and derivatives.

 
















Maximum exposure to credit risk

(Audited)

 

 

2017

2016

 


Maximum
exposure


Offset


Net


Maximum
exposure


Offset


Net


 

 

$m


$m


$m


$m


$m


$m


Derivatives

 

219,818


(204,829

)

14,989


290,872


(262,233

)

28,639


Loans and advances to customers held at amortised cost

 

962,964


(35,414

)

927,550


861,504


(33,657

)

827,847


- personal

 

374,762


(2,946

)

371,816


337,826


(3,629

)

334,197


- corporate and commercial

 

516,754


(29,459

)

487,295


460,209


(27,686

)

432,523


- non-bank financial institutions

 

71,448


(3,009

)

68,439


63,469


(2,342

)

61,127


Loans and advances to banks held at amortised cost

 

90,393


(273

)

90,120


88,126


(248

)

87,878


Reverse repurchase agreements - non-trading

 

201,553


(3,724

)

197,829


160,974


(4,764

)

156,210


Total balance sheet exposure to credit risk

 

2,305,592


(244,240

)

2,061,352


2,204,751


(300,902

)

1,903,849


Total off-balance sheet

 

723,917


-


723,917


692,915


-


692,915


- financial guarantees and similar contracts

 

38,328


-


38,328


37,072


-


37,072


- loan and other credit-related commitments

 

685,589


-


685,589


655,843


-


655,843


At 31 Dec

 

3,029,509


(244,240

)

2,785,269


2,897,666


(300,902

)

2,596,764


 




HSBC Holdings plc  Annual Report and Accounts 2017

83

 

 

Report of the Directors | Risk

 

Concentration of exposure

The geographical diversification of our lending portfolio, and our broad range of global businesses and products, ensured that we did not overly depend on a few markets or businesses to generate growth in 2017.

For an analysis of:



financial investments, see Note 15 on the Financial Statements;

 



trading assets, see Note 10 on the Financial Statements;

 



derivatives, see page 94 and Note 14 on the Financial Statements; and

 



loans and advances by industry sector and by the location of the principal operations of the lending subsidiary (or, in the case of the operations of The Hongkong and Shanghai Banking Corporation, HSBC Bank plc, HSBC Bank Middle East Limited and HSBC Bank USA, by the location of the lending branch) see page 90 for wholesale lending and page 95 for personal lending.

 

Credit quality of financial instruments

(Audited)

We assess the credit quality of all financial instruments that are subject to credit risk. Additional credit quality information in respect of our consolidated holdings of ABSs is provided on page 100.

For the purpose of the following disclosure, loans past due up to 90 days and not otherwise classified as impaired are separately classified as past due but not impaired, irrespective of their credit quality grade. Trading assets, financial assets designated at fair value and financial investments exclude equity securities as they are not subject to credit risk.























Distribution of financial instruments by credit quality


(Audited)



Neither past due nor impaired

Past due
but not
impaired


Impaired


Total
gross
amount


Impairment
allowances


Total




Strong


Good


Satisfactory


Sub-
standard





$m


$m


$m


$m


$m


$m


$m


$m


$m



Cash and balances at central banks

179,155


1,043


407


19






180,624




180,624



Items in the course of collection from other banks

6,322


29


273


4






6,628




6,628



Hong Kong Government certificates of indebtedness

34,186


-


-


-






34,186




34,186



Trading assets

137,983


22,365


26,438


1,949






188,735




188,735



- treasury and other eligible bills

15,412


531


491


1,098






17,532




17,532



- debt securities

84,493


9,517


12,978


498






107,486




107,486



- loans and advances to banks

15,496


5,778


4,757


26






26,057




26,057



- loans and advances to customers

22,582


6,539


8,212


327






37,660




37,660



Financial assets designated at fair value

3,378


269


1,029


28






4,704




4,704



Derivatives

181,195


31,827


5,874


922






219,818




219,818



Loans and advances to customers held at amortised cost

503,759


222,343


204,162


16,114


8,600


15,470


970,448


(7,484

)

962,964



- personal

324,960


26,612


14,549


780


4,658


4,922


376,481


(1,719

)

374,762



- corporate and commercial

140,382


176,745


176,661


14,784


3,422


10,254


522,248


(5,494

)

516,754



- non-bank financial institutions

38,417


18,986


12,952


550


520


294


71,719


(271

)

71,448



Loans and advances to banks held at amortised cost

77,175


9,026


4,144


39


9


-


90,393


-


90,393



Reverse repurchase agreements - non-trading

143,154


32,321


25,636


442


-


-


201,553


-


201,553



Financial investments

356,065


10,463


15,017


2,886


-


728


385,159




385,159



Other assets

12,714


6,526


10,705


681


107


143


30,876


(48

)

30,828



- endorsements and acceptances

1,430


4,636


3,455


183


15


31


9,750




9,750



- accrued income and other

11,175


1,837


7,124


361


91


56


20,644




20,644



- assets held for sale

109


53


126


137


1


56


482


(48

)

434



At 31 Dec 2017

1,635,086


336,212


293,685


23,084


8,716


16,341


2,313,124


(7,532

)

2,305,592




%


%


%


%


%


%


%







Percentage of total gross amount

70.7


14.5


12.7


1.0


0.4


0.7


100.0






 




84

HSBC Holdings plc  Annual Report and Accounts 2017

 

 





















Distribution of financial instruments by credit quality (continued)

 

Neither past due nor impaired

Past due

but not

impaired


Impaired


Total

gross

amount


Impairment

allowances


Total


 

Strong


Good


Satisfactory


Sub-

standard


 

$m


$m


$m


$m


$m


$m


$m


$m


$m


Cash and balances at central banks

126,838


711


444


16






128,009




128,009


Items in the course of collection from other banks

4,656


14


329


4






5,003




5,003


Hong Kong Government certificates of indebtedness

31,228


-


-


-






31,228




31,228


Trading assets

127,997


20,345


21,947


1,232


 

 

171,521


 

171,521


- treasury and other eligible bills

13,595


672


138


46


 

 

14,451


 

14,451


- debt securities

73,171


7,746


12,741


396


 

 

94,054


 

94,054


- loans and advances to banks

15,356


6,119


3,250


44


 

 

24,769


 

24,769


- loans and advances to customers

25,875


5,808


5,818


746


 

 

38,247


 

38,247


Financial assets designated at fair value

3,249


367


542


314






4,472




4,472


Derivatives

236,693


45,961


7,368


850






290,872




290,872


Loans and advances to customers
held at amortised cost

437,531


200,385


185,717


18,831


8,662


18,228


869,354


(7,850

)

861,504


- personal

290,313


24,544


12,505


884


5,062


6,490


339,798


(1,972

)

337,826


- corporate and commercial

111,848


158,878


163,107


17,504


3,128


11,362


465,827


(5,618

)

460,209


- non-bank financial institutions

35,370


16,963


10,105


443


472


376


63,729


(260

)

63,469


Loans and advances to banks held at amortised cost

73,516


8,238


6,293


73


6


-


88,126


-


88,126


Reverse repurchase agreements - non-trading

123,822


18,223


18,166


763


-


-


160,974


-


160,974


Financial investments

401,010


13,579


13,570


2,940


-


1,031


432,130




432,130


Other assets

12,977


5,884


9,619


1,071


360


1,251


31,162


(250

)

30,912


- endorsements and acceptances

1,160


3,688


3,125


474


35


92


8,574


 

8,574


- accrued income and other

10,043


1,660


6,102


331


89


129


18,354


 

18,354


- assets held for sale

1,774


536


392


266


236


1,030


4,234


(250

)

3,984


At 31 Dec 2016

1,579,517


313,707


263,995


26,094


9,028


20,510


2,212,851


(8,100

)

2,204,751


 

%


%


%


%


%


%


%


 

 

Percentage of total gross amount

71.4


14.2


11.9


1.2


0.4


0.9


100.0


 

 

Past due but not impaired gross financial instruments

(Audited)

Past due but not impaired gross financial instruments are those loans where, although customers have failed to make payments in accordance with the contractual terms of their facilities, they have not met the impaired loan criteria described on page 86.

 

In North America, past due but not impaired balances decreased, mainly due to the final loan sales in our US CML run-off portfolio. Past due but not impaired balances are concentrated in the up to 29 days ageing bucket.

 















Past due but not impaired gross financial instruments by geographical region

(Audited)

 

Europe


Asia


MENA


North
America


Latin
America


Total


 

$m


$m


$m


$m


$m


$m


At 31 Dec 2017

1,324


3,892


852


2,015


633


8,716


At 31 Dec 2016

1,206


3,484


1,260


2,549


529


9,028
















Ageing analysis of days for past due but not impaired gross financial instruments

(Audited)


Up to 29 days


30-59
days


60-89
days


90-179
days


180 days
and over


Total



$m


$m


$m


$m


$m


$m


Loans and advances to customers and banks held at amortised cost

6,837


1,255


493


10


14


8,609


- personal

3,455


866


337


-


-


4,658


- corporate and commercial

2,899


343


156


10


14


3,422


- financial

483


46


-


-


-


529


Other financial instruments

33


12


18


12


32


107


At 31 Dec 2017

6,870


1,267


511


22


46


8,716









Loans and advances to customers and banks held at amortised cost

6,743


1,320


587


11


7


8,668


- personal

3,696


986


380


-


-


5,062


- corporate and commercial

2,593


316


201


11


7


3,128


- financial

454


18


6


-


-


478


Other financial instruments

264


47


23


12


14


360


At 31 Dec 2016

7,007


1,367


610


23


21


9,028


 




HSBC Holdings plc  Annual Report and Accounts 2017

85

 

 

Report of the Directors | Risk

 

Impaired loans

(Audited)

Impaired loans and advances are those that meet any of the following criteria:



Wholesale loans and advances classified as customer risk rating ('CRR') 9 or CRR 10: these grades are assigned when HSBC considers that the customer is either unlikely to pay their credit obligations in full without recourse to security, or is more than 90 days past due on any material credit obligation to HSBC.

 



Retail loans and advances classified as expected loss ('EL') 9 or EL 10: these grades are typically assigned to retail loans and

 

advances more than 90 days past due unless they have been individually assessed as not impaired.



Renegotiated loans and advances: loans where we have changed the contractual cash flows due to credit distress of the obligor. Renegotiated loans remain classified as impaired until there is sufficient evidence to demonstrate a significant reduction in the risk of non-payment of future cash flows.

In personal lending, the completion of loan sales in our US CML run-off portfolio reduced impaired loan balances by a further $1.5bn. The reduction in corporate and commercial balances is a result of fewer significant current year impaired loans together with loan credit grade improvements, repayments and write-offs.



















Movement in impaired loans by industry sector

 

2017

2016

 

Personal


Corporate and commercial


Financial


Total


Personal


Corporate and commercial


Financial


Total


 

$m


$m


$m


$m


$m


$m


$m


$m


At 1 Jan

6,490


11,362


376


18,228


11,507


11,949


322


23,778


Classified as impaired during the year

2,671


3,691


17


6,379


3,521


6,032


133


9,686


Transferred from impaired to unimpaired during
the year

(677

)

(1,324

)

(8

)

(2,009

)

(1,210

)

(922

)

(7

)

(2,139

)

Amounts written off

(1,330

)

(1,257

)

(53

)

(2,640

)

(1,252

)

(1,720

)

(11

)

(2,983

)

Net repayments and other

(2,232

)

(2,218

)

(38

)

(4,488

)

(6,076

)

(3,977

)

(61

)

(10,114

)

At 31 Dec

4,922


10,254


294


15,470


6,490


11,362


376


18,228
















Impaired loans by industry sector and geographical region


Europe


Asia


MENA


North
America


Latin
America


Total



$m


$m


$m


$m


$m


$m


Non-renegotiated impaired loans

4,551


1,645


870


1,180


452


8,698


- personal

1,648


475


227


665


280


3,295


- corporate and commercial

2,895


1,146


639


508


172


5,360


- financial

8


24


4


7


-


43


Renegotiated impaired loans

3,491


604


1,079


1,426


172


6,772


- personal

381


125


120


958


43


1,627


- corporate and commercial

2,926


478


895


466


129


4,894


- financial

184


1


64


2


-


251


At 31 Dec 2017

8,042


2,249


1,949


2,606


624


15,470


Impaired loans % of total gross loans and advances

2.0%


0.5%


5.4%


2.2%


2.6%


1.5%









Non-renegotiated impaired loans

4,354


1,771


1,042


1,913


399


9,479


- personal

1,239


453


459


1,043


220


3,414


- corporate and commercial

3,029


1,291


582


865


179


5,946


- financial

86


27


1


5


-


119


Renegotiated impaired loans

3,708


728


1,188


2,929


196


8,749


- personal

648


113


72


2,213


30


3,076


- corporate and commercial

2,868


614


1,052


716


166


5,416


- financial

192


1


64


-


-


257


At 31 Dec 2016

8,062


2,499


2,230


4,842


595


18,228


Impaired loans % of total gross loans and advances

2.3%


0.6%


5.5%


4.1%


2.9%


1.9%









Currency translation adjustment

855


72


(25

)

37


20


959


31 Dec 2016 at 31 Dec 2017 exchange rates

8,917


2,571


2,205


4,879


615


19,187


Movement - constant currency basis

(875

)

(322

)

(256

)

(2,273

)

9


(3,717

)

31 Dec 2017 as reported

8,042


2,249


1,949


2,606


624


15,470


 




86

HSBC Holdings plc  Annual Report and Accounts 2017

 

 

Renegotiated loans and forbearance

The following tables show the gross carrying amounts of the Group's holdings of renegotiated loans and advances to customers by industry sector, geographical region, credit quality classification and arrangement type.

 

The completion of loan sales in our US CML run-off portfolio reduced renegotiated loans by $2.0bn during 2017.

 













Renegotiated loans and advances to customers by industry sector

 

First lien residential mortgages


Other personal lending


Corporate and commercial


Non-bank financial institutions


Total


 

$m


$m


$m


$m


$m


Neither past due nor impaired

476


268


2,082


257


3,083


Past due but not impaired

58


49


120


-


227


Impaired

1,329


298


4,894


251


6,772


At 31 Dec 2017

1,863


615


7,096


508


10,082


Impairment allowances on renegotiated loans

165


127


1,584


151


2,027


 

 

 

 

 

 

Neither past due nor impaired

976


282


1,848


260


3,366


Past due but not impaired

346


78


301


-


725


Impaired

2,751


325


5,416


257


8,749


At 31 Dec 2016

4,073


685


7,565


517


12,840


Impairment allowances on renegotiated loans

267


150


1,667


130


2,214
















Renegotiated loans and advances to customers by geographical region


Europe


Asia


MENA


North America


Latin
America


Total



$m


$m


$m


$m


$m


$m


At 31 Dec 2017

5,667


921


1,622


1,604


268


10,082


At 31 Dec 2016

5,855


1,046


1,871


3,736


332


12,840


A range of forbearance strategies are employed in order to improve the management of customer relationships, maximise collection opportunities and, if possible, avoid default, foreclosure or repossession.

 

The following tables show renegotiated loans by arrangement type as a percentage of the total value of arrangements offered. In personal lending, renegotiated loans have been allocated to the single most dominant arrangement type. The movements in personal lending arrangement types in 2017 are mainly driven by the loan sales in our US CML run-off portfolio.





Renegotiated loans by arrangement type: personal lending

 

2017

2016

 

%

%

Interest rate and terms modifications

42.6

21.9

Payment concessions

15.8

14.3

Collection re-age

2.1

19.2

Modification re-age

24.0

34.6

Other

15.5

10.0

At 31 Dec 2017

100.0

100.0

Corporate renegotiated loans often require the granting of more than one arrangement type as part of an effective strategy. The percentages reported in the table below include the effect of loans being reported in more than one arrangement type.  





Renegotiated loans by arrangement type: corporate and commercial, and financial


2017

2016


%

%

Maturity term extensions

35.8

37.3

Reductions in margin, principal forgiveness, debt equity swaps and interest, fees or penalty payment forgiveness

23.8

21.4

Other changes to repayment profile

17.7

19.4

Interest only conversion

9.0

9.3

Other

13.7

12.6

At 31 Dec 2017

100.0

100.0

 




HSBC Holdings plc  Annual Report and Accounts 2017

87

 

 

Report of the Directors | Risk

 

Impairment of loans and advances

(Audited)

For an analysis of LICs by global business, see page 40.

The tables below analyse the loan impairment charges for the year by industry sector for impaired loans and advances that are either

 

individually or collectively assessed, and for collective impairment allowances on loans and advances that are classified as not impaired.

 
















Loan impairment charge to the income statement by industry sector



Europe


Asia


MENA


North

America


Latin

America


Total



Footnote

$m


$m


$m


$m


$m


$m


Personal


140


243


92


32


452


959


- first lien residential mortgages


6


(1

)

5


-


(27

)

(17

)

- other personal


134


244


87


32


479


976


Corporate and commercial


619


298


83


(163

)

90


927


- manufacturing and international trade and services


314


236


95


18


59


722


- commercial real estate and other property-related


200


21


(4

)

9


-


226


- other commercial


105


41


(8

)

(190

)

31


(21

)

Financial


66


17


22


1


-


106


At 31 Dec 2017


825


558


197


(130

)

542


1,992










Personal


162


264


226


219


832


1,703


- first lien residential mortgages


1


(1

)

10


149


7


166


- other personal


161


265


216


70


825


1,537


Corporate and commercial


337


388


53


500


330


1,608


- manufacturing and international trade and services


38


306


105


81


195


725


- commercial real estate and other property-related


(15

)

(28

)

(16

)

3


25


(31

)

- other commercial


314


110


(36

)

416


110


914


Financial


34


2


13


(10

)

-


39


At 31 Dec 2016

45

533


654


292


709


1,162


3,350


For footnote, see page 116.















Charge for impairment losses as a percentage of average gross loans and advances to customers by geographical region


Europe


Asia


MENA


North
America


Latin
America


Total



%


%


%


%


%


%


New allowances net of allowance releases

0.33


0.17


0.79


(0.05

)

3.20


0.29


Recoveries

(0.09

)

(0.03

)

(0.14

)

(0.07

)

(0.41

)

(0.07

)

At 31 Dec 2017

0.24


0.14


0.65


(0.12

)

2.79


0.22


Amount written off net of recoveries

0.23


0.13


1.35


0.28


2.42


0.28









New allowances net of allowance releases

0.23


0.23


0.93


0.62


7.02


0.46


Recoveries

(0.08

)

(0.04

)

(0.13

)

(0.06

)

(0.56

)

(0.07

)

At 31 Dec 2016

0.15


0.19


0.80


0.56


6.46


0.39


Amount written off net of recoveries

0.26


0.14


0.84


0.48


2.99


0.32


 




88

HSBC Holdings plc  Annual Report and Accounts 2017

 

 















Movement in impairment allowances by industry sector and by geographical region


Europe


Asia


MENA


North
America


Latin
America


Total



$m


$m


$m


$m


$m


$m


At 1 Jan 2017

2,789


1,635


1,681


1,272


473


7,850


Amounts written off













Personal

(438

)

(366

)

(329

)

(100

)

(487

)

(1,720

)

- first lien residential mortgages

(8

)

(6

)

(42

)

(26

)

(9

)

(91

)

- other personal

(430

)

(360

)

(287

)

(74

)

(478

)

(1,629

)

Corporate and commercial

(648

)

(273

)

(119

)

(273

)

(63

)

(1,376

)

- manufacturing and international trade and services

(318

)

(250

)

(74

)

(44

)

(18

)

(704

)

- commercial real estate and other property-related

(121

)

(10

)

(37

)

(20

)

(4

)

(192

)

- other commercial

(209

)

(13

)

(8

)

(209

)

(41

)

(480

)

Financial

(74

)

(1

)

-


(2

)

-


(77

)

Total amounts written off

(1,160

)

(640

)

(448

)

(375

)

(550

)

(3,173

)

Recoveries of amounts written off in previous years













Personal

296


104


39


38


68


545


- first lien residential mortgages 

9


4


-


17


25


55


- other personal

287


100


39


21


43


490


Corporate and commercial

35


10


2


37


13


97


- manufacturing and international trade and services

10


9


1


11


3


34


- commercial real estate and other property-related 

8


-


1


1


-


10


- other commercial

17


1


-


25


10


53


Financial

2


-


-


-


-


2


Total recoveries of amounts written off in previous years

333


114


41


75


81


644


Charge to income statement

825


558


197


(130

)

542


1,992


Exchange and other movements

274


5


(10

)

(51

)

(47

)

171


At 31 Dec 2017

3,061


1,672


1,461


791


499


7,484


Impairment allowances against banks:













- individually assessed

-


-


-


-


-


-


Impairment allowances against customers:













- individually assessed 

2,296


1,056


1,104


383


121


4,960


- collectively assessed

765


616


357


408


378


2,524


Impairment allowances at 31 Dec 2017

3,061


1,672


1,461


791


499


7,484









At 1 Jan 2016

3,477


1,525


1,810


2,041


720


9,573


Amounts written off













Personal

(412

)

(358

)

(208

)

(284

)

(340

)

(1,602

)

- first lien residential mortgages

(10

)

(6

)

(3

)

(142

)

(12

)

(173

)

- other personal

(402

)

(352

)

(205

)

(142

)

(328

)

(1,429

)

Corporate and commercial

(730

)

(285

)

(137

)

(381

)

(297

)

(1,830

)

- manufacturing and international trade and services

(380

)

(172

)

(78

)

(125

)

(10

)

(765

)

- commercial real estate and other property-related

(109

)

(31

)

(54

)

(35

)

(223

)

(452

)

- other commercial

(241

)

(82

)

(5

)

(221

)

(64

)

(613

)

Financial

(1

)

(5

)

(18

)

-


-


(24

)

Total amounts written off

(1,143

)

(648

)

(363

)

(665

)

(637

)

(3,456

)

Recoveries of amounts written off in previous years













Personal

225


124


34


54


78


515


- first lien residential mortgages

3


4


-


26


8


41


- other personal

222


120


34


28


70


474


Corporate and commercial

35


24


10


18


22


109


- manufacturing and international trade and services

15


23


5


9


16


68


- commercial real estate and other property-related

9


-


-


2


-


11


- other commercial

11


1


5


7


6


30


Financial

1


1


-


1


-


3


Total recoveries of amounts written off in previous years

261


149


44


73


100


627


Charge to income statement

533


654


292


709


1,162


3,350


Exchange and other movements

(339

)

(45

)

(102

)

(886

)

(872

)

(2,244

)

At 31 Dec 2016

2,789


1,635


1,681


1,272


473


7,850


Impairment allowances against banks:













- individually assessed

-


-


-


-


-


-


Impairment allowances against customers:













- individually assessed

2,060


1,038


1,137


540


157


4,932


- collectively assessed

729


597


544


732


316


2,918


Impairment allowances at 31 Dec 2016

2,789


1,635


1,681


1,272


473


7,850


 

 




HSBC Holdings plc  Annual Report and Accounts 2017

89

 

 

Report of the Directors | Risk

 



















Movement in impairment allowances on loans and advances to customers and banks

(Audited)

 

2017

2016

 

Banks

individually

assessed


Customers

 

Banks

individually

assessed


Customers

 

 

Individually

assessed


Collectively

assessed


Total


Individually

assessed


Collectively

assessed


Total


 

$m


$m


$m


$m


$m


$m


$m


$m


At 1 Jan

-


4,932


2,918


7,850


18


5,402


4,153


9,573


Amounts written off

-


(1,468

)

(1,705

)

(3,173

)

(18

)

(1,831

)

(1,607

)

(3,456

)

Recoveries of loans and advances previously written off

-


119


525


644


-


107


520


627


Charge to income statement

-


1,114


878


1,992


-


1,831


1,519


3,350


Exchange and other movements

-


263


(92

)

171


-


(577

)

(1,667

)

(2,244

)

At 31 Dec

-


4,960


2,524


7,484


-


4,932


2,918


7,850


Impairment allowances % of loans and advances

-


0.5%


0.3%


0.8%


-


0.6%


0.3%


0.8%


Wholesale lending

Total wholesale lending balances increased by $67bn with foreign exchange differences accounting for $30bn of the increase.

While the tables are presented on a reported basis, the commentary that follows is on a constant currency basis.

In Asia, particularly within Hong Kong, lending balances increased by $34bn. In this region, demand for lending increased across most industry sectors with notable growth in commercial real estate and property-related lending of $15bn and international trade services of $10bn.

In Europe, overall lending increased by $1.8bn owing to decreased lending in the UK of $2.8bn being offset by increased lending in the rest of Europe, mainly in France and Germany.

 

In North America, lending increased by $2.3bn in the US and Canada. The US bank loans increased by $5.8bn largely due to excess liquidity placement. This was mostly offset by decreased US corporate and commercial lending of $5.1bn as paydowns and maturities exceeded new loan originations owing to our continued efforts to improve returns.

In MENA, overall lending fell by $3.2bn, mainly within the UAE owing to a combination of large run-offs and repayments together with the exiting of some customer relationships.

In Latin America, lending increased by $2.3bn largely in Mexico.
















Total wholesale lending gross loans


Europe


Asia


MENA


North
America


Latin
America


Total


Total as a % of total gross loans


$m


$m


$m


$m


$m


$m


%

Corporate and commercial

182,501


250,950


21,533


54,915


12,349


522,248


49.2

- manufacturing

29,098


32,275


2,836


14,503


3,145


81,857


7.7

- international trade and services

65,149


84,340


10,130


10,272


3,336


173,227


16.3

- commercial real estate

25,956


40,246


687


8,917


1,506


77,312


7.3

- other property-related

7,982


46,164


1,821


7,999


369


64,335


6.1

- government

3,619


5,767


1,366


406


570


11,728


1.1

- other commercial

50,697


42,158


4,693


12,818


3,423


113,789


10.7

Financial

46,274


81,730


7,609


21,746


4,753


162,112


15.3

- non-bank financial institutions

32,093


26,311


1,107


10,926


1,282


71,719


6.8

- banks

14,181


55,419


6,502


10,820


3,471


90,393


8.5

Gross loans at 31 Dec 2017

228,775


332,680


29,142


76,661


17,102


684,360


64.5

Loan and other credit-related commitments

143,015


195,396


17,935


123,267


11,666


491,279



- corporate and commercial

123,972


179,302


17,390


102,666


10,795


434,125



- financial

19,043


16,094


545


20,601


871


57,154

















Corporate and commercial

161,653


212,848


22,078


58,276


10,972


465,827


48.6

- manufacturing

27,005


32,564


2,941


15,348


2,785


80,643


8.4

- international trade and services

55,875


72,166


8,448


11,035


2,518


150,042


15.6

- commercial real estate

21,460


32,798


724


7,849


1,340


64,171


6.7

- other property-related

7,025


37,628


1,856


8,823


306


55,638


5.8

- government

3,009


2,919


1,619


354


541


8,442


0.9

- other commercial

47,279


34,773


6,490


14,867


3,482


106,891


11.2

Financial

43,666


79,254


10,370


14,823


3,742


151,855


15.9

- non-bank financial institutions

31,307


19,517


2,599


9,750


556


63,729


6.7

- banks

12,359


59,737


7,771


5,073


3,186


88,126


9.2

Gross loans at 31 Dec 2016

205,319


292,102


32,448


73,099


14,714


617,682


64.5















Currency translation adjustment

21,696


6,604


(84

)

1,297


40


29,553



31 Dec 2016 at 31 Dec 2017 exchange rates

227,015


298,706


32,364


74,396


14,754


647,235



Movement - constant currency basis

1,760


33,974


(3,222

)

2,265


2,348


37,125



31 Dec 2017 as reported

228,775


332,680


29,142


76,661


17,102


684,360



Loan and other credit-related commitments

135,394


183,508


18,562


124,720


9,849


472,033



- corporate and commercial

112,229


167,298


18,474


96,301


9,174


403,476



- financial

23,165


16,210


88


28,419


675


68,557



 




90

HSBC Holdings plc  Annual Report and Accounts 2017

 

 















Total wholesale lending impairment allowances


Europe


Asia


MENA


North America


Latin
America


Total



$m


$m


$m


$m


$m


$m


Corporate and commercial

2,286


1,375


1,092


557


184


5,494


- manufacturing

332


372


188


114


70


1,076


- international trade and services

671


612


480


101


35


1,899


- commercial real estate

362


10


142


75


-


589


- other property-related

347


44


161


41


42


635


- government

3


-


6


-


-


9


- other commercial

571


337


115


226


37


1,286


Financial

183


27


39


22


-


271


- non-bank financial institutions

183


27


39


22


-


271


- banks

-


-


-


-


-


-


Impairment allowances at 31 Dec 2017

2,469


1,402


1,131


579


184


5,765


Impairment allowances % of impaired loans

41.1%


85.0%


70.6%


58.9%


61.1%


54.7%















Corporate and commercial

2,048


1,343


1,137


880


210


5,618


- manufacturing

411


342


174


139


38


1,104


- international trade and services

473


647


476


81


35


1,712


- commercial real estate

402


11


144


67


36


660


- other property-related

167


34


202


37


55


495


- government

2


-


1


-


1


4


- other commercial

593


309


140


556


45


1,643


Financial

216


9


15


20


-


260


- non-bank financial institutions

216


9


15


20


-


260


- banks

-


-


-


-


-


-


Impairment allowances at 31 Dec 2016

2,264


1,352


1,152


900


210


5,878


Impairment allowances % of impaired loans

36.7%


69.9%


67.8%


56.7%


60.9%


50.0%















Currency translation adjustment

260


33


(5

)

19


9


316


31 Dec 2016 at 31 Dec 2017 exchange rates

2,524


1,385


1,147


919


219


6,194


Movement - on constant currency basis

(55

)

17


(16

)

(340

)

(35

)

(429

)

31 Dec 2017 as reported

2,469


1,402


1,131


579


184


5,765


Commercial real estate



















Commercial real estate lending


Europe


Asia


MENA


   North America


Latin America


Total


UK


Hong Kong



$m


$m


$m


$m


$m


$m


$m


$m


Gross loans and advances

















Neither past due nor impaired

24,822


40,175


500


8,637


1,407


75,541


18,361


31,325


Past due but not impaired

56


55


5


197


34


347


2


49


Impaired loans

1,078


16


182


83


65


1,424


895


11


At Dec 2017

25,956


40,246


687


8,917


1,506


77,312


19,258


31,385


-  of which: renegotiated loans

1,112


-


190


97


79


1,478


1,010


-


Impairment allowances

362


10


142


75


-


589


302


7


 

 

 

 

 

 

 

 

 

Gross loans and advances

 

 

 

 

 

 

 

 

Neither past due nor impaired

20,208


32,688


541


7,650


1,255


62,342


15,143


25,561


Past due but not impaired

41


88


-


89


3


221


1


29


Impaired loans

1,212


22


183


110


81


1,608


1,027


15


At Dec 2016

21,461


32,798


724


7,849


1,339


64,171


16,171


25,605


-  of which: renegotiated loans

1,117


-


192


118


98


1,525


997


-


Impairment allowances

403


11


144


67


35


660


330


8


Commercial real estate lending includes the financing of corporate, institutional and high net worth customers who are investing primarily in income-producing assets and, to a lesser extent, in their construction and development. The portfolio is globally diversified with larger concentrations in Hong Kong, the UK, the US and Canada.

Our global exposure is centred largely on cities with economic, political or cultural significance. In many less-developed markets, industry is moving from the development and rapid construction of recent years to an increasing focus on investment stock consistent with more developed markets.

 

In more developed markets, our exposure mainly comprises the financing of investment assets, the redevelopment of existing stock and the augmentation of both commercial and residential markets to support economic and population growth. In less-developed commercial real estate markets, our exposures comprise lending for development assets on relatively short tenors with a particular focus on supporting larger, better capitalised developers involved in residential construction or assets supporting economic expansion.

Commercial real estate lending grew $13bn, including foreign exchange movements of $2.9bn, mainly in Hong Kong and, to a lesser extent, within the UK and Canada.

 




HSBC Holdings plc  Annual Report and Accounts 2017

91

 

 

Report of the Directors | Risk

 

Refinance risk in commercial real estate

Commercial real estate lending tends to require the repayment of a significant proportion of the principal at maturity. Typically, a customer will arrange repayment through the acquisition of a new loan to settle the existing debt. Refinance risk is the risk that a

 

customer, being unable to repay the debt on maturity, fails to refinance it at commercial rates. We monitor our commercial real estate portfolio closely, assessing indicators for signs of potential issues with refinancing.



















Commercial real estate loans and advances maturity analysis


Europe


Asia


MENA


North
America


Latin America


Total


UK


Hong Kong



$m


$m


$m


$m


$m


$m


$m


$m


On demand, overdrafts or revolving













< 1 year

6,192


10,559


268


4,678


260


21,957


4,651


8,531


1-2 years

4,440


7,693


119


1,178


58


13,488


3,339


5,502


2-5 years

13,109


15,856


117


2,199


734


32,015


10,716


11,723


> 5 years

2,215


6,138


183


862


454


9,852


552


5,629


At Dec 2017

25,956


40,246


687


8,917


1,506


77,312


19,258


31,385


 

 

 

 

 

 

 

 

 

On demand, overdrafts or revolving

 

 

 

 

 

 

 

 

< 1 year

5,687


7,773


280


3,568


328


17,636


4,701


5,574


1-2 years

2,904


5,075


72


1,453


27


9,531


1,930


3,365


2-5 years

10,846


13,691


250


1,733


309


26,829


8,778


10,858


> 5 years

2,024


6,259


122


1,095


675


10,175


762


5,808


At Dec 2016

21,461


32,798


724


7,849


1,339


64,171


16,171


25,605


Collateral on loans and advances

Collateral held is analysed separately for commercial real estate and for other corporate, commercial and financial (non-bank) lending. The following tables include off-balance sheet loan commitments, primarily undrawn credit lines.

The collateral measured in the following tables consists of fixed first charges on real estate, and charges over cash and marketable financial instruments. The values in the tables represent the expected market value on an open market basis; no adjustment has been made to the collateral for any expected costs of recovery. Marketable securities are measured at their fair value.

Other types of collateral such as unsupported guarantees and floating charges over the assets of a customer's business are not measured 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 for disclosure purposes.

 

For impaired loans, the collateral values cannot be directly compared with impairment allowances recognised. The loan-to-value ('LTV') figures use open market values with no adjustments. Impairment allowances are calculated on a different basis, by considering other cash flows and adjusting collateral values for costs of realising collateral as explained further on page 189.

Commercial real estate loans and advances

The value of commercial real estate collateral is determined by using a combination of external and internal valuations and physical inspections. For CRR 1-7, local valuation policies determine the frequency of review on the basis of local market conditions because of the complexity of valuing collateral for commercial real estate. For CRR 8-10, almost all collateral would have been revalued within the last three years.

In Hong Kong, market practice is typically for lending to major property companies to be either secured by guarantees or unsecured. In Europe, facilities of a working capital nature are generally not secured by a first fixed charge, and are therefore disclosed as not collateralised.

 




92

HSBC Holdings plc  Annual Report and Accounts 2017

 

 



















Commercial real estate loans and advances including loan commitments by level of collateral

(Audited)






Europe


Asia


MENA


North America


Latin America


Total


UK


Hong Kong



$m


$m


$m


$m


$m


$m


$m


$m


Rated CRR/EL 1 to 7

















Not collateralised

6,114


18,338


315


590


397


25,754


4,812


12,678


Fully collateralised

25,958


30,289


192


11,201


931


68,571


20,709


24,708


Partially collateralised (A)

1,631


1,623


-


1,797


149


5,200


968


1,229


- collateral value on A

1,270


975


-


1,281


76


3,602


568


729


Total

33,703


50,250


507


13,588


1,477


99,525


26,489


38,615


Rated CRR/EL 8

















Not collateralised

5


-


-


-


-


5


3


-


Fully collateralised

145


-


-


77


-


222


129


-


- LTV ratio: less than 50%

64


-


-


3


-


67


64


-


- 51% to 75%

34


-


-


7


-


41


32


-


- 76% to 90%

23


-


-


66


-


89


19


-


- 91% to 100%

24


-


-


1


-


25


14


-


Partially collateralised (B)

62


-


-


10


-


72


55


-


- collateral value on B

42


-


-


1


-


43


40


-


Total

212


-


-


87


-


299


187


-


Rated CRR/EL 9 to 10

















Not collateralised

56


-


2


2


3


63


46


-


Fully collateralised

445


10


194


45


16


710


376


5


- LTV ratio: less than 50%

82


6


19


26


15


148


60


-


- 51% to 75%

165


2


-


6


1


174


149


2


- 76% to 90%

127


2


-


13


-


142


122


2


- 91% to 100%

71


-


175


-


-


246


45


1


Partially collateralised (C)

441


6


-


36


10


493


351


6


- collateral value on C

250


3


-


13


32


298


188


3


Total

942


16


196


83


29


1,266


773


11


At 31 Dec 2017

34,857


50,266


703


13,758


1,506


101,090


27,449


38,626


 

 

 

 

 

 

 

 

 

Rated CRR/EL 1 to 7

 

 

 

 

 

 

 

 

Not collateralised

3,887


12,714


391


561


760


18,313


2,888


9,971


Fully collateralised

21,815


27,296


152


10,618


449


60,330


18,009


21,821


Partially collateralised (A)

1,360


1,106


-


1,388


63


3,917


1,004


644


- collateral value on A

1,021


552


-


991


7


2,571


672


314


Total

27,062


41,116


543


12,567


1,272


82,560


21,901


32,436


Rated CRR/EL 8

 

 

 

 

 

 

 

 

Not collateralised

12


-


-


1


-


13


11


-


Fully collateralised

190


-


-


6


-


196


158


-


- LTV ratio: less than 50%

54


-


-


4


-


58


39


-


- 51% to 75%

76


-


-


1


-


77


70


-


- 76% to 90%

44


-


-


-


-


44


39


-


- 91% to 100%

16


-


-


1


-


17


10


-


Partially collateralised (B)

91


-


-


11


-


102


82


-


- collateral value on B

70


-


-


1


-


71


61


-


Total

293


-


-


18


-


311


251


-


Rated CRR/EL 9 to 10

 

 

 

 

 

 

 

 

Not collateralised

62


3


4


4


2


75


16


-


Fully collateralised

764


14


194


85


61


1,118


740


10


- LTV ratio: less than 50%

79


7


19


5


31


141


62


4


- 51% to 75%

571


5


-


34


14


624


569


4


- 76% to 90%

64


1


-


7


16


88


64


1


- 91% to 100%

50


1


175


39


-


265


45


1


Partially collateralised (C)

384


5


-


21


2


412


361


5


- collateral value on C

148


5


-


13


36


202


131


5


Total

1,210


22


198


110


65


1,605


1,117


15


At 31 Dec 2016

28,565


41,138


741


12,695


1,337


84,476


23,269


32,451


Other corporate, commercial and financial (non-bank) loans are analysed separately in the table below, which focuses on the regions containing the majority of our loans and advances balances. For financing activities in other corporate and commercial lending, collateral value is not strongly correlated to principal repayment performance.

 

Collateral values are generally refreshed when an obligor's general credit performance deteriorates and we have to assess the likely performance of secondary sources of repayment should it prove necessary to rely on them.

Accordingly, the table below reports values only for customers with CRR 8 to 10, recognising that these loans and advances generally have valuations that are comparatively recent.

 




HSBC Holdings plc  Annual Report and Accounts 2017

93

 

 

Report of the Directors | Risk

 



















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

(Audited)


Europe


Asia


MENA


North
America


Latin America


Total


UK


Hong Kong



$m


$m


$m


$m


$m


$m


$m


$m


Rated CRR/EL 8

















Not collateralised

1,730


42


109


1,721


121


3,723


320


15


Fully collateralised

293


9


25


222


4


553


103


5


- LTV ratio: less than 50%

72


7


9


96


4


188


25


3


- 51% to 75%

73


2


12


69


-


156


65


2


- 76% to 90%

16


-


4


19


-


39


11


-


- 91% to 100%

132


-


-


38


-


170


2


-


Partially collateralised (A)

94


140


34


224


-


492


91


135


- collateral value on A

62


12


3


128


1


206


59