Annual Financial Report - 3 of 7

RNS Number : 9098Y
HSBC Holdings PLC
08 March 2017
 

Report of the Directors | Risk


Risk
 
 
Page

Our conservative risk appetite
64

Top and emerging risks
64

Externally driven
64

Internally driven
66

Areas of special interest
67

Process of UK withdrawal from the European Union
67

Oil and gas prices
68

Risk management
68

Our risk management framework
68

Our material banking and insurance risks
71

Credit risk management
73

Liquidity and funding risk management
75

Market risk management
77

Operational risk management
80

Regulatory compliance risk management
81

Financial crime risk management
81

Insurance manufacturing operations risk management
82

Other material risks
 
- Reputational risk management
83

- Sustainability risk management
84

- Pension risk management
84

Key developments and risk profile in 2016
85

Key developments in 2016
85

Credit risk profile
85

Liquidity and funding risk profile
106

Market risk profile
114

Operational risk profile
121

Insurance manufacturing operations risk profile
121

Our conservative risk appetite
Throughout its history, HSBC has maintained a 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.
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 arising from our products and services 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 70. During 2016, we made a number of changes to our top and emerging risks to reflect our assessment of the issues facing HSBC and their effect on the Group, which are described on page 27.
Our current top and emerging risks are as follows.
Externally driven
Economic outlook and capital flows
Global economic growth remained muted in 2016, with headwinds adversely affecting both developed and emerging markets.
The UK electorate's vote to leave the European Union ('EU') caused significant market volatility in its immediate aftermath, and since then sterling has depreciated against major currencies. Uncertainty regarding the terms of the UK's exit agreement, its future relationship with the EU and its trading relationship with the rest of the world may lead to economic uncertainty and market volatility, which could affect both the Group and its customers.
Following robust policy action during the course of 2016, market concerns have eased over the extent of the slowdown of the mainland Chinese economy, and the potential for further renminbi depreciation. However, a prolonged or severe slowdown cannot be ruled out, which would have wider ramifications for regional and global economic growth, and global trade and capital flows, as a consequence.
While oil and gas prices have partly recovered from the lows of 2015, global supply and demand imbalances continue to place considerable financial strain on some producers and exporters. A continuation of low oil prices, particularly in conjunction with a low inflation environment and/or low or negative interest rates, would adversely affect global growth prospects and, as a consequence, our results.
Mitigating actions
•
We actively assess the impact of economic developments in key markets on specific customers, customer segments or portfolios and take appropriate mitigating action - that may include revising risk appetite 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. Analysis undertaken on our oil and gas lending portfolios are described on page 68, and our wider approach to stress testing is described on page 70.
•
We have carried out detailed reviews of our wholesale credit portfolios, particularly across those sectors most affected by the UK referendum result. We have also run a number of stress tests on our wholesale and trading portfolios to examine potential impacts under a range of possible exit scenarios and develop a suite of possible mitigating actions.
Geopolitical risk
Our operations and portfolios are exposed to risks arising from political instability, civil unrest and military conflict in many parts of the world. These may include physical risk to our staff and/or physical damage to our assets, disruption to our operations and a curtailment in global trade flows.
The outcome of the US election has added to concerns about a rise in protectionism. This has been accentuated in many parts of the world by rapid technological change and income inequality. Any amplification of this trend could cause a curtailment in global trade, and thus impact HSBC's traditional lines of business.

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European states are experiencing heightened political tension, reflecting concerns over migration, fears of terrorism, increased tension with Russia, and uncertainty about the future relationship between the UK and the EU. Elections in France, Germany, the Netherlands and possibly Italy in 2017 are adding to the uncertainty.
In the Middle East, the terrorist group Daesh has come under increasing pressure as an international coalition recaptured territory across Syria and Iraq. Despite this, Daesh has proved capable of carrying out terrorist attacks both in neighbouring countries and further afield.
In Asia, ongoing territorial disputes in the South China Sea and a region-wide build-up in military capability have strained diplomatic relations, and are testing the resolve of the US to defend freedom of navigation.
Mitigating actions
•
We continually monitor the geopolitical outlook, in particular in countries where we have material exposures and/or a physical presence. We established a new dedicated forum to monitor and advise senior management on global developments, including analysis on how the Group's strategy could be affected by geopolitical events.
•
We have taken steps to increase the physical security of our premises and have enhanced our major incident response capabilities, particularly in those geographical areas deemed to be at a higher risk from terrorism and military conflicts.
•
Our internal credit risk ratings of sovereign counterparties take geopolitical factors into account and drive our appetite for conducting business in those countries. Where necessary, we adjust our country limits and exposures to reflect our risk appetite and mitigate risks as appropriate.
•
We incorporate geopolitical scenarios, such as conflicts in countries where we have a significant presence or political developments that could disrupt our operations, into our internal stress tests to assess their potential effect on our portfolios and businesses.
Turning of the credit cycle
Although the credit environment has stabilised in the latter part of the year, due in part to further monetary loosening, there is a risk that the credit cycle could turn sharply in 2017 if economic and/or geopolitical shocks unfold.
Stress could appear across a wide array of credit segments, particularly given the substantial amounts of external refinancing due in emerging markets in 2017 and 2018. Sentiment towards mainland China could also deteriorate amid concerns over its increasing debt burden, or political events in the US, UK and EU could deliver negative economic outcomes. Impairment allowances could increase if the credit quality of our customers is affected by less favourable global economic conditions in some markets. Should oil prices remain low or fall, our oil and gas portfolios would come under further pressure.
Mitigating actions
•
We closely monitor economic developments in key markets and sectors, taking 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 manage risk appetite where necessary.
•
Reviews of key portfolios are undertaken regularly to ensure that individual customer or portfolio risks are understood and that the level of facilities offered and our ability to manage these through any downturn are appropriate.
 
Cyber threat and unauthorised access to systems
HSBC and other public and private organisations continue to be the targets of increasing and more sophisticated cyber attacks that may disrupt customer services.
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 within our industry.
Regulatory and technological developments 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, operational structures, 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, which could be introduced with different, potentially conflicting requirements and to differing timetables by different regulatory regimes. Regulatory changes may affect the activities of the Group as a whole, or of some or all of its principal subsidiaries.
While the rise of financial technology ('fintech') presents a number of opportunities that we are actively engaging in, there is also a risk that it could disrupt financial institutions' traditional business model.
Mitigating actions
•
We are engaged closely 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.
•
We have strengthened governance and resourcing around regulatory change management. Significant regulatory programmes, such as the implementation of International Financial Reporting Standard 9, are overseen by the Group Change Committee (see 'Execution risk' on page 67).
•
We are actively pursuing opportunities in the fintech space, and have established HSBC Digital Solutions, a specialist team to design, build and run digital services. We have also established a technology advisory board to help ensure we are fully aware of, and respond to, industry developments as they arise.
Regulatory focus on conduct of business and financial crime
Financial institutions remain under considerable scrutiny regarding conduct of business, particularly in relation to fair outcomes for customers and orderly and transparent operations in financial markets, as well as financial crime. Regulators, prosecutors, the media and the public all have heightened expectations as to the behaviour and conduct of financial institutions, and any shortcomings or failure to demonstrate adequate controls are in place to mitigate such risks could result in regulatory sanctions or fines. This could also lead to

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an increase in civil litigation arising from or relating to issues which are subject to regulatory investigation, sanction or fine.
Mitigating actions
•
We have created a new function, Financial Crime Risk, which brings together all areas of financial crime risk management at HSBC. For further details, see 'Financial crime risk management' on page 81.
•
We have also continued to enhance our management of conduct in areas including the treatment of potentially vulnerable customers, market surveillance, employee training and performance management (see 'Regulatory compliance risk management' on page 81).
US deferred prosecution agreement and related agreements and consent orders
HSBC is subject to a five-year deferred prosecution agreement ('US DPA') with the US DoJ and related agreements and consent orders with the FRB, the OCC and the FCA. Under the agreements entered into with the DoJ and the FCA in 2012, an independent compliance monitor (the 'Monitor') was appointed in July 2013 for an expected five-year period to produce annual assessments of the effectiveness of the Group's anti-money laundering ('AML') and sanctions compliance programme.
The design and execution of the AML and sanctions remediation plans to address the findings of the US DPA and the Monitor are complex and require major investments in people, systems and other infrastructure. This complexity creates significant execution risk that could affect our ability to effectively identify and manage financial crime risk and remedy AML and sanctions compliance deficiencies in a timely manner. This, in turn, could impact our ability to satisfy the Monitor or comply with the terms of the US DPA and related agreements and consent orders, and may require us to take additional remedial measures in the future. These risks could be further heightened if the Monitor's reports were to become public.
In February 2017, the Monitor delivered his third annual follow-up review report as required by the US DPA. In his report, which is discussed on page 82, the Monitor concluded that, in 2016, HSBC continued to make progress in enhancing its financial crime compliance controls, including improvements to our global AML policies and procedures. However, the Monitor also expressed significant concerns about the pace of that progress, instances of potential financial crime that the DoJ and HSBC are reviewing further and on-going systems and control deficiencies that in his view raised questions as to whether HSBC is adhering to all its obligations under the US DPA. The Monitor also found that there remain substantial challenges for HSBC to meet its goal of developing a reasonably effective and sustainable AML and sanctions compliance programme. In addition, the Monitor did not certify as to HSBC's implementation of and adherence to remedial measures specified in the US DPA.
Potential consequences of breaching the US DPA could include the imposition of additional terms and conditions on HSBC, an extension of the agreement, including its monitorship, or the criminal prosecution of HSBC that could, in turn, entail further financial penalties and collateral consequences.
Moreover, 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, become subject to legal or regulatory enforcement actions by OFAC or other US agencies and be required to pay substantial fines or penalties. In addition, any such breaches of US legislation could constitute a breach of the US DPA.
 
Under the terms of the US DPA, upon notice and an opportunity to be heard, the DoJ has sole discretion to determine whether HSBC has breached the US DPA.
Mitigating actions
•
We continued to make progress during 2016 toward putting in place an effective and sustainable AML and sanctions compliance programme, including through the creation of a new Financial Crime Risk function and improvements in technology and systems to manage financial crime risk.
•
We are working to implement the agreed recommendations flowing from the Monitor's previous reviews, and to implement the agreed recommendations from the 2016 review.
Internally driven
IT systems infrastructure and resilience
HSBC continues to invest in the reliability and resilience of our IT Systems, to help ensure that disruption to customer services resulting in reputational and regulatory damage does not occur.
Mitigating actions
•
We are part-way through a multi-year investment programme that is 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 simplifying our service provision and replacing older IT infrastructure and applications. These investments are designed to improve IT systems resilience.
•
During 2016, we continued to upgrade our IT Systems, improve disruption free change, and materially reduce the number of incidents relating to our critical business services. These enhancements led to a material improvement in service availability during the year and helped reduce impact to our customers and colleagues by 45% (when compared with the same period in 2015).
Impact of organisational change and regulatory demands on employees
The cumulative workload arising from our regulatory reform and remediation programmes, together with those related to the delivery of our strategy, continues to place increasingly complex and conflicting demands on a workforce that operates in an employment market where expertise in key markets is often in short supply and mobile. The scale of organisational change, including the establishment of the ring-fenced bank in the UK, has increased pressure on employees and requires us to ensure that key skills and experience are retained. Furthermore, the outcome of the UK referendum on EU membership has led to some uncertainties regarding movement of labour.
Mitigating actions
•
We have enhanced our wellbeing programme to support our employees, particularly those affected by the Group's considerable change agenda.
•
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 and extensive relocation support to existing employees in the UK ring-fenced bank.
•
We continue to increase the level of specialist resource in key areas, and to engage with our regulators as they finalise new regulations. We use a broad array of talent-sourcing channels, succession planning for key management roles, and heightened promotion of opportunities internally, with particular attention in our more challenging markets.

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Execution risk
Execution risk remained heightened during 2016 as we continued to work towards delivering the strategic actions announced at the Investor Update in June 2015 (see page 12). These, along with the regulatory reform agenda and our commitments under the US DPA, require the management of significant projects that are resource intensive and time sensitive. Risks arising from the volume, magnitude and complexity of the projects underway to meet these demands may include regulatory censure, reputational damage or financial losses.
Mitigating actions
•
We have strengthened our prioritisation and governance processes for significant projects. The Group Change Committee ('GCC'), chaired by the Group Chief Operating Officer, oversees the most significant programmes and provides regular updates to the Risk Management Meeting of the GMB.
•
The GCC monitors the concentration of deliverables to ensure that potential resource constraints over the medium term are understood and addressed.
Third-party risk management
We utilise third parties for the provision of a range of goods and services, in common with other financial services providers. Global regulators have increased their scrutiny of these arrangements and expect firms to be able to demonstrate adequate control over the selection, governance and oversight of their third parties, including affiliates. Any deficiency in our management of third-party risk could affect our ability to meet strategic, regulatory or client expectations. This may, in turn, lead to a range of consequences, including regulatory censure or reputational damage.
Mitigating actions
•
We are part-way through a multi-year strategic programme to enhance our third-party risk management capability. This is designed to enable the consistent risk assessment of any third-party service against key criteria, along with associated control monitoring, testing and assurance throughout the third-party life cycle.
•
A new Group policy and supporting framework was published in December 2016. The supporting delivery model and technology will be developed and will start to deploy in the second half of 2017.
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 and fraud risk management, and financial reporting. Regulatory requirements for models are rapidly increasing and often fast-moving. The scale and scope of model development expected by regulators pose significant execution challenges, especially where the breadth and scope are beyond what has previously been expected of the Group.
Regulatory scrutiny and supervisory concerns over banks' use of models is considerable, particularly the internal models and assumptions used by banks in the calculation of regulatory capital. If regulatory approval for key capital models is not achieved in a timely manner, we could be required to hold additional capital.
Mitigating actions
•
We have strengthened our model risk governance framework by establishing additional global model oversight committees and implementing policies and standards in accordance with key regulatory requirements.
•
We have strengthened our governance over the development, usage and validation of models including
 
the creation of centralised global analytical functions with necessary subject matter expertise.
•
We have hired additional subject matter experts within our Independent Model Review sub-function and empowered the team to ensure appropriate challenge and feedback are given to models prior to and as part of their ongoing use.
•
We have strengthened the model risk policy and introduced a Group-wide single model inventory system detailing key metrics on all models, and an assessment of their relative importance to the organisation.
Data management
The Group currently uses a large number of systems and applications to support business processes and operations. Multiple data sources, including customer data sources, introduce the need for reconciliation to reduce the risk of error. Strong data governance and enhanced data quality are required to meet our regulatory obligations relating to risk data aggregation and risk reporting as set out by the Basel Committee and our obligations under the US DPA, as well as to service our customers more effectively and improve our product offering.
Mitigating actions
•
The Chief Information Officer continues to drive the Group's efforts to enhance data governance, quality and architecture. These services underpin key programmes and initiatives, such as our Global Standards programme.
•
We are significantly reducing the number of systems and applications that support key business processes, which will streamline the number of data sources across the Group, particularly data used in our customer and transaction screening processes.
•
We continue to make progress on key initiatives and projects to implement our data strategy and work towards meeting our Basel Committee data obligations.
Areas of special interest
During 2016, we considered a number of particular areas because of the effect they may have on the Group. While these areas have been identified as part of our top and emerging risks, further details of the actions taken during the year are provided below.
Process of UK withdrawal from the European Union
The period of uncertainty and market volatility that followed the UK's decision to leave the EU is likely to continue until the UK's future relationship with the EU and the rest of the world is clearer. Given the time-frame and the complex negotiations involved, and assuming Article 50 is invoked by the end of March 2017, a clearer picture is not expected to emerge for some time. HSBC is working with clients as they adapt to this new environment and plan for what might follow.
Meeting our customers' needs following the UK's departure from the EU will likely require adjustments to our cross-border banking model. However, with Article 50 not yet invoked and formal negotiations not yet initiated, it is too early to determine precisely what will be required or what the likely effects on HSBC might be. Despite this uncertainty, use of HSBC's existing subsidiaries in France, Germany, Malta and Poland should help us more quickly and seamlessly adapt our banking model to this new landscape. Such changes could, among other things, increase our operating costs and require us to relocate staff and businesses outside the UK to other jurisdictions.
Through this period of uncertainty, our priorities are to continue to support our clients, take appropriate actions to mitigate risks and maintain stability, and deliver on our strategy. We are actively monitoring our portfolio to identify areas of stress, with

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vulner able sectors subject to management review to determine if any adjustment to our risk policy or appetite is required. As the UK's negotiating priorities and likelihood of achieving them become clearer, we will continue to monitor developments and take actions required to meet these priorities.
Oil and gas prices
Oil prices improved throughout 2016 and in early 2017, particularly after Opec agreed to cut supply levels. The improved oil prices resulted in a decline in new loan impairments in the second half of the year. The medium- to long-term outlook remains uncertain as technological change impacts the supply side through cheaper methods of extraction and the demand side through the development of renewable energy sources. At 31 December 2016, HSBC's overall portfolio directly exposed to oil and gas sector had drawn risk exposure of $28bn (2015: $29bn). The portfolio has the following credit quality distribution: 'strong' and 'good' 53% (2015: 56%), 'satisfactory' 28% (2015: 35%), 'sub-standard' 15% (2015: 7%) and 'impaired' 4% (2015: 2%), with the majority of the exposures located in North America, Asia and Europe. Loan impairment charges in 2016 were approximately $0.3bn. The sector remains under enhanced monitoring with risk appetite and new lending significantly curtailed.
 
Risk management
This section describes the enterprise-wide 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-wide 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.
Key components of our risk management framework
HSBC Values and risk culture
 
 
 
 
 
 
 
 
 
 
 
Governance and structure
 
The Board and its sub-committees
 
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 132).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The Risk Management Meeting of the Group Management Board and its sub-committees
 
Responsible for the enterprise-wide management of all risks, including key policies and frameworks for the management of risk within the Group (see page 69). The Global Standards Steering Meeting is responsible for the management of financial crime risk (see page 81).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk governance framework
 
Ensures appropriate oversight of and accountability for the management
of risk (see page 68).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Responsibilities
 
Three lines of defence model
 
Our three lines of defence model defines roles and responsibilities for
risk management (see page 69).
 
 
 
 
 
 
 
 
 
 
 
Global Risk function
 
An independent function to help ensure the necessary balance in risk/return decisions (see page 69).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Processes
 
Enterprise-wide risk management tools
 
Processes to identify, monitor, mitigate and report risks to ensure
we remain within our risk appetite (see pages 70 to 71).
 
 
 
 
 
 
 
 
Risk appetite
 
Top and emerging risks
 
 
 
 
 
 
 
 
 
Risk map
 
Stress testing
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Controls
 
Banking and insurance risks
 
Material risks arising from our business activities that are measured, monitored and managed (see pages 71 to 72).
 
 
 
 
 
 
 
 
 
 
 
Risk Policies and Practices
 
Set by risk stewards for each of our material banking and insurance risks
(see pages 68 to 73.
 
 
 
 
 
 
 
 
 
 
 
Internal Controls
 
The operational risk management framework defines minimum standards and processes for managing operational risks and internal controls (see page 80).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Systems and tools
Our risk culture
Risk culture refers to HSBC's norms, attitudes and behaviours related to risk awareness, risk taking and risk management.
HSBC has long recognised the importance of a strong risk culture, the fostering of which is a key responsibility of senior executives. Our risk culture is reinforced by HSBC Values and our Global Standards 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. 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. Mandatory training materials are updated regularly,

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describing technical, cultural and ethical aspects of the various risks assumed by the Group and how they should be managed effectively. 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 concerns by this route. All allegations of retaliation reported are escalated to senior management. For details on the governance of our whistleblowing policy, see pages 140 and 144.
Our risk culture is also reinforced by our approach to remuneration. Individual awards, including those for senior executives, are based on compliance with 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 153.
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 page 82).
Executive accountability for the monitoring, assessment and management of risk resides with the Group Chief Risk Officer. He is supported by the Risk Management Meeting of the Group Management Board ('RMM').
In the second half of 2016, we established a Financial Crime Risk ('FCR') function and appointed a Group Head of FCR, who reports to the Group Chief Executive and chairs the Global Standards Steering Meeting. The FCR function is dedicated to implementing the most effective global standards to combat financial crime, as described under 'Financial crime risk management' on page 81.
Day-to-day responsibility for risk management is delegated to senior managers with individual accountability for decision making. These managers are supported by global functions as described under 'Three lines of defence' below.
We use a defined executive risk governance structure to help ensure appropriate oversight and accountability of risk, which
facilitates the reporting and escalation to the RMM. This structure is summarised below.
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-wide risk management framework
•
Forward-looking assessment of the risk environment, analysing the possible risk impact 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-wide 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 140.
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
We use an activity-based three lines of defence model to delineate management accountabilities and responsibilities for risk management and the control environment. This creates a robust control environment to manage risks.
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

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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 tools are summarised below.
Risk appetite
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'). This 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 143). Additionally, quantitative metrics are defined along with appetite and tolerance thresholds for key risk areas.
Risk map
The Group risk map provides a point-in-time view of the risk profiles of countries, regions and global businesses across all risk categories. 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 71.
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 64.
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 demonstrates our capital strength and enhances our resilience against external shocks. It also helps us understand and mitigate risks, and informs our decisions about capital levels. As well as taking part in regulators' stress tests, we conduct our own internal stress tests.
Many of our regulators - especially the Bank of England ('BoE'), the Federal Reserve and the HKMA - utilise stress testing as an essential prudential regulatory tool and the Group has focused significant governance attention and resourcing to meet their requirements. We place particular emphasis on the global enterprise-wide stress test run on the Group by the BoE, our lead regulator.
In 2016, 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. The results for HSBC included an assumed dividend payment in the first year of the severe stress projection period.
This outcome reflected our conservative risk appetite, and diversified geographical and business mix. It also reflected our ongoing strategic actions, including the sale of operations in Brazil, RWA reductions in GB&M and continued sales from our US CML run-off portfolio. These actions have materially reduced our RWAs, strengthened our capital position and made us even more robust under stress.
Bank of England stress test results for 2016
The BoE's stress test in 2016 specified a global downturn with severe effects in the UK, US, Hong Kong and China, which accounted for approximately two-thirds of HSBC's RWAs at the end of 2015. The assumed GDP growth rates are detailed in the following table. We estimated that the impact on global GDP in this scenario was about as severe as the global financial crisis of 2007 to 2009, but with a much greater focus on emerging markets. This made it particularly severe for HSBC, given its priority markets in these areas.
Assumed GDP growth rates in the 2016 Bank of England
stress test scenario
 
2015

2016

2017

2018

 
%

%

%

%

UK
2.2

(4.3
)
1.1

1.7

USA
1.8

(3.0
)
0.8

1.6

China
6.7

(0.5
)
4.2

5.6

Hong Kong
1.9

(7.4
)
1.5

2.7

Source: Bank of England.
PRA assumed GDP growth rates are shown in terms of fourth quarter on fourth quarter annual changes.
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 11.9% at the end of 2015, the BoE showed projected minimum stressed CET1 ratios of 7.6% and 9.1% before and after the impact of strategic management actions.

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Results of Bank of England stress tests for the past three years
 
2016
2015
2014
 
%
%
%
CET1 ratio at scenario start point
11.9
10.9
10.8
Minimum stressed CET1 ratio after
strategic management actions
9.1
7.7
8.7
Fall in CET1 ratio
2.8
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 used intensively in our enterprise-wide risk management and capital management frameworks. Risks to our capital plan are assessed through a range of scenarios which explore risks that management needs to consider under stress. They include potential adverse macroeconomic, geopolitical and operational risk events, and potential events that are specific to HSBC. The selection of scenarios reflects our risk appetite relating to metrics such as profitability, capital or liquidity. Stress testing analysis helps management understand the nature and extent of any vulnerability. 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 Hong Kong Monetary Authority. 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.
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 73)
 
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 which 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 75)
 
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;
•
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 77)
 
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 portfolios; and
•
non-trading portfolios.
Market risk exposures arising from our insurance operations are discussed on page 123.
Market risk is:
•
measured in terms of value at risk ('VaR'), which measures the potential losses on risk positions over a specified time horizon for a given level of confidence, and assessed using stress testing;
•
monitored using VaR, stress testing and other measures including the sensitivity of net interest income and the sensitivity of 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 80)
 
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 effectiveness of controls;
•
monitored using key indicators and other internal control activities; and
•
managed primarily by global business and functional managers that identify and assess risks, implement controls to manage them and monitor the effectiveness of these controls using the operational risk management framework.

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Description of risks - banking operations
Risks
Arising from
Measurement, monitoring and management of risk
Regulatory compliance risk (see page 81)
 
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 counter-parties, 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 our regulatory compliance risk assessments 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.
Financial crime risk (see page 81)
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 compliance risk appetite statement 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.
Other material risks
Reputational risk (see page 83)
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 84)
Pension risk is the risk of increased costs to HSBC from the post-employment benefit plans that HSBC has established for 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 Committee and ultimately the RMM.
Sustainability risk (see page 84)
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.

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HSBC Holdings plc Annual Report and Accounts 2016

Description of risks - insurance manufacturing operations
Risks
Arising from
Measurement, monitoring and management of risk
Financial risk (see page 123)
 
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 not being able 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 125)
 
Insurance risk is the risk that, over time, the cost of the contract, 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.
Credit risk management
Details of changes in our credit risk profile in 2016 can be found on page 85, in 'Key developments and risk profile in 2016'.
There were no material changes to the policies and practices for the management of credit risk in 2016.
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. The mapping is reviewed on a regular basis and the most recent review resulted in sovereign BBB+ and BBB exposures previously mapped to Credit Quality band 'Good' being mapped to Credit Quality Band 'Strong'. Sovereign BB+ and BB exposures previously mapped to Credit Quality band 'Satisfactory' being mapped to Credit Quality Band 'Good'. This represents a change in disclosure mapping unrelated to changes in counterparty creditworthiness. Had this mapping been applied in 2015, sovereign exposures would be changed as follows: 'Satisfactory' $1.4bn decrease, 'Good' $4.3bn decrease and $5.7bn 'Strong' increase.

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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
CRR1 to CRR2
0 - 0.169
EL1 to EL2
0 - 0.999
Good
 
BB to BBB-
BBB+ to BBB-
CRR3
0.170 - 0.740
EL3
1.000 - 4.999
Satisfactory
 
BB- to B and unrated
BB+ to B and unrated
CRR4 to CRR5
0.741 - 4.914
EL4 to EL5
5.000 - 19.999
Sub-standard
 
B- to C
B- to C
CRR6 to CRR8
4.915 - 99.999
EL6 to EL8
20.000 - 99.999
Impaired
3
Default
Default
CRR9 to CRR10
100
EL9 to EL10
100+ or defaulted
1
Customer risk rating.
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 90. These also include retail accounts classified as EL1 to EL8 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 below).
Renegotiated loans and forbearance
(Audited)
Where a loan is modified due to significant concerns about the borrower's ability to meet contractual payments when due, a range of forbearance strategies is employed in order to improve the management of customer relationships, maximise collection opportunities and, if possible, avoid default, foreclosure or repossession.
Identifying renegotiated loans
Loans are identified as renegotiated loans when we modify the contractual payment terms due to significant credit distress of the borrower. 'Forbearance' describes concessions made on the contractual terms of a loan in response to an obligor's financial difficulties. We classify and report loans on which concessions have been granted under conditions of credit distress as 'renegotiated loans' when their contractual payment terms have been modified because we have significant concerns about the borrowers' ability to meet contractual payments when due. When considering modification terms, the borrower's continued ability to repay is assessed and where they are unrelated to payment arrangements, whilst potential indicators of impairment, these loans are not considered as renegotiated loans. In HSBC Finance, loan modification and re-age policies, renegotiated real estate loans are not eligible for a subsequent renegotiation for six or 12 months depending upon the action, with a maximum of five renegotiations permitted within a five-year period. 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. Any new loans that arise following derecognition events will continue to be disclosed as renegotiated loans.
Credit quality of renegotiated loans
On execution of the renegotiation, the loan will also be classified as impaired if it is not already so classified. In wholesale lending, all of the facilities with a customer, including loans which have not been modified, are considered impaired
 
following the provision of a renegotiated loan. In our US CML run-off portfolio in HSBC Finance, loans which are in the early stages of delinquency (less than 60 days delinquent) and typically have the equivalent of two payments deferred for the first time are not considered impaired, as the contractual payment deferrals are deemed to be insignificant compared with payments due on the loan as a whole.
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. In our US CML run-off portfolio in HSBC Finance, all modified loans with terms of more than two years are considered to be permanently impaired.
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 often encountered in these segments.
For wholesale lending, renegotiated loans are typically assessed individually. Credit risk ratings are intrinsic to the impairment assessment. 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 to 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 to the Financial Statements.

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HSBC Holdings plc Annual Report and Accounts 2016

In HSBC Finance, the carrying amounts of residential mortgages and second lien loans in excess of net realisable value are written off at or before the time foreclosure is completed or settlement is reached with the borrower. If there is no reasonable expectation of recovery, and foreclosure is pursued, the loan is normally written off no later than the end of the month in which the loan becomes 180 days contractually past due.
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 but, in very exceptional circumstances, to longer 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 this time.
For secured personal facilities, final write-off should generally occur within 60 months of the default at the latest.
In the event of bankruptcy or analogous proceedings, write-off may occur earlier than the 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 changes in our liquidity and funding risk profile in 2016 can be found on page 85, in 'Key developments and risk profile in 2016'.
Liquidity and funding risk management framework
HSBC has an internal liquidity and funding risk management framework ('LFRF') which aims to allow it to withstand very severe liquidity stresses. It is designed to be adaptable to changing business models, markets and regulations.
The management of liquidity and funding is primarily undertaken locally (by country) in our operating entities in compliance with the Group's LFRF, and with practices and
 
limits set by the GMB through the RMM and approved by the Board. Our general policy is that each defined operating entity should be self-sufficient in funding its own activities. Where transactions exist between operating entities, they are reflected symmetrically in both entities.
As part of our asset, liability and capital management ('ALCM') structure, we have established asset and liability committees ('ALCO') at Group level, in the regions and in operating entities. The terms of reference of all ALCOs include the monitoring and control of liquidity and funding.
The primary responsibility for managing liquidity and funding within the Group's framework and risk appetite resides with the local operating entities' ALCOs, Holdings ALCO and the RMM. The remaining smaller operating entities are overseen by regional ALCOs, with appropriate escalation of significant issues to Holdings ALCO and the RMM.
Operating entities are predominantly defined on a country basis to reflect our local management of liquidity and funding. Typically, an operating entity will be defined as a single legal entity. However, to take account of the situation where operations in a country are booked across multiple subsidiaries or branches:
•
an operating entity may be defined as a wider sub-consolidated group of legal entities if they are incorporated in the same country, liquidity and funding are freely fungible between the entities and permitted by local regulation, and the definition reflects how liquidity and funding are managed locally; or
•
an operating entity may be defined more narrowly as a principal office (branch) of a wider legal entity operating in multiple countries, reflecting the local country management of liquidity and funding.
The RMM reviews and agrees annually the list of entities it directly oversees and the composition of these entities.
Key developments in 2016
On 1 January 2016, the Group implemented a new LFRF. It uses the liquidity coverage ratio ('LCR') and net stable funding ratio ('NSFR') regulatory framework as a foundation, but adds extra metrics, limits and overlays to address firm-specific risks:
The LFRF is delivered using the following key aspects:
•
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;
•
intra-day liquidity; and
•
forward-looking funding assessments.
The new internal LFRF and the risk tolerance limits were approved by the Board on the basis of recommendations made by the Group Risk Committee.
Our annual individual liquidity adequacy assessment process aims to:

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Report of the Directors | Risk


•
identify risks that are not reflected in the LFRF, and, where required, to assess additional limits required locally; and
•
validate the risk tolerance at the operating entity level by demonstrating that reverse stress testing scenarios are acceptably remote and ensuring vulnerabilities have been assessed through the use of severe stress scenarios.
Management of liquidity and funding risk
Liquidity coverage ratio
The HSBC application of the LCR metric involves the following two key assumptions about the definition of operational deposits and the ability to transfer liquidity from non-EU legal entities:
•
we define operational deposits as transactional (current) accounts arising from the provision of custody services by HSBC Security Services or Global Liquidity and Cash Management, where the operational component is assessed to be the lower of the current balance and the separate notional values of debits and credits across the account in the previous calculation period; and
•
we assume no transferability of liquidity from non-EU entities other than to the extent currently permitted.
Net stable funding ratio
HSBC uses the NSFR as a basis for establishing stable funding around the Group.
Liquid assets of HSBC's principal operating entities
Liquid assets are held and managed on a stand-alone operating entity basis. Most are held directly by each operating entity's Balance Sheet Management ('BSM') department, primarily for the purpose of managing liquidity risk in line with the LFRF.
The liquid asset buffer may also include securities in held-to-maturity portfolios. To qualify as part of the liquid asset buffer, held-to-maturity portfolios must have a deep and liquid repo market in the underlying security.
Liquid assets also include any unencumbered liquid assets held outside BSM departments for any other purpose. The LFRF gives ultimate control of all unencumbered assets and sources of liquidity to BSM.
Sources of funding
Customer deposits in the form of current accounts and savings deposits payable on demand or at short notice form the significant part of our stable funding, and we place considerable importance on maintaining their stability. For deposits, stability depends upon maintaining depositor confidence in our capital strength and liquidity, and on competitive and transparent pricing.
We also access wholesale funding markets by issuing senior secured and unsecured debt securities (publicly and privately) and borrowing from the secured repo markets against high-quality collateral, in order to obtain funding for non-banking subsidiaries that do not accept deposits, to align asset and liability maturities and currencies, and to maintain a presence in local wholesale markets.
Ordinary share capital and retained reserves, non-core capital instruments and total loss-absorbing capacity ('TLAC') eligible debt securities are also a source of stable funding.
Analysis of on-balance sheet encumbered and unencumbered assets and off-balance sheet collateral
An asset is defined as encumbered if it has been pledged as collateral against an existing liability and, as a result, is no longer available to the Group to secure funding, satisfy collateral needs or be sold to reduce the funding requirement. An asset is therefore categorised as unencumbered if it has not been pledged against an existing liability. Unencumbered assets are further segmented into four separate sub-categories: 'Readily realisable assets', 'Other realisable assets', 'Reverse repo/stock
 
borrowing receivables and derivative assets' and 'Cannot be pledged as collateral'.
Liquidity behaviouralisation
All stable deposits are assumed under the Group's frameworks to have a liquidity behaviouralised life beyond one year and to represent a homogeneous source of stable funding. The behaviouralisation of assets is far more granular and seeks to differentiate the period for which we must assume that we will need stable funding for the asset.
Funds transfer pricing
Our funds transfer pricing policies give rise to a two-stage funds transfer pricing approach, reflecting the fact that we separately manage interest rate risk and liquidity and funding risk under different assumptions. They have been developed to be consistent with our risk management frameworks. Each operating entity is required to apply the Group's transfer pricing policy framework to determine for each material currency the most appropriate interest rate risk transfer pricing curve, a liquidity premium curve (which is the spread over the interest rate risk transfer pricing curve) and a liquidity recharge assessment (which is the spread under or over the interest rate risk transfer pricing curve).
Repos and stock lending
GB&M provides collateralised security financing services to its clients, providing them with cash financing or specific securities. When cash is provided to clients against collateral in the form of securities, the cash provided is recognised on the balance sheet as a reverse repo. When securities are provided to clients against cash collateral, the cash received is recognised on the balance sheet as a repo or, if the securities are equity securities, as stock lending.
Each operating entity manages its collateral through a central collateral pool, in line with the LFRF. When specific securities need to be delivered and the entity does not have them currently available within the central collateral pool, the securities are borrowed on a collateralised basis. When securities are borrowed against cash collateral, the cash provided is recognised on the balance sheet as a reverse repo or, if the securities are equity securities, as stock borrowing.
Operating entities may also borrow cash against collateral in the form of securities, using the securities available in the central collateral pool. Repos and stock lending can be used in this way to fund the cash requirement arising from securities owned outright by Markets to facilitate client business, and the net cash requirement arising from financing client securities activity.
Reverse repos, stock borrowing, repos and stock lending are reported net when the IFRS offsetting criteria are met. In some cases, transactions to borrow or lend securities are collateralised using securities. These transactions are off-balance sheet.
Any security accepted as collateral for a reverse repo or stock borrowing transaction must be of very high quality and its value subject to an appropriate haircut. Securities borrowed under reverse repo or stock borrowing transactions can only be recognised as part of the liquidity asset buffer for the duration of the transactions and only if the security received is eligible under the liquid asset policy within the LFRF.
Credit controls are in place to ensure that the fair value of any collateral received remains appropriate to collateralise the cash or fair value of securities given.
HSBC Holdings
HSBC Holdings' primary sources of cash 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

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issuances. Cash is primarily used for the provision of capital and subordinated funding to subsidiaries, 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. 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 2016, 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.
None of the subsidiaries that are excluded from our regulatory consolidation has capital resources below its minimum regulatory requirement.
Market risk management
Details of changes in our market risk profile in 2016 can be found on page 85, in 'Key developments and risk profile in 2016'.
There were no material changes to our policies and practices for the management of market risk in 2016.
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.
Risk types
Trading risk
Non-trading risk
•
Foreign exchange and commodities
•
Interest rates
•
Credit spreads
•
Equities
•
Structural foreign exchange
•
Interest rates1
•
Credit spreads
Global business
GB&M and BSM2
GB&M, BSM2,
GPB, CMB and RBWM
Risk measure
VaR | Sensitivity z">VaR VaR. The management of this risk is described on page 106.
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.
 
 
 
Group Chairman/
Group Chief Executive
 
 
 
Risk Management Meeting of the GMB
 
 
 
Group traded risk
 
 
 
 
 
 
Specific
measures
 
 
Entity risk management committee
 
 
 
Principal office manager
 
 
 
 
Business/desk/trader
 
 
 
 
 
 

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Market risk mea sures
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 which incorporate 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 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.
We hedge structural foreign exchange exposures only in limited circumstances. Our structural foreign exchange exposures are managed with the primary objective of ensuring, where

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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.
Interest rate risk in the banking book
The Asset, Liability and Capital Management ('ALCM') function is responsible for measuring and controlling interest rate risk in the banking book under the supervision of the RMM.
The component of the interest rate risk in the banking book outside Balance Sheet Management ('BSM') or Global Markets that can be economically neutralised by fixed-rate government bonds or interest rate derivatives is transfer priced to and managed by BSM. The banking book interest rate risk transferred to BSM is reflected in the Group's non-traded VaR measure.
BSM is overseen by the Market Risk and Product Control functions in exactly the same way as Global Markets.
The price at which interest rate risk is transferred to BSM is determined by the entity's prevailing interest rate risk transfer pricing curve defined by operating entities Asset and Liability Management Committee ('ALCO'), in accordance with the Group's funds transfer pricing policies. The transfer price seeks to reflect the price at which BSM could neutralise the risk in the market at the point of transfer.
The banking book interest rate risk within HSBC Holdings is not transferred to BSM and is managed as an ALCO book.
Interest rate risk behaviouralisation
In assessing the banking book interest rate risk outside BSM and Global Markets, interest rate repricing behaviouralisation techniques are used where the interest repricing profile is uncertain due to customer/bank optionality or where non-interest bearing balances are withdrawable.
The maximum tenor to which any individual tranche of a non-interest bearing withdrawable/repayable customer balance or equity can be behaviouralised is 10 years. The maximum weighted average behaviouralised tenor for any portfolio is five years. Interest-bearing managed/administered rate balances are behaviouralised to tenors less than one year, typically one month or three months.
The maximum percentage of any portfolio that can be behaviouralised is 90% with the residual treated as contractual, meaning overnight.
Unlike liquidity risk, which is assessed on the basis of a very severe stress scenario, banking book interest rate risk is assessed and managed according to business-as-usual conditions. In many cases, the contractual profile of banking book assets/liabilities arising from assets/liabilities created outside Markets or BSM does not reflect the behaviour observed.
Where there is no certainty with regard to interest rate repricing profile, behaviouralisation is used to assess the market interest rate risk of banking book assets/liabilities and this assessed market risk is transferred to BSM, in accordance with the rules governing the transfer of interest rate risk from the global businesses to BSM.
Behaviouralisation is applied in three key areas:
•
the assessed repricing frequency of managed rate balances;
•
the assessed duration of non-interest bearing balances, typically capital and current accounts; and
•
the base case expected prepayment behaviour or pipeline take-up rate for fixed-rate balances with embedded optionality.
Interest rate behaviouralisation policies have to be formulated in line with the Group's behaviouralisation policies and approved at least annually by local ALCOs.
 
The extent to which balances can be behaviouralised is driven by:
•
the amount of the current balance that can be assessed as constant under business-as-usual conditions; and
•
for managed rate balances, the historical market interest rate repricing behaviour observed; or
•
for non-interest bearing balances, the duration for which the balance is expected to remain under business-as-usual conditions. This assessment is often driven by the re-investment tenors available to BSM to neutralise the risk through the use of fixed-rate government bonds or interest rate derivatives, and for derivatives the availability of cash flow hedging capacity.
Measurement of interest rate risk in the banking book
Interest rate risk in the banking book is measured and controlled using three metrics:
•
non-traded VaR;
•
net interest income sensitivity; and
•
economic value of equity.
Non-traded VaR excludes the non-traded interest rate risk not transferred to BSM and the non-traded interest rate risk of HSBC Holdings.
Net interest income ('NII') sensitivity captures the expected impact of changes in interest rates on base case projected net interest income.
Economic value of equity ('EVE') captures the expected impact of changes in interest rates on base case economic value. It captures all non-traded items irrespective of the profit and loss accounting treatment.
Balance Sheet Management
Effective governance across BSM is supported by the dual reporting lines it has to the Chief Executive Officer of GB&M and to the Group Treasurer. In each operating entity, BSM is responsible for managing liquidity and funding under the supervision of the local ALCO (which usually meets on a monthly basis). It also manages the banking book interest rate positions transferred to it within a Markets limit structure.
In executing the management of the liquidity risk on behalf of ALCO, and managing the banking book interest rate positions transferred to it, BSM invests in highly rated liquid assets in line with the Group's liquid asset policy. The majority of the liquidity is invested in central bank deposits and government, supranational and agency securities, with most of the remainder held in short-term interbank and central bank loans.
Withdrawable central bank deposits are accounted for as cash balances. Interbank loans, statutory central bank reserves and loans to central banks are accounted for as loans and advances to banks. BSM's holdings of securities are accounted for as available-for-sale or, to a lesser extent, held-to-maturity assets.
Statutory central bank reserves are not recognised as liquid assets. The statutory reserves that would be released in line with the Group's stressed customer deposit outflow assumptions are reflected as stressed inflows.
BSM is permitted to use derivatives as part of its mandate to manage interest rate risk. Derivative activity is predominantly through the use of vanilla interest rate swaps which are part of cash flow hedging and fair value hedging relationships.
Credit risk in BSM is predominantly limited to short-term bank exposure created by interbank lending, exposure to central banks and high-quality sovereigns, supranationals or agencies which constitute the majority of BSM's liquidity portfolio. BSM does not manage the structural credit risk of any Group entity balance sheet.
BSM is permitted to enter into single name and index credit derivatives activity, but it does so to manage credit risk on the

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exposure specific to its securities portfolio in limited circumstances only. The risk limits are extremely limited and closely monitored. At 31 December 2016, BSM had no open credit derivative index risk.
VaR is calculated on positions held in BSM and is calculated by applying the same methodology used for the Markets business and utilised as a tool for market risk control purposes.
The vast majority of BSM's VaR arises from banking book portfolios and is classified as non-traded VaR.
BSM is predominantly involved in managing liquidity in accordance with the LFRF, managing the daily cash position and managing the non-traded interest rate risk transferred to it, within non-traded market risk limits.
Net interest income 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.
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 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 assumption, other than instances where the size of the balances or repricing is deemed interest rate sensitive (non-interest bearing current account migration and fixed rate loan early prepayment) and where non-traded VaR is assumed to contractually run off. This effect, however, does not incorporate actions which would probably be taken by BSM or in the business units to mitigate the effect of interest rate risk. In reality, BSM proactively seeks to change the interest rate risk profile to optimise net revenues. 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 and then 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 interest rates over which the entity has discretion in terms of the timing and extent of rate changes.
Economic value of equity
An economic value of equity ('EVE value') represents the present value of future banking book cash flows that could be distributed to equity providers under a managed run-off scenario, which represents the current book value of equity plus the present value of future net interest income under a managed run-off scenario. The present value of net interest income under a managed run-off and under any interest rate scenario can therefore be assessed by deducting the book value of equity from the EVE value calculated.
An EVE sensitivity is the extent to which the EVE value will change due to a pre-specified movement in interest rates, where all other economic variables are held constant. The EVE sensitivity represents the sensitivity of discounted net interest income plus the sensitivity of the net present value of any transactions used to hedge the interest income earned on equity. If the EVE sensitivity is adjusted to remove the sensitivity in net present value of any transactions used to hedge the interest income earned on equity, the resulting adjusted EVE sensitivity represents the extent to which, under a managed run-off scenario, discounted net interest income is sensitive to a pre-specified movement in interest rates.
 
When assessing the sensitivity of economic value of equity to interest rate movements, the timing of principal cash flows can vary but the amount remains constant.
Operating entities are required to monitor EVE sensitivity as a percentage of total capital resources and adjusted EVE sensitivity as a percentage of the present value of future net interest income (base case EVE minus book value of equity) under a managed run-off assumption.
EVE can also be used for assessing the economic capital required to support interest rate risk in the banking book ('IRRBB'):
•
Where EVE under any scenario is higher than the current balance sheet carrying value of equity, the banking book income stream is positive (i.e. profit) and therefore capital accretive under that scenario and no economic capital for IRRBB is required.
•
Where EVE of any scenario is lower than the current balance sheet carrying value of equity, the banking book income stream is negative (i.e. loss) and therefore capital deductive under that scenario and economic capital for IRRBB should be held against this loss.
Where banking book assets/liabilities are fair valued through profit and loss or where the fair value changes impact capital resources (i.e. available for sale), economic capital for this interest rate sensitivity is additionally assessed using a stressed VaR approach.
HSBC Holdings
As a financial services holding company, HSBC Holdings has limited market risk activity. 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; providing dividend payments to its equity shareholders and interest payments to providers of debt capital; and maintaining a supply of short-term capital resources for deployment under extraordinary circumstances. It does not take proprietary trading positions.
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 2016 can be found on page 121, in 'Operational risk exposures in 2016'.
Responsibility for minimising operational risk lies with all HSBC's employees. Specifically, all staff are required to manage the operational risks of the business and operational activities for which they are responsible.
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.

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Key developments in 2016
HSBC's operational risk management framework ('ORMF') is our overarching approach for managing operational risk, the purpose of which is to:
•
identify and manage our non-financial operational risks in an effective manner;
•
remain within the Group's operational risk appetite, which helps the organisation understand the level of risk it is willing to accept; and
•
drive forward-looking risk awareness and assist management focus during 2016.
Activity to strengthen our risk culture and better embed the use of the ORMF was further implemented in 2016, in particular the use of the activity-based three lines of defence model, which sets out roles and responsibilities for managing operational risks 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 68.
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.
Operational risk is organised as a specific risk discipline within Global Risk, and a formal governance structure provides oversight over its management. The Global Operational Risk sub-function supports the Group Chief Risk Officer and the Global Operational Risk Committee. It is responsible for leading the embedding of the ORMF and assurance of adherence to associated policies and processes across the first and second lines. It is also responsible for preparation of operational risk reporting at Group level, including reports for consideration by the RMM and the Group Risk Committee. The Global Operational Risk Committee meets at least quarterly to discuss key risk issues and review the effective implementation of the ORMF.
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 centralised database is used to record the results of the operational risk management process. Operational risk and control self-assessments are inputted and maintained by business units. Business and functional management and business risk and control managers 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 operational risk database and reported to the RMM 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, supporting the business in delivering fair outcomes for customers, maintaining the integrity of financial markets and achieving HSBC's strategic objectives.
Key developments in 2016
In the second half of 2016, we restructured part of our Global Risk function. The Financial Crime Compliance sub-function became part of our new Financial Crime Risk function, which reports directly to the Group Chief Executive (see 'Financial crime risk management' below). The RC sub-function remains part of Global Risk, and continues to oversee management of regulatory compliance risk.
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.
Conduct of business
In 2016, we continued to take steps to raise our standards relating to conduct, which included:
•
designing further global mandatory conduct training for delivery to all employees in 2017;
•
incorporating the assessment of expected values and behaviours as key determinants in recruitment, performance appraisal and remuneration processes;
•
improving our Group-wide market surveillance capability;
•
introducing policies and procedures to strengthen support for potentially vulnerable customers;
•
enhancing the quality and depth of conduct management information and how it is used across the Group;
•
implementing an assessment process to check the effectiveness of our conduct initiatives across the Group; and
•
assessing conduct standards and practices within our key third-party suppliers and distributors.
The Board maintained oversight of conduct matters through the Conduct & Values Committee.
Further information on our conduct is provided in the Strategic Report on page 22 and www.hsbc.com. For conduct-related costs relating to significant items, see page 62.
Financial crime risk management
Overview
In the second half of 2016, we established a Financial Crime Risk ('FCR') function and appointed a Group Head of FCR, who reports to the Group Chief Executive and chairs the Global Standards Steering Meeting. FCR is a global function that brings together all areas of financial crime risk management at HSBC and is dedicated to implementing the most effective global standards to combat financial crime. The function has been set up to enable us to build on our achievements in managing financial crime risk effectively across the bank and

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to continue to strengthen financial crime detection, and anti-money laundering ('AML'), sanctions and anti-bribery and corruption compliance.
Key developments in 2016
The FCR function encompasses FCR Assurance, Financial Crime Compliance, Financial Crime Threat Mitigation, the Global Standards programme, the Monitor Liaison Office, FCR Strategy Implementation, FCR Chief of Staff and FCR COO.
The structure has been designed around the following key principles:
•
FCR sets policy and standards, provides subject matter expertise and guidance, drives execution at country level via regions, and maintains line of business subject matter expertise in support of the global businesses.
•
Country-level execution accountability is driven by a common set of global principles with material variations managed by exception.
•
Sub-functions within FCR are leveraged across the global function, ensuring consistency and utilising expertise and resourcing.
Key risk management processes
We continue to embed policies and procedures, introduce new technology solutions and support the cultural change needed to effectively manage financial crime risk. A key enhancement during 2016 was the deployment of our global customer due diligence system to 35 markets for RBWM, 52 for CMB, 36 for GB&M and two for GPB. This, along with the enhanced financial crime risk training that we have taken more than 3,500 senior leaders through globally, will help ensure our people have the guidance and tools that they need.
The Group Head of FCR attends the Financial System Vulnerabilities Committee ('FSVC'), which reports to the Board on matters relating to financial crime and financial system abuse and provides a forward-looking perspective on financial crime risk, as well as cyber and information security. In 2016, the FSVC assumed responsibility from the CVC for oversight of controls relating to anti-bribery and corruption.
Throughout the year the Committee received regular reports from country chief executives on the actions being taken by management to address local financial crime risk issues and vulnerabilities, and also received reports on specific issues.
The Monitor
Under the agreements entered into with the DoJ and the FCA in 2012, including the five-year US DPA, the Monitor 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.
In February 2017, the Monitor delivered his third annual follow-up review report based on various thematic and country reviews he had conducted over the course of 2016. In his report, the Monitor concluded that, in 2016, HSBC continued to make progress in enhancing its financial crime compliance controls, including improvements to its Global AML policies and procedures. However, the Monitor also expressed significant concerns about the pace of that progress, instances of potential financial crime that the DoJ and HSBC are reviewing further and on-going systems and control deficiencies that in his view raised questions as to whether HSBC is adhering to its obligations under the US DPA - a matter that would be determined by the DoJ in its sole discretion. The Monitor also found that there remain substantial challenges for HSBC to meet its goal of developing a reasonably effective and sustainable AML and sanctions compliance programme. In addition, the Monitor did not certify as to HSBC's implementation of and adherence to remedial measures specified in the US DPA. The 'US deferred prosecution
 
agreement and related agreements and consent orders' are discussed in 'Top and emerging risks' on page 64.
Throughout 2016, the FSVC received regular reports on HSBC's relationship with the Monitor and its compliance with the US DPA. The FSVC received regular updates on the preliminary findings arising from the Monitor's third annual review, and has received the Monitor's third annual review report.
Insurance manufacturing operations risk management
Details of changes in our insurance manufacturing operations risk profile in 2016 can be found on page 121, in '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 2016.
Governance
(Audited)
Insurance risks are managed to a defined risk appetite, which is aligned to the Group risk appetite and risk management framework, including the Group three lines of defence model. For details of the Group's governance framework, see page 68. The Group 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 the 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, 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 a range of strategies that could be employed including the hedging of investment risk, repricing current products to reflect lower interest rates, improving risk diversification, moving towards less capital intensive products, and developing investment strategies to optimise the expected returns against the cost of economic capital.
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,

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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 also 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 to best 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.
•
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 local insurance manufacturing subsidiaries, and are aggregated and reported to the Group Insurance Credit Risk and Group Credit Risk functions. Stress testing is performed by Group Insurance on the investment credit exposures using credit spread sensitivities and default probabilities.
We use a number of tools to manage and monitor credit risk. These include a credit report which contains a watch-list of investments with current credit concerns. The report is circulated monthly to senior management in Group Insurance and the individual country chief risk officers to identify investments which 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:
•
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
There were no material changes to our policies and practices for the management of reputational risk in 2016.
Overview
Reputational risk relates to stakeholders' perceptions, whether fact-based or otherwise. 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 lapse in standards of integrity, compliance, customer service or operating efficiency represents a potential reputational risk.
Governance and structure
The development of policies, management and mitigation of reputational risk are coordinated through the Group Reputational Risk Policy Committee, which is chaired by the Group Chairman. In parallel, the Global Risk Resolution Committee, chaired by the Chief Risk Officer, is the highest decision-making forum in the Group for 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 our regions and global businesses. Both committees keep the RMM apprised of areas and activities presenting significant reputational risk and, where appropriate, make recommendations to the RMM to mitigate such risks. Significant issues posing reputational risk are also reported to the Board and the Conduct & Values Committee, where appropriate.
Key risk management processes
The External Affairs 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 Group 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 is jointly managed by 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 HSBC 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.
We have taken, and are taking, measures to address the requirements of the US DPA and enhance our AML, sanctions

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and other regulatory compliance frameworks. These measures should also enhance our reputational risk management in the future. For further details on our financial crime risk, see 'Financial crime risk management' on page 81.
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 2016
In 2016, we issued a revised mining and metals policy. It replaced the one introduced in 2007, and responds to increasing concerns regarding climate change by addressing thermal coal mining, and provides more details on how we deal with human rights issues in the sector.
We also created a new training module for relevant relationship managers globally on our sustainability risk policies and their responsibilities, to ensure consistent implementation. Furthermore, we continued to improve the way sustainability risk is recorded in our information management system.
Governance and structure
The Global Risk function, with input from the Global Corporate Sustainability function, is mandated to manage sustainability risk globally, working through 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 they provide finance to; 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 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 2016.
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 is in place. Pension risk is managed by a network of local and regional pension risk forums. The Global Pensions Oversight Committee 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;
•
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 years and more frequently if required by local legislation or circumstances. The process generally involves an extensive asset and liability review.

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Key developments and risk profile in 2016
Key developments in 2016
In 2016, HSBC undertook a number of initiatives to enhance its approach to the management of risk. These included:
•
Implementing a new internal liquidity and funding risk management framework which uses the liquidity coverage ratio and net stable funding ratio regulatory framework as a foundation, as described on page 75 of the 'Liquidity and funding risk management' section.
•
Undertaking activities to strengthen our risk culture and further embed the use of the operational risk management framework, as described on page 81 of the 'Operational risk management' section.
•
Implementing a number of initiatives to raise our standards in relation to the conduct of our business, as described on page 81 of the 'Regulatory compliance risk management' section.
•
Restructuring part of our Global Risk function. The Financial Crime Compliance sub-function became part of our new Financial Crime Risk ('FCR') function. The Regulatory Compliance sub-function remains part of Global Risk, and continues to oversee management of regulatory compliance risk.
•
Establishing an FCR function and appointing a Group Head of FCR, who chairs the Global Standards Steering Meeting and reports to the Group Chief Executive, to oversee all areas of financial crime risk management at HSBC. The FCR function is dedicated to implementing the most effective global standards to combat financial crime, as described on page 81 of the 'Financial crime risk management' section.
•
Issuing a revised mining and metals policy and creating a new training module for relevant relationship managers globally on our sustainability risk policies and their responsibilities, to ensure consistent implementation, as described on page 84 in the 'Sustainability risk management' section.
There were no material changes to our policies and practices for the management of credit risk, market risk, insurance manufacturing operations risk, reputational risk and sustainability risk in 2016.
Credit risk profile
 
 
Page
Credit risk in 2016
85
Credit exposure
86
Wholesale lending
94
Personal lending
100
HSBC Finance
102
Supplementary information
104
HSBC Holdings
105
Securitisation exposures and other structured products
105
Credit risk in 2016
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.
A summary of our current policies and practices regarding the management of credit risk is set out on pages 73 to 75.
The effect of commodity price movements in the oil and gas sectors is provided in 'Areas of special interest' on page 67.
 
Gross loans and advances declined by $67bn, mainly due to foreign exchange effects reducing balances by $68bn.
Loan impairment charges and other credit provisions for the year were $3.4bn.
In wholesale lending, balances declined by $33bn mainly due to foreign exchange movements of $41bn. Excluding foreign exchange movements, lending balances decreased in North America, and in Middle East and North Africa but were more than offset by increases in Asia and Latin America. Europe lending balances were broadly unchanged.
In personal lending, balances decreased by $34bn, mainly due to foreign exchange movements of $26bn and $13bn in North America largely due to continued repayments and loan sales in the US CML run-off portfolio. Excluding foreign exchange movements and the US CML run-off portfolio, lending balances increased in Europe, Asia and Latin America and were offset by a decrease in Middle East and North Africa.
Information on constant currency movements is provided on page 30.
Summary of credit risk
 
2016

2015

 
 
$bn

$bn

Page

At 31 Dec
 
 
 
2,898

2,947

86

- total assets subject to credit risk
2,205

2,234

 
- off-balance sheet commitments subject to credit risk
693

713

 
958

1,024

 
- personal lending
340

374

101

- wholesale lending
618

650

95

18

24

90

- personal lending
6

12

 
- wholesale lending
12

12

 
 
%

%

 
Impaired loans as a % of gross loans and advances


 
 
- personal lending
1.8

3.1

 
- wholesale lending
1.9

1.9

 
- personal and wholesale lending
1.9

2.3

 
 
$bn

$bn

 
Impairment allowances
7.9

9.6

94

- personal lending
2.0

2.9

101

- wholesale lending
5.9

6.7

96

Loans and advances net of
impairment allowances
950

1,015

 
For year ended 31 Dec


 
 
Loan impairment charge
3.3

3.6

92

- personal lending
1.7

1.8

 
- wholesale lending
1.6

1.8

 
Other credit risk provisions
0.1

0.1

 
 
3.4

3.7

 

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Report of the Directors | Risk


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)
 
2016
 
2015


 
Loan impairment charges by industry ($bn)
 
2016
 
2015

Loan impairment allowances over five years ($bn)
 
 
Personal
 
 
 
Wholesale
 
 
 
 
 
 
 
 
 
t
 
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 balance sheet movements is provided on page 42.
The offset on derivatives remains in line with the movements in maximum exposure amounts.
The offset on corporate and commercial loans to customers decreased by $17bn. This reduction was mainly related to corporate overdraft balances where a small number of clients benefited from the use of net interest arrangements across overdrafts and deposits. As a result, net risk exposures are usually stable, while gross balances can be volatile.

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'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 30 and pages 198 and 201 of the Financial Statements for further details of collateral in respect of certain loans and advances and derivatives.
Maximum exposure to credit risk
(Audited)
 
 
2016
2015
 

Maximum
exposure

Offset

Net

Maximum
exposure

Offset

Net

 
 
$m

$m

$m

$m

$m

$m

Derivatives
 
290,872

(262,233
)
28,639

288,476

(258,755
)
29,721

Loans and advances to customers held at amortised cost
 
861,504

(33,657
)
827,847

924,454

(52,190
)
872,264

- personal
 
337,826

(3,629
)
334,197

371,203

(5,373
)
365,830

- corporate and commercial
 
460,209

(27,686
)
432,523

493,078

(44,260
)
448,818

- non-bank financial institutions
 
63,469

(2,342
)
61,127

60,173

(2,557
)
57,616

Loans and advances to banks held at amortised cost
 
88,126

(248
)
87,878

90,401

(53
)
90,348

Reverse repurchase agreements - non-trading
 
160,974

(4,764
)
156,210

146,255

(900
)
145,355

Total balance sheet exposure to credit risk
 
2,204,751

(300,902
)
1,903,849

2,234,409

(311,898
)
1,922,511

Total off-balance sheet
 
692,915

-

692,915

712,546

-

712,546

- financial guarantees and similar contracts
 
37,072

-

37,072

46,116

-

46,116

- loan and other credit-related commitments
 
655,843

-

655,843

666,430

-

666,430

At 31 Dec
 
2,897,666

(300,902
)
2,596,764

2,946,955

(311,898
)
2,635,057


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 to generate growth in 2016.
For an analysis of:
•
financial investments, see Note 15 to the Financial Statements;
•
trading assets, see Note 10 to the Financial Statements;
 
•
derivatives, see page 99 and Note 14 to 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 94 for wholesale lending and page 100 for personal lending.

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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 105.
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. The changes to the mapping of sovereign external ratings to credit quality bands, described on page 73, mainly impacts the credit quality of financial investments in 2016 with an increase in the 'Strong' rating band and a decrease in the 'Good' and 'Satisfactory' rating bands.

 
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
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

 
Assets held for sale
1,774

536

392

266

236

1,030

4,234

(250
)
3,984

 
Other assets
11,203

5,348

9,227

805

124

221

26,928



26,928

 
- 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

 
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







88
HSBC Holdings plc Annual Report and Accounts 2016

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
97,365

583

939

47





98,934



98,934

Items in the course of collection from other banks
5,318

32

416

2





5,768



5,768

Hong Kong Government certificates of indebtedness
28,410

-

-

-





28,410



28,410

Trading assets
116,633

21,243

19,894

576

 
 
158,346

 
158,346

- treasury and other eligible bills
6,749

790

190

100

 
 
7,829

 
7,829

- debt securities
77,088

10,995

10,656

299

 
 
99,038

 
99,038

- loans and advances to banks
14,546

4,391

3,239

127

 
 
22,303

 
22,303

- loans and advances
to customers
18,250

5,067

5,809

50

 
 
29,176

 
29,176

Financial assets designated at fair value
3,037

701

736

383





4,857



4,857

Derivatives
248,101

32,056

7,209

1,110





288,476



288,476

Loans and advances to customers
held at amortised cost
472,691

214,152

194,393

16,836

12,179

23,758

934,009

(9,555
)
924,454

- personal
309,720

29,322

15,021

944

7,568

11,507

374,082

(2,879
)
371,203

- corporate and commercial
127,673

168,772

171,466

15,379

4,274

11,949

499,513

(6,435
)
493,078

- non-bank financial institutions
35,298

16,058

7,906

513

337

302

60,414

(241
)
60,173

Loans and advances to banks held
at amortised cost
73,226

11,929

4,836

407

1

20

90,419

(18
)
90,401

Reverse repurchase agreements
- non-trading
108,238

16,552

20,931

46

-

488

146,255

-

146,255

Financial investments
382,328

18,600

16,341

4,525

-

1,326

423,120



423,120

Assets held for sale
10,177

9,605

17,279

1,635

703

2,133

41,532

(1,454
)
40,078

Other assets
8,306

5,688

10,204

632

147

333

25,310

 
25,310

- endorsements and acceptances
1,084

3,850

3,798

343

22

52

9,149

 
9,149

- accrued income and 
other
7,222

1,838

6,406

289

125

281

16,161

 
16,161

At 31 Dec 2015
1,553,830

331,141

293,178

26,199

13,030

28,058

2,245,436

(11,027
)
2,234,409

 
%

%

%

%

%

%

%

 
 
Percentage of total gross amount
69.2

14.7

13.1

1.2

0.6

1.2

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 90.
In North America, past due but not impaired balances decreased, mainly due to the continued repayments and loan sales in the US CML run-off portfolio.

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 2016
1,206

3,484

1,260

2,549

529

9,028

At 31 Dec 2015
1,599

3,444

1,263

5,474

1,250

13,030


HSBC Holdings plc Annual Report and Accounts 2016
89

Report of the Directors | Risk


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
6,743

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

Assets held for sale
194

29

13

-

-

236

- disposal group
11

3

3

-

-

17

- non-current assets held for sale
183

26

10

-

-

219

Other financial instruments
70

18

10

12

14

124

At 31 Dec 2016
7,007

1,367

610

23

21

9,028

 
 
 
 
 
 
 
Loans and advances to customers and banks held at amortised cost
9,403

1,917

727

111

21

12,179

- personal
5,665

1,401

502

-

-

7,568

- corporate and commercial
3,432

505

225

93

19

4,274

- financial
306

11

-

18

2

337

Assets held for sale
476

137

90

-

-

703

- disposal group
476

136

89

-

-

701

- non-current assets held for sale
-

1

1

-

-

2

Other financial instruments
80

35

14

10

9

148

At 31 Dec 2015
9,959

2,089

831

121

30

13,030

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 continued repayments and loan sales in the US CML run-off portfolio reduced impaired loan balances by a further $4.2bn.
Movement in impaired loans by industry sector
 
2016
2015
 
Personal

Corporate and commercial

Financial

Total

Personal

Corporate and commercial

Financial

Total

 
$m

$m

$m

$m

$m

$m

$m

$m

At 1 Jan
11,507

11,949

322

23,778

15,160

13,795

375

29,330

Classified as impaired during the year
3,521

6,032

133

9,686

5,995

5,469

96

11,560

Transferred from impaired to unimpaired during the year
(1,210
)
(922
)
(7
)
(2,139
)
(2,346
)
(922
)
(38
)
(3,306
)
Amounts written off
(1,252
)
(1,720
)
(11
)
(2,983
)
(2,263
)
(1,424
)
(14
)
(3,701
)
Net repayments and other
(6,076
)
(3,977
)
(61
)
(10,114
)
(5,039
)
(4,969
)
(97
)
(10,105
)
At 31 Dec
6,490

11,362

376

18,228

11,507

11,949

322

23,778


90
HSBC Holdings plc Annual Report and Accounts 2016

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
4,354

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
%
 
 
 
 
 
 
 
Non-renegotiated impaired loans
4,583

1,760

1,051

2,177

623

10,194

- personal
1,361

385

475

1,786

211

4,218

- corporate and commercial
3,135

1,368

552

389

411

5,855

- financial
87

7

24

2

1

121

Renegotiated impaired loans
4,682

615

1,127

6,753

407

13,584

- personal
878

131

41

6,208

31

7,289

- corporate and commercial
3,607

480

1,086

545

376

6,094

- financial
197

4

-

-

-

201

At 31 Dec 2015
9,265

2,375

2,178

8,930

1,030

23,778

Impaired loans % of total gross loans and advances
2.3
%
0.6
%
4.6
%
6.5
%
4.8
%
2.3
%
 
 
 
 
 
 
 
Currency translation adjustment
(1,170
)
(22
)
(194
)
12

(162
)
(1,536
)
31 Dec 2015 at 31 Dec 2016 exchange rates
8,095

2,353

1,984

8,942

868

22,242

Movement - constant currency basis
(33
)
146

246

(4,100
)
(273
)
(4,014
)
31 Dec 2016 as reported
8,062

2,499

2,230

4,842

595

18,228

Renegotiated loans and forbearance
The most significant portfolio of renegotiated loans was in North America, substantially all of which were retail loans held by HSBC Finance Corporation ('HSBC Finance'). The ongoing repayments and loan sales in the US CML run-off portfolio reduced renegotiated loans by $8.7bn during 2016.
 
The following tables show the gross carrying amounts of the Group's holdings of renegotiated loans and advances to customers by industry sector, geography, credit quality classification and arrangement type.

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
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

 
 
 
 
 
 
Neither past due nor impaired
3,973

716

2,152

391

7,232

Past due but not impaired
1,753

243

123

24

2,143

Impaired
6,556

733

6,094

201

13,584

At 31 Dec 2015
12,282

1,692

8,369

616

22,959

Impairment allowances on renegotiated loans
870

252

2,098

119

3,339

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 2016
5,855

1,046

1,871

3,736

332

12,840

At 31 Dec 2015
7,121

943

1,945

12,372

578

22,959


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 tables below 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.

HSBC Holdings plc Annual Report and Accounts 2016
91

Report of the Directors | Risk


Renegotiated loans by arrangement type: personal lending
 
%
Interest rate and terms modifications
21.9
Payment concessions
14.3
Collection re-age
19.2
Modification re-age
34.6
Other
10.0
At 31 Dec 2016
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
 
%
Maturity term extensions
37.3
Reductions in margin, principal forgiveness, debt equity swaps and interest, fees or penalty payment forgiveness
21.4
Other changes to repayment profile
19.4
Interest only conversion
9.3
Other
12.6
At 31 Dec 2016
100.0
 
Impairment of loans and advances
(Audited)
For an analysis of loan impairment charges and other credit risk provisions by global business, see page 38.
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

 
$m

$m

$m

$m

$m

$m

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
533

654

292

709

1,162

3,350

 
 
 
 
 
 
 
Personal
109

309

276

157

983

1,834

- first lien residential mortgages
(8
)
(1
)
50

70

41

152

- other personal
117

310

226

87

942

1,682

Corporate and commercial
415

372

212

319

451

1,769

- manufacturing and international trade and services
138

250

127

26

305

846

- commercial real estate and other property-related
33

18

49

24

47

171

- other commercial
244

104

36

269

99

752

Financial
14

-

(18
)
(7
)
-

(11
)
At 31 Dec 2015
538

681

470

469

1,434

3,592

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
0.23

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

 
 
 
 
 
 
 
New allowances net of allowance releases
0.26

0.23

1.35

0.41

5.37

0.48

Recoveries
(0.11
)
(0.05
)
(0.14
)
(0.06
)
(0.50
)
(0.09
)
At 31 Dec 2015
0.15

0.18

1.21

0.35

4.87

0.39

Amount written off net of recoveries
0.22

0.12

1.17

0.45

3.94

0.37


92
HSBC Holdings plc Annual Report and Accounts 2016

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 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

 
 
 
 
 
 
 
At 1 Jan 2015
3,971

1,356

1,890

2,640

2,529

12,386

Amounts written off












Personal
(468
)
(416
)
(273
)
(554
)
(996
)
(2,707
)
- first lien residential mortgages
(12
)
(6
)
(1
)
(344
)
(24
)
(387
)
- other personal
(456
)
(410
)
(272
)
(210
)
(972
)
(2,320
)
Corporate and commercial
(644
)
(179
)
(235
)
(106
)
(309
)
(1,473
)
- manufacturing and international trade and services
(233
)
(149
)
(215
)
(28
)
(213
)
(838
)
- commercial real estate and other property-related
(244
)
(5
)
(8
)
(57
)
(30
)
(344
)
- other commercial
(167
)
(25
)
(12
)
(21
)
(66
)
(291
)
Financial
(12
)
-

-

(2
)
-

(14
)
Total amounts written off
(1,124
)
(595
)
(508
)
(662
)
(1,305
)
(4,194
)
Recoveries of amounts written off in previous years












Personal
320

135

50

57

119

681

- first lien residential mortgages
6

4

-

26

(17
)
19

- other personal
314

131

50

31

136

662

Corporate and commercial
46

30

3

18

27

124

- manufacturing and international trade and services
16

20

2

8

15

61

- commercial real estate and other property-related
24

5

-

5

2

36

- other commercial
6

5

1

5

10

27

Financial
2

-

-

1

-

3

Total recoveries of amounts written off in previous years
368

165

53

76

146

808

Charge to income statement
538

681

470

469

1,434

3,592

Exchange and other movements
(276
)
(82
)
(95
)
(482
)
(2,084
)
(3,019
)
At 31 Dec 2015
3,477

1,525

1,810

2,041

720

9,573

Impairment allowances against banks:












- individually assessed
-

-

18

-

-

18

Impairment allowances against customers:












- individually assessed
2,572

908

1,157

327

438

5,402

- collectively assessed
905

617

635

1,714

282

4,153

Impairment allowances at 31 Dec 2015
3,477

1,525

1,810

2,041

720

9,573



HSBC Holdings plc Annual Report and Accounts 2016
93

Report of the Directors | Risk

< /div>

Movement in impairment allowances on loans and advances to customers and banks
(Audited)
 
2016
2015
 
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
18

5,402

4,153

9,573

49

6,195

6,142

12,386

Amounts written off
(18
)
(1,831
)
(1,607
)
(3,456
)
-

(1,368
)
(2,826
)
(4,194
)
Recoveries of loans and advances previously written off
-

107

520

627

-

86

722

808

Charge to income statement
-

1,831

1,519

3,350

(11
)
1,516

2,087

3,592

Exchange and other movements
-

(577
)
(1,667
)
(2,244
)
(20
)
(1,027
)
(1,972
)
(3,019
)
At 31 Dec
-

4,932

2,918

7,850

18

5,402

4,153

9,573

Impairment allowances % of loans and advances
-

0.6
%
0.3
%
0.8
%
-

0.6
%
0.4
%
0.9
%
Wholesale lending
Total wholesale lending balances declined by $33bn including foreign exchange movements of $41bn, of which $31bn related to the UK. In North America, lending decreased by $6.1bn, mainly in the US as paydowns and maturities exceeded new loan originations. This reflected our efforts to improve returns with more disciplined lending.
In Middle East and North Africa, overall lending fell by $5.8bn, including $3.4bn of foreign exchange movements. Other
 
causes of the decline were mainly in Turkey, where some portfolios are being reduced, and in the UAE, where we sold loans and exited certain customer relationships. These decreases were partly offset by loan growth mainly in Egypt and Oman.
In Asia, lending balances increased by $13bn. This reflected strong credit growth in the fourth quarter of 2016 across a range of industries, and principally in Hong Kong, partly offset by foreign exchange decreases of $3.8bn.

94
HSBC Holdings plc Annual Report and Accounts 2016

Total wholesale lending gross loans
 
Europe

Asia

MENA

North America

Latin America

Total

As a % of total gross loans
 
$m

$m

$m

$m

$m

$m

%
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
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

 
 
 
 
 
 
 
 
 
Corporate and commercial
187,508

211,224

26,525

62,882

11,374

499,513

48.8
- manufacturing
36,623

34,272

4,884

17,507

2,572

95,858

9.4
- international trade and services
61,598

72,199

10,621

11,505

3,096

159,019

15.5
- commercial real estate
26,148

32,371

798

7,032

1,577

67,926

6.7
- other property-related
7,129

35,206

2,102

8,982

45

53,464

5.2
- government
3,653

1,132

1,695

203

772

7,455

0.7
- other commercial
52,357

36,044

6,425

17,653

3,312

115,791

11.3
Financial
50,447

68,321

11,761

16,308

3,996

150,833

14.7
- non-bank financial institutions
33,345

13,969

2,597

9,822

681

60,414

5.9
- banks
17,102

54,352

9,164

6,486

3,315

90,419

8.8
Gross loans at 31 Dec 2015
237,955

279,545

38,286

79,190

15,370

650,346

63.5
 
 
 
 
 
 
 
 
Currency translation adjustment
(32,287
)
(3,846
)
(3,446
)
557

(2,316
)
(41,338
)
 
31 Dec 2015 at 31 Dec 2016 exchange rates
205,668

275,699

34,840

79,747

13,054

609,008

 
Movement - constant currency basis
(349
)
16,403

(2,392
)
(6,648
)
1,660

8,674

 
31 Dec 2016 as reported
205,319

292,102

32,448

73,099

14,714

617,682

 
Loan and other credit-related commitments
125,029

171,566

20,829

126,912

19,151

463,487

 
- corporate and commercial
104,832

159,947

20,610

102,369

18,155

405,913

 
- financial
20,197

11,619

219

24,543

996

57,574

 

HSBC Holdings plc Annual Report and Accounts 2016
95

Report of the Directors | Risk


Total wholesale lending impairment allowances
 
Europe

Asia

MENA

North America

Latin America

Total

 
$m

$m

$m

$m

$m

$m

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
%
 
 
 
 
 
 
 
Corporate and commercial
2,638

1,256

1,254

777

510

6,435

- manufacturing
459

254

204

140

49

1,106

- international trade and services
796

599

456

123

48

2,022

- commercial real estate
613

35

145

76

343

1,212

- other property-related
234

72

270

55

1

632

- government
6

-

-

-

2

8

- other commercial
530

296

179

383

67

1,455

Financial
194

13

22

30

-

259

- non-bank financial institutions
194

13

4

30

-

241

- banks
-

-

18

-

-

18

Impairment allowances at 31 Dec 2015
2,832

1,269

1,276

807

510

6,694

Impairment allowances % of impaired loans
40.3
%
68.3
%
77.7
%
86.2
%
64.7
%
54.6
%
 
 
 
 
 
 
 
Currency translation adjustment
(502
)
(21
)
(101
)
(21
)
(78
)
(723
)
31 Dec 2015 at 31 Dec 2016 exchange rates
2,330

1,248

1,175

786

432

5,971

Movement - on constant currency basis
(66
)
104

(23
)
114

(222
)
(93
)
31 Dec 2016 as reported
2,264

1,352

1,152

900

210

5,878


Commercial real estate
Our commercial real estate lending disclosures focus on the regions containing the majority of our balances for loans and
 
advances. Europe, Asia and North America accounted for 97% of our total commercial real estate lending at 31 December 2016 (31 December 2015: 97%).
Commercial real estate lending
 
31 Dec
2016
Total

of which:
31 Dec
2015
Total

of which:
 
Europe

Asia

   North America

Europe

Asia

   North America

 
$m

$m

$m

$m

$m

$m

$m

$m

Gross loans and advances
 
 
 
 
 
 
 
 
Neither past due nor impaired
62,342

20,208

32,688

7,650

64,926

24,426

32,182

6,659

Past due but not impaired
221

41

88

89

454

89

119

212

Impaired loans
1,608

1,212

22

110

2,546

1,633

70

161

Total gross loans and advances
64,171

21,461

32,798

7,849

67,926

26,148

32,371

7,032

-  of which: renegotiated loans
1,525

1,117

-

118

2,134

1,586

6

150

Impairment allowances
660

403

11

67

1,212

613

35

76


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 was $3.8bn lower, largely because of a fall in the value of sterling contributing to a foreign exchange movement of $4.0bn. Total lending balances in Europe declined by $4.7bn, including foreign exchange movements of $3.5bn, partly offset by increases in lending in Asia and North America.

96
HSBC Holdings plc Annual Report and Accounts 2016

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
 
31 Dec
2016
Total

of which:
31 Dec
2015
Total

of which:
 
Europe

Asia

North
America

Europe

Asia

North
America

 
$m

$m

$m

$m

$m

$m

$m

$m

On demand, overdrafts or revolving
 
 
 
 
 
 
 
 
< 1 year
17,636

5,687

7,773

3,568

19,579

6,757

8,811

2,992

1-2 years
9,531

2,904

5,075

1,453

11,408

4,354

5,934

939

2-5 years
26,829

10,846

13,691

1,733

25,268

11,442

11,399

2,037

> 5 years
10,175

2,024

6,259

1,095

11,671

3,595

6,227

1,064

Gross loans and advances
64,171

21,461

32,798

7,849

67,926

26,148

32,371

7,032


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 179.
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 and 9-10, 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.


HSBC Holdings plc Annual Report and Accounts 2016
97

Report of the Directors | Risk


Commercial real estate loans and advances including loan commitments by level of collateral
(Audited)
 
 
 
 
 
31 Dec
2016
Total

of which:
31 Dec
2015
Total

of which:
 
Europe

Asia

North America

Europe

Asia

North America

 
$m

$m

$m

$m

$m

$m

$m

$m

Rated CRR/EL 1 to 7
















Not collateralised
18,313

3,887

12,714

561

17,834

4,493

12,329

8

Fully collateralised
60,330

21,815

27,296

10,618

62,618

25,735

26,270

9,997

Partially collateralised (A)
3,917

1,360

1,106

1,388

6,265

2,961

1,924

1,264

- collateral value on A
2,571

1,021

552

991

4,270

2,045

1,175

981

Total
82,560

27,062

41,116

12,567

86,717

33,189

40,523

11,269

Rated CRR/EL 8
















Not collateralised
13

12

-

1

28

28

-

-

Fully collateralised
196

190

-

6

682

668

4

9

- LTV ratio: less than 50%
58

54

-

4

92

86

-

5

- 51% to 75%
77

76

-

1

385

377

4

4

- 76% to 90%
44

44

-

-

174

174

-

-

- 91% to 100%
17

16

-

1

31

31

-

-

Partially collateralised (B)
102

91

-

11

122

120

1

1

- collateral value on B
71

70

-

1

87

87

-

-

Total
311

293

-

18

832

816

5

10

Rated CRR/EL 9 to 10
















Not collateralised
75

62

3

4

422

65

51

2

Fully collateralised
1,118

764

14

85

1,124

899

18

76

- LTV ratio: less than 50%
141

79

7

5

221

174

10

15

- 51% to 75%
624

571

5

34

513

425

2

27

- 76% to 90%
88

64

1

7

156

139

2

10

- 91% to 100%
265

50

1

39

234

161

4

24

Partially collateralised (C)
412

384

5

21

1,032

716

5

66

- collateral value on C
202

148

5

13

555

397

3

35

Total
1,605

1,210

22

110

2,578

1,680

74

144

At 31 Dec
84,476

28,565

41,138

12,695

90,127

35,685

40,602

11,423


98
HSBC Holdings plc Annual Report and Accounts 2016

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.
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)
 
31 Dec
2016
Total

of which:
31 Dec
2015
Total

of which:
 
Europe

Asia

North
America

Europe

Asia

North
America

 
$m

$m

$m

$m

$m

$m

$m

$m

Rated CRR/EL 8
 
 
 
 
 
 
 
 
Not collateralised
5,283

1,766

405

2,976

2,529

1,611

164

609

Fully collateralised
600

141

3

362

930

349

41

454

- LTV ratio: less than 50%
249

86

2

151

174

58

13

95

- 51% to 75%
168

34

1

118

430

267

8

85

- 76% to 90%
96

10

-

79

214

20

18

168

- 91% to 100%
87

11

-

14

112

4

2

106

Partially collateralised (A)
465

191

12

242

336

99

47

179

- collateral value on A
57

23

3

26

148

65

17

58

Total
6,348

2,098

420

3,580

3,795

2,059

252

1,242

Rated CRR/EL 9 to 10
 
 
 
 
 
 
 
 
Not collateralised
3,508

1,439

848

154

4,877

2,805

889

80

Fully collateralised
2,545

1,394

447

488

1,853

789

440

323

- LTV ratio: less than 50%
838

570

126

59

514

270

94

47

- 51% to 75%
615

412

104

85

553

336

149

47

- 76% to 90%
414

180

86

53

231

87

74

27

- 91% to 100%
678

232

131

291

555

96

123

202

Partially collateralised (B)
2,368

478

642

771

3,079

1,667

506

423

- collateral value on B
1,034

322

268

353

1,374

770

236

283

Total
8,421

3,311

1,937

1,413

9,809

5,261

1,835

826

At 31 Dec
14,769

5,409

2,357

4,993

13,604

7,320

2,087

2,068

During the year, a number of counterparties were downgraded to CRR 8, mainly in the US' energy, commodities and Latin American portfolios. In the UK, a single large counterparty balance was settled which partly reduced the CRR 9 balance.
Other credit risk exposures
In addition to collateralised lending, other credit enhancements are employed and methods used to mitigate credit risk arising from financial assets. These are summarised below:
•
Some securities issued by governments, banks and other financial institutions benefit from additional credit enhancement provided by government guarantees that cover the assets.
•
Debt securities issued by banks and financial institutions include ABSs and similar instruments which are supported by underlying pools of financial assets. Credit risk associated with ABSs is reduced through the purchase of credit default swap ('CDS') protection.
Disclosure of the Group's holdings of ABSs and associated CDS protection is provided on page 105.
•
Trading loans and advances mainly consist of cash collateral posted to satisfy margin requirements. There is limited credit risk on cash collateral posted since in the event of default of the counterparty these would be set-off against the related liability. Reverse repos and stock borrowing are by their nature collateralised.
Collateral accepted as security that the Group is permitted to sell or repledge under these arrangements is described on page 231 of the Financial Statements.
 
•
•
The Group's maximum exposure to credit risk includes financial guarantees and similar contracts granted, as well as loan and other credit-related commitments. Depending on the terms of the arrangement, we may use additional credit mitigation if a guarantee is called upon or a loan commitment is drawn and subsequently defaults.
For further information on these arrangements, see Note 33 on the Financial Statements.
Derivatives
HSBC participates in transactions exposing us to counterparty credit risk. Counterparty credit risk is the risk of financial loss if the counterparty to a transaction defaults before satisfactorily settling it. It arises principally from over-the-counter ('OTC') derivatives and securities financing transactions and is calculated in both the trading and non-trading books. Transactions vary in value by reference to a market factor such as an interest rate, exchange rate or asset price.
The counterparty risk from derivative transactions is taken into account when reporting the fair value of derivative positions. The adjustment to the fair value is known as the credit value adjustment ('CVA').
For an analysis of CVAs, see Note 11 on the Financial Statements.
The table below reflects by risk type the fair values and gross notional contract amounts of derivatives cleared through an exchange, central counterparty and non-central counterparty.

HSBC Holdings plc Annual Report and Accounts 2016
99

Report of the Directors | Risk< /div>


Notional contract amounts and fair values of derivatives by product type
 
2016
2015
 
Notional

Fair value
Notional

Fair value
 
amount

Assets

Liabilities

amount

Assets

Liabilities

 
$m

$m

$m

$m

$m

$m

Foreign exchange
5,846,095

127,413

119,781

5,690,354

96,341

95,598

- exchange traded
12,657

209

65

195,612

167

76

- central counterparty cleared OTC
66,209

698

748

29,263

406

443

- non-central counterparty cleared OTC
5,767,229

126,506

118,968

5,465,479

95,768

95,079

Interest rate
13,944,763

255,385

250,022

14,675,036

279,154

271,367

- exchange traded
1,075,299

277

214

1,259,888

49

8

- central counterparty cleared OTC
8,207,550

120,017

122,022

8,774,674

117,877

117,695

- non-central counterparty cleared OTC
4,661,914

135,091

127,786

4,640,474

161,228

153,664

Equity
472,169

7,410

9,240

501,834

8,732

10,383

- exchange traded
250,810

919

2,173

265,129

1,888

2,601

- non-central counterparty cleared OTC
221,359

6,491

7,067

236,705

6,844

7,782

Credit
448,220

5,199

5,767

463,344

6,961

6,884

- central counterparty cleared OTC
122,832

1,954

1,941

90,863

1,779

2,069

- non-central counterparty cleared OTC
325,388

3,245

3,826

372,481

5,182

4,815

Commodity and other
62,009

2,020

1,564

51,683

3,148

2,699

- exchange traded
5,596

117

-

8,136

38

-

- non-central counterparty cleared OTC
56,413

1,903

1,564

43,547

3,110

2,699

Total OTC derivatives
19,428,894

395,905

383,922

19,653,486

392,194

384,246

- total OTC derivatives cleared by central counterparties
8,396,591

122,669

124,711

8,894,800

120,062

120,207

- total OTC derivatives not cleared by central counterparties
11,032,303

273,236

259,211

10,758,686

272,132

264,039

Total exchange traded derivatives
1,344,362

1,522

2,452

1,728,765

2,142

2,685

Gross
20,773,256

397,427

386,374

21,382,251

394,336

386,931

Offset


(106,555
)
(106,555
)


(105,860
)
(105,860
)
At 31 Dec


290,872

279,819



288,476

281,071

The purposes for which HSBC uses derivatives are described in Note 16 on the Financial Statements.
The International Swaps and Derivatives Association ('ISDA') Master Agreement is our preferred agreement for documenting derivatives activity. It is common, and our preferred practice, for the parties to execute a Credit Support Annex ('CSA') in conjunction with the ISDA Master Agreement. Under a CSA, collateral is passed between the parties to mitigate the counterparty risk inherent in outstanding positions. The majority of our CSAs are with financial institutional clients.
We manage the counterparty exposure on our OTC derivative contracts by using collateral agreements with counterparties and netting agreements. Currently, we do not actively manage our general OTC derivative counterparty exposure in the credit markets, although we may manage individual exposures in certain circumstances.
We place strict policy restrictions on collateral types and as a consequence the types of collateral received and pledged are, by value, highly liquid and of a strong quality, being predominantly cash.
Where a collateral type is required to be approved outside the collateral policy, approval is required from a committee of senior representatives from Markets, Legal and Risk.
See page 251 and Note 30 on the Financial Statements for details regarding legally enforceable right of offset in the event of counterparty default and collateral received in respect of derivatives.
Personal lending
On a reported basis, total personal lending reduced by $34bn, mainly due to foreign exchange movements of $26bn and the ongoing repayments and loan sales of our US CML run-off portfolio in North America of $13bn.
Loan impairment allowances reduced by $0.9bn, largely due to the reduction in our US CML run-off portfolio.
Loan impairment charges for personal lending, remained flat at $1.7bn for 2016. For further analysis of loan impairment charges and other credit risk provisions by global business, see page 38.
 
While the tables are presented on a reported basis, the commentary that follows is on a constant currency basis and excludes the effect of the ongoing run-off and loan sales in the US CML run-off portfolio.
 
Overall, personal lending increased by $5.6bn compared with 31 December 2015. The growth was in mortgage balances which increased by $7.5bn across the Group. UK mortgage balances increased by $4.2bn as we grew our UK mortgage market share through increased sales across various channels including the expanded use of broker relationships. Mortgages in Hong Kong and China grew by $4.5bn as a result of successful marketing campaigns and business growth initiatives. This growth was offset by a $1.4bn reduction in Singapore, following a decision to continue to constrain the size of our mortgage portfolio.
The quality of both our Hong Kong and UK mortgage books remained high, with negligible defaults and impairment allowances. The average LTV ratio on new mortgage lending in Hong Kong was 47% compared with an estimated 29% for the overall mortgage portfolio. The LTV ratio on new lending in the UK was 59% compared with the average of 40% for the total mortgage portfolio.
Group credit policy prescribes the range of acceptable residential property LTV thresholds, with the maximum upper limit for new loans set at between 75% and 95%. Specific LTV thresholds and debt-to-income ratios are managed at regional and country levels. They must comply with the Group's policies, strategy and risk appetite, but vary to reflect the local factors: economic and housing market conditions, regulations, portfolio performance, pricing and product features.
Other personal lending balances declined by $1.9bn, mainly due to reductions resulting from the continued repositioning of the Global Private Bank. This was offset by growth in RBWM, in other personal lending products including $0.7bn in the UK and $0.5bn in Mexico.

100
HSBC Holdings plc Annual Report and Accounts 2016

Total personal lending gross loans
 
Europe

Asia

MENA

North
America

Latin
America

Total

As a %
of total gross loans
 
$m

$m

$m

$m

$m

$m

First lien residential mortgages
108,008

98,072

2,535

39,239

1,924

249,778

26.1
- of which:













interest only (including offset)
33,045

876

92

113

-

34,126

3.6
affordability including ARMs
297

3,427

-

14,182

-

17,906

1.9
Other personal lending
38,491

36,628

5,209

5,717

3,975

90,020

9.4
- other
29,297

26,059

3,072

3,061

2,018

63,507

6.6
- credit cards
9,096

10,438

1,816

993

1,595

23,938

2.5
- second lien residential mortgages
97

24

2

1,631

-

1,754

0.2
- motor vehicle finance
1

107

319

32

362

821

0.1
146,499

134,700

7,744

44,956

5,899

339,798

35.5
Loan and other credit-related commitments
49,029

111,123

4,291

13,944

5,423

183,810

 
 
 
 
 
 
 
 
 
First lien residential mortgages
125,098

94,606

2,704

50,117

1,986

274,511

26.8
- of which:













interest only (including offset)
40,906

936

-

180

-

42,022

4.1
affordability including ARMs
356

3,966

-

17,041

-

21,363

2.1
Other personal lending
42,568

38,101

6,861

8,069

3,972

99,571

9.7
- other
31,763

27,682

4,246

3,284

1,816

68,791

6.7
- credit cards
10,803

10,189

2,241

996

1,780

26,009

2.5
- second lien residential mortgages
-

33

2

3,762

-

3,797

0.4
- motor vehicle finance
2

197

372

27

376

974

0.1
167,666

132,707

9,565

58,186

5,958

374,082

 
 
 
 
 
 
 
 
 
Currency translation adjustment
(24,032
)
(1,145
)
(810
)
519

(950
)
(26,418
)

143,634

131,562

8,755

58,705

5,008

347,664


Movement - constant currency basis
2,865

3,138

(1,011
)
(13,749
)
891

(7,866
)

31 Dec 2016 as reported
146,499

134,700

7,744

44,956

5,899

339,798


Loan and other credit-related commitments
67,787

103,153

5,318

14,510

12,175

202,943


Total personal lending impairment allowances
 
 
 
 
 
 
 
 
 
Europe

Asia

MENA

North
America

Latin
America

Total

 
 
$m

$m

$m

$m

$m

$m

 
225

34

81

289

14

643

Other personal lending
 
300

249

448

83

249

1,329

- other
 
224

122

226

23

128

723

- credit cards
 
76

127

217

34

117

571

- second lien residential mortgages
 
-

-

-

26

-

26

- motor vehicle finance
 
-

-

5

-

4

9

 
525

283

529

372

263

1,972

Impairment allowances % of impaired loans
 
27.8
%
50.0
%
99.6
%
11.4
%
105.2
%
30.4
%
 
 
 
 
 
 
 
 
First lien residential mortgages
 
276

29

26

991

22

1,344

Other personal lending
 
374

227

507

241

186

1,535

- other
 
296

104

285

31

80

796

- credit cards
 
78

122

216

30

102

548

- second lien residential mortgages
 
-

-

-

180

-

180

 
-

1

6

-

4

11

 
650

256

533

1,232

208

2,879

Impairment allowances % of impaired loans
 
29.0
%
49.6
%
103.3
%
15.4
%
86.0
%
25.0
%
 
 
 
 
 
 
 
 
Currency translation adjustment
 
(82
)
(4
)
(53
)
2

(35
)
(172
)
31 Dec 2015 at 31 Dec 2016 exchange rates
 
568

252

480

1,234

173

2,707

Movement - constant currency basis
 
(43
)
31

49

(862
)
90

(735
)
31 Dec 2016 as reported
 
525

283

529

372

263

1,972



HSBC Holdings plc Annual Report and Accounts 2016
101

Report of the Directors | Risk


Exposure to UK interest-only mortgage loans
Of total UK mortgage lending, interest-only mortgage products contributed $32bn, including $12bn of offset mortgages in First Direct and $1.2bn of endowment mortgages.
The following information is presented for HSBC Bank plc interest-only mortgage loans with balances of $15bn at the end of 2016. During the year, $0.17bn of interest-only mortgages matured. Of these, 1,416 loans with total balances of $0.07bn were repaid in full, 106 loans with balances of $0.01bn have agreed future repayment plans and 529 loans with balances of $0.09bn are subject to ongoing individual assessment.
 
The profile of expiring UK interest-only loans was as follows.
UK interest-only mortgage loans


$m

Expired interest-only mortgage loans

209

Interest-only mortgage loans by maturity



- 2017

248

- 2018

517

- 2019

567

- 2020

570

- 2021-2025

3,071

- Post 2025

9,347

At 31 Dec 2016

14,529


HSBC Finance
Gross loan portfolio of HSBC Finance real estate secured balances
 
Re-aged

Modified
and re-aged

Modified

Total
renegotiated
loans

Total non-
renegotiated
loans

Total
gross
loans

Total
impairment
allowances

Impairment
allowances/
gross loans
 
$m

$m

$m

$m

$m

$m

$m

%
At 31 Dec 2016
876

1,015

75

1,966

3,688

5,654

190

3.4
At 31 Dec 2015
4,858

5,257

519

10,634

8,612

19,246

986

5.1
Residential mortgages, including second lien mortgages, decreased by $14bn to $6bn at 31 December 2016. In addition to the continued loan sales in the US CML run-off portfolio, we transferred a further $12bn to 'Assets held for sale' during 2016, of which $1.6bn remained at the year end due to be sold in February 2017. The average gain on sale of foreclosed properties that arose after we took title to the property was 2%.
There was a decrease in impairment allowances from $1.0 bn at 31 December 2015 to $0.2bn at the end of 2016, reflecting reduced levels of delinquency, and lower levels of both new impaired loans and loan balances outstanding as a result of continued liquidation of the portfolio.
Across the first and second lien residential mortgages in our US CML run-off portfolio, two months and over delinquent balances halved to $1.0bn during 2016.
Renegotiated real estate secured accounts in HSBC Finance reduced by $8.7bn or 82% and represented 67% at 31 December 2016 (2015: 91%) of our total renegotiated loans in North America, of which $1.3bn were classified as impaired (2015: $5.1bn). During 2016, the aggregate number of renegotiated loans in HSBC Finance reduced due to the portfolio repayments and further loan sales in the US CML run‑off portfolio.

 
Collateral and other credit enhancements held
(Audited)
The following table shows the values of the fixed charges we hold over specific assets where we have previously enforced, and are able to enforce, collateral in satisfying a debt because the borrower has failed to meet contractual obligations, and where the collateral is cash or can be realised by sale in an established market.
The collateral valuation excludes any adjustments for obtaining and selling the collateral and, in particular, loans shown as not collateralised or partially collateralised may also benefit from other forms of credit mitigants.

102
HSBC Holdings plc Annual Report and Accounts 2016

Residential mortgage loans 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

Non-impaired loans and advances
 
 
 
 
 
 
 
 
Fully collateralised
111,799

104,122

2,333

35,773

1,813

255,840

106,006

65,480

- LTV ratio: less than 50%
63,404

63,009

617

12,454

676

140,160

61,128

44,732

- 51% to 60%
19,129

18,198

369

8,124

316

46,136

18,094

10,656

- 61% to 70%
14,437

10,908

505

9,471

366

35,687

13,222

3,851

- 71% to 80%
9,029

7,370

659

4,374

253

21,685

8,433

2,958

- 81% to 90%
4,963

3,463

148

888

144

9,606

4,509

2,324

- 91% to 100%
837

1,174

35

462

58

2,566

620

959

Partially collateralised:
 
 
 
 
 
 
 
 
Greater than 100% (A)
430

41

69

373

26

939

284

1

- 101% to 110%
150

20

15

179

17

381

106

1

- 111% to 120%
64

2

11

85

5

167

33

-

- greater than120%
216

19

43

109

4

391

145

-

Collateral on A
342

27

40

328

25

762

197

1

Non-impaired loans and advances
112,229

104,163

2,402

36,146

1,839

256,779

106,290

65,481

Impaired loans and advances
 
 
 
 
 
 
 
 
Fully collateralised
1,213

247

59

2,905

85

4,509

1,059

42

- LTV ratio: less than 50%
580

109

21

825

8

1,543

521

34

- 51% to 60%
222

49

3

527

3

804

200

4

- 61% to 70%
180

24

13

540

4

761

158

1

- 71% to 80%
122

29

4

449

3

607

101

1

- 81% to 90%
66

19

9

336

67

497

52

1

- 91% to 100%
43

17

9

228

-

297

27

1

Partially collateralised:
 
 
 
 
 
 
 
 
Greater than 100% (B)
80

7

73

182

-

342

42

-

- 101% to 110%
37

3

10

94

-

144

17

-

- 111% to120%
12

2

12

38

-

64

7

-

- greater than 120%
31

2

51

50

-

134

18

-

Collateral on B
66

5

64

152

-

287

33

-

Impaired loans and advances
1,293

254

132

3,087

85

4,851

1,101

42

At 31 Dec 2016
113,522

104,417

2,534

39,233

1,924

261,630

107,391

65,523

 
 
 
 
 
 
 
 
 
Non impaired loans and advances
 
 
 
 
 
 
 
 
Fully collateralised
127,697

100,102

2,560

41,567

1,869

273,795

122,221

61,784

- LTV ratio: less than 50%
70,732

59,212

714

12,369

710

143,737

68,362

42,589

- 51% to 60%
24,069

16,625

442

8,266

387

49,789

23,068

9,193

- 61% to 70%
17,449

12,548

532

10,472

378

41,379

16,755

5,252

- 71% to 80%
10,184

7,813

576

6,279

256

25,108

9,593

2,391

- 81% to 90%
4,258

2,773

265

2,556

104

9,956

3,930

1,379

- 91% to 100%
1,005

1,131

31

1,625

34

3,826

513

980

Partially collateralised:
 
 
 
 
 
 
 
 
Greater than 100% (A)
535

168

51

1,208

13

1,975

321

97

- 101% to110%
212

154

16

709

7

1,098

126

97

- 111% to 120%
76

5

5

288

2

376

29

-

- greater than 120%
247

9

30

211

4

501

166

-

Collateral on A
430

155

41

1,147

11

1,784

221

95

Non-impaired loans and advances
128,232

100,270

2,611

42,775

1,882

275,770

122,542

61,881

Impaired loans and advances
 
 
 
 
 
 
 
 
Fully collateralised
1,392

222

59

6,713

109

8,495

1,191

46

- LTV ratio: less than 50%
513

105

23

1,247

90

1,978

469

42

- 51% to 60%
270

38

8

990

6

1,312

254

2

- 61% to 70%
249

29

10

1,199

5

1,492

204

1

- 71% to 80%
171

18

6

1,257

5

1,457

143

1

- 81% to 90%
102

25

7

1,184

2

1,320

72

-

- 91% to 100%
87

7

5

836

1

936

49

-

Partially collateralised:
 
 
 
 
 
 
 
 
Greater than 100% (B)
178

8

18

628

1

833

49

-

- 101% to110%
130

3

1

375

1

510

15

-

- 111% to 120%
11

2

3

147



163

5

-

- greater than 120%
37

3

14

106



160

29

-

Collateral value on B
160

6

13

547

-

726

36

-

Impaired loans
1,570

230

77

7,341

110

9,328

1,240

46

At 31 Dec 2015
129,802

100,500

2,688

50,116

1,992

285,098

123,782

61,927


HSBC Holdings plc Annual Report and Accounts 2016
103

Report of the Directors | Risk


Supplementary information
Gross loans and advances to customers by country
 
First lien residential mortgages

Other personal

Property-related

Commercial, international trade and other

Total

 
$m

$m

$m

$m

$m

Europe
108,008

38,491

28,485

164,465

339,449

- UK 
101,822

17,820

21,707

124,341

265,690

- France
2,676

13,786

5,220

22,153

43,835

- Germany
1

192

413

8,322

8,928

- Switzerland
506

5,848

213

1,660

8,227

- other
3,003

845

932

7,989

12,769

Asia
98,072

36,628

70,426

161,940

367,066

- Hong Kong
63,566

24,558

54,219

88,921

231,264

- Australia
10,134

757

2,164

6,804

19,859

- India
1,280

388

1,040

5,979

8,687

- Indonesia
63

334

165

4,384

4,946

- Mainland China
7,192

1,107

4,788

20,451

33,538

- Malaysia
2,719

3,065

1,693

4,179

11,656

- Singapore
6,194

4,502

2,920

11,832

25,448

- Taiwan
4,036

671

55

5,074

9,836

- other
2,888

1,246

3,382

14,316

21,832

Middle East and North Africa (excluding Saudi Arabia)
2,535

5,209

2,580

22,107

32,431

- Egypt
-

272

73

1,327

1,672

- Turkey
301

1,554

247

2,214

4,316

- UAE
1,981

1,867

1,883

13,037

18,768

- other
253

1,516

377

5,529

7,675

North America
39,239

5,717

16,672

51,355

112,983

- US
22,756

2,676

11,835

38,199

75,466

- Canada
15,220

2,831

4,586

12,515

35,152

- other
1,263

210

251

641

2,365

Latin America
1,924

3,975

1,646

9,880

17,425

- Mexico
1,803

2,849

1,528

7,118

13,298

- other
121

1,126

118

2,762

4,127

At 31 Dec 2016
249,778

90,020

119,809

409,747

869,354

Europe
125,098

42,568

33,277

187,576

388,519

- UK 
117,346

20,797

25,700

149,327

313,170

- France
3,606

12,130

6,070

20,380

42,186

- Germany
4

203

347

7,941

8,495

- Switzerland
511

8,045

224

834

9,614

- other
3,631

1,393

936

9,094

15,054

Asia
94,606

38,101

67,577

157,616

357,900

- Hong Kong
60,943

24,389

50,825

80,609

216,766

- Australia
9,297

726

1,592

6,448

18,063

- India
1,248

431

637

5,728

8,044

- Indonesia
56

346

71

4,965

5,438

- Mainland China
5,716

1,645

6,185

23,703

37,249

- Malaysia
2,792

3,113

1,993

4,947

12,845

- Singapore
7,743

5,392

3,334

11,021

27,490

- Taiwan
3,866

629

126

5,291

9,912

- other
2,945

1,430

2,814

14,904

22,093

Middle East and North Africa (excluding Saudi Arabia)
2,704

6,861

2,900

26,222

38,687

- Egypt
1

549

104

2,097

2,751

- Turkey
446

2,414

302

4,231

7,393

- UAE
1,854

2,286

1,833

14,199

20,172

- other
403

1,612

661

5,695

8,371

North America
50,117

8,069

16,014

56,690

130,890

- US
34,382

4,813

11,435

42,439

93,069

- Canada
14,418

3,029

4,315

13,490

35,252

- other
1,317

227

264

761

2,569

Latin America
1,986

3,972

1,622

10,433

18,013

- Mexico
1,881

2,828

1,498

7,844

14,051

- other
105

1,144

124

2,589

3,962

At 31 Dec 2015
274,511

99,571

121,390

438,537

934,009

The above tables analyse 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 and HSBC Bank USA, by the location of the lending branch.

104
HSBC Holdings plc Annual Report and Accounts 2016

HSBC Holdings
(Audited)
Risk in HSBC Holdings is overseen by the HSBC Holdings Asset and Liability Management Committee ('Holdings ALCO'). The major risks faced by HSBC Holdings are credit risk, liquidity risk and market risk (in the form of interest rate risk and foreign exchange risk), of which the most significant is credit risk.
Credit risk in HSBC Holdings primarily arises from transactions with Group subsidiaries and from guarantees issued in support of obligations assumed by certain Group operations in the normal conduct of their business. It principally represents claims on Group subsidiaries in Europe and North America.
In HSBC Holdings, all financial instruments carrying amount represents the maximum exposure to credit risk. Derivatives have an offset balance of $1.8bn at 31 December 2016
(2015: $2.5bn).
 
The credit quality of loans and advances and financial investments, both of which consist of intra-Group lending, is assessed as 'strong' or 'good', with 100% of the exposure being neither past due nor impaired (2015: 100%).
Securitisation exposures and other structured products
The following table summarises the carrying amount of our ABS exposure by categories of collateral and includes assets held in the GB&M legacy credit portfolio with a carrying value of $11bn (2015: $15bn).
At 31 December 2016, the available-for-sale reserve in respect of ABSs was a deficit of $749m (2015: deficit of $1,021m). For 2016, the impairment write-back in respect of ABSs was
$121m (2015: write-back of $85m).
Carrying amount of HSBC's consolidated holdings of ABSs
 
Trading

Available for sale

Held to maturity

Designated at fair value through profit or loss

Loans and receivables

Total

Of which
held through consolidated
SEs

 
$m

$m

$m

$m

$m

$m

$m

Mortgage-related assets:
 
 
 
 
 
 
 
Sub-prime residential
63

1,544

-

-

104

1,711

618

US Alt-A residential
-

1,453

5

-

39

1,497

1,382

US Government agency and sponsored enterprises:
MBSs
247

13,070

12,788

-

-

26,105

-

Other residential
662

362

-

-

54

1,078

152

Commercial property
348

1,146

-

-

141

1,635

707

Leveraged finance-related assets
175

1,284

-

-

70

1,529

735

Student loan-related assets
140

2,865

-

-

11

3,016

2,616

Other assets
1,278

730

-

19

48

2,075

404

At 31 Dec 2016
2,913

22,454

12,793

19

467

38,646

6,614

 
 
 
 
 
 
 
 
Mortgage-related assets:
 
 
 
 
 
 
 
Sub-prime residential
73

2,247

-

1

132

2,453

1,075

US Alt-A residential
-

1,989

7

-

55

2,051

1,796

US Government agency and sponsored enterprises:
MBSs
166

15,082

13,997

-

-

29,245

-

Other residential
812

780

-

-

108

1,700

253

Commercial property
590

2,308

-

-

201

3,099

1,656

Leveraged finance-related assets
240

2,294

-

-

149

2,683

1,310

Student loan-related assets
236

2,991

-

-

25

3,252

2,679

Other assets
1,184

880

-

23

128

2,215

565

At 31 Dec 2015
3,301

28,571

14,004

24

798

46,698

9,334


HSBC Holdings plc Annual Report and Accounts 2016
105

Report of the Directors | Risk


Liquidity and funding risk profile
 
 
Page

Liquidity and funding risk in 2016
106

Management of liquidity and funding risk
106

Sources of funding
107

Analysis of on-balance sheet encumbered and unencumbered assets and off-balance sheet collateral
108

Contractual maturity of financial liabilities
111

HSBC Holdings
112


Liquidity and funding risk in 2016
A summary of our current policies and practices regarding the management of liquidity and funding risk is set out on page 106.
The liquidity position of the Group remained strong in 2016. The amount of our unencumbered liquid assets was $560bn. We recognised $447bn of these liquid assets for the purposes of the Group consolidated LCR, which was 136%.
Management of liquidity and funding risk
Liquidity coverage ratio
The Liquidity Coverage Ratio ('LCR') aims to ensure that a bank has sufficient unencumbered high-quality liquid assets ('HQLA') to meet its liquidity needs in a 30-calendar-day liquidity stress scenario. HQLA consist of cash or assets that can be converted into cash at little or no loss of value in markets. We reported a Group European Commission ('EC') LCR at 31 December 2016 of 136% (31 December 2015: 116%) to the PRA.
We assume no transferability of liquidity from non-EU entities other than to the extent currently permitted. This results in $113bn of HQLA being excluded from the Group's LCR.
The ratio of total consolidated HQLA to the EC LCR denominator at 31 December 2016 was 171% (31 December 2015: 142%), reflecting the additional $113bn (31 December 2015: $94bn) of HQLAs excluded from the Group LCR.
At 31 December 2016, all the Group's principal operating entities were within the LCR risk tolerance level established by the Board and applicable under the Group's internal liquidity and funding risk management framework ('LFRF').
The liquidity position of the Group can also be represented by the stand-alone ratios of each of our principal operating entities. The Board and RMM decide the criteria for categorising an operating entity as a principal entity. The main criterion is a material balance sheet size. The following table displays the individual LCR levels for our principal operating entities on an EC LCR basis. The ratios for operating entities in non-EU jurisdictions can vary from local LCR measures due to differences in the way non-EU regulators have implemented the Basel III recommendations.
Operating entities' LCRs
 
 
At Dec
 
 
2016
2015
 
Footnotes
%
%
HSBC UK liquidity group
47
123
107
The Hongkong and Shanghai Banking Corporation - Hong Kong Branch
48
185
150
The Hongkong and Shanghai Banking Corporation - Singapore Branch
48
154
189
HSBC Bank USA
 
130
116
HSBC France
49
122
127
Hang Seng Bank
 
218
199
HSBC Canada
49
142
142
HSBC Bank China
 
253
183
HSBC Middle East - UAE Branch
 
241
 
HSBC Mexico
 
177
 
HSBC Private Bank
 
178
 
For footnotes, see page 126.
 
Net stable funding ratio
The Net Stable Funding Ratio ('NSFR') requires institutions to maintain sufficient stable funding relative to required stable funding, and reflects a bank's long-term funding profile (funding with a term of more than a year). It is designed to complement the LCR.
At 31 December 2016, the Group's principal operating entities were within the NSFR risk tolerance level established by the Board and applicable under the LFRF.
The table below displays the NSFR levels for the principal HSBC operating entities.
Our NSFR levels were not disclosed at the last year-end, so there are no comparatives.
Operating entities' NSFRs
 
 
At
31 Dec 2016
 
Footnotes
%
HSBC UK liquidity group
47
116
The Hongkong and Shanghai Banking Corporation - Hong Kong Branch
48
157
The Hongkong and Shanghai Banking Corporation - Singapore Branch
48
112
HSBC Bank USA
 
120
HSBC France
49
120
Hang Seng Bank
 
162
HSBC Canada
49
139
HSBC Bank China
 
149
HSBC Middle East - UAE Branch
 
141
HSBC Mexico
 
128
HSBC Private Bank
 
155
Depositor concentration and term funding maturity concentration
The LCR and NSFR metrics assume a stressed outflow based on a portfolio of depositors within each deposit segment. The validity of these assumptions is challenged if the portfolio of depositors is not large enough to avoid depositor concentration. Operating entities are exposed to term re-financing concentration risk if the current maturity profile results in future maturities being overly concentrated in any defined period.
At 31 December 2016, all principal operating entities were within the risk tolerance levels set for depositor concentration and term funding maturity concentration. These risk tolerances were established by the Board and are applicable under the LFRF.
Liquid assets of HSBC's principal operating entities
The table below shows the unweighted liquidity value of assets categorised as liquid, which is used for the purposes of calculating the LCR metric.
This reflects the stock of unencumbered liquid assets at the reporting date, using the regulatory definition of liquid assets. The amount recognised by entity at the Group level is different from the amount recognised at a solo entity level, reflecting where liquidity cannot be freely transferred up to Group.

106
HSBC Holdings plc Annual Report and Accounts 2016

Liquid assets of HSBC's principal entities
 
 
31 Dec 2016
 
 
Recognised at Group and entity level

Recognised at entity level only

 
Footnotes
$m

$m

HSBC UK liquidity group
47




Level 1
 
143,884

143,884

Level 2a
 
2,085

2,085

Level 2b
 
7,663

7,663

The Hongkong and Shanghai Banking Corporation - Hong Kong Branch
 




Level 1
 
48,342

98,963

Level 2a
 
23,790

23,790

Level 2b
 
3,450

3,450

HSBC Bank USA
 




Level 1
 
53,409

72,931

Level 2a
 
14,995

14,995

Level 2b
 
10

10

Hang Seng Bank
 




Level 1
 
21,798

37,525

Level 2a
 
1,474

1,474

Level 2b
 
199

199

Total of HSBC's other principal entities
50




Level 1
 
74,239

90,579

Level 2a
 
6,240

6,240

 
226

226

For footnotes, see page 126.
Sources of funding
(Audited)
Our primary sources of funding are customer current accounts and customer savings deposits payable on demand or at short notice. We issue wholesale securities (secured and unsecured) to supplement our customer deposits and change the currency mix, maturity profile or location of our liabilities.
The following 'Funding sources and uses' table provides a consolidated view of how our balance sheet is funded, and should be read in light of the LFRF, which requires operating entities to manage liquidity and funding risk on a stand-alone basis.
The table analyses our consolidated balance sheet according to the assets that primarily arise from operating activities and the sources of funding primarily supporting these activities. Assets and liabilities that do not arise from operating activities are presented as a net balancing source or deployment of funds.
In 2016, the level of customer accounts continued to exceed the level of loans and advances to customers. The positive funding gap was predominantly deployed in liquid assets (cash and balances with central banks and financial investments) as required by the LFRF.
Loans and advances to banks continued to exceed deposits by banks, meaning the Group remained a net unsecured lender to the banking sector.
For a summary of sources and utilisation of repos and stock lending, see the Risk Management section on page 68.
 
Funding sources and uses
 
 
2016

2015

 
 
$m

$m

Sources
 
 
 
Customer accounts
 
1,272,386

1,289,586

Deposits by banks
 
59,939

54,371

Repurchase agreements - non-trading
 
88,958

80,400

Debt securities in issue
 
65,915

88,949

Liabilities of disposal groups held for sale
 
2,790

36,840

Subordinated liabilities
 
20,984

22,702

Financial liabilities designated at fair value
 
86,832

66,408

Liabilities under insurance contracts
 
75,273

69,938

Trading liabilities
 
153,691

141,614

- repos
 
1,428

442

- stock lending
 
3,643

8,859

- settlement accounts
 
15,271

10,530

- other trading liabilities
 
133,349

121,783

Total equity
 
182,578

197,518

At 31 Dec
 
2,009,346

2,048,326

Uses
 
 
 
Loans and advances to customers
 
861,504

924,454

Loans and advances to banks
 
88,126

90,401

Reverse repurchase agreements - non-trading
 
160,974

146,255

Assets held for sale
 
4,389

43,900

Trading assets
 
235,125

224,837

- reverse repos
 
4,780

438

- stock borrowing
 
5,427

7,118

- settlement accounts
 
17,850

12,127

- other trading assets
 
207,068

205,154

Financial investments
 
436,797

428,955

Cash and balances with central banks
 
128,009

98,934

Net deployment in other balance sheet assets and liabilities
 
94,422

90,590

At 31 Dec
 
2,009,346

2,048,326


HSBC Holdings plc Annual Report and Accounts 2016
107

Report of the Directors | Risk


Wholesale term debt maturity profile
The maturity profile of our wholesale term debt obligations is set out in the following table 'Wholesale funding cash flows payable by HSBC under financial liabilities by remaining contractual maturities'.
 
The balances in the table are not directly comparable with those in the consolidated balance sheet as the table presents gross cash flows relating to principal payments and not the balance sheet carrying value, which include debt securities and subordinated liabilities measured at fair value.
Wholesale funding cash flows payable by HSBC under financial liabilities by remaining contractual maturities
 
Due not
more than
1 month

Due over
1 month
but not more than
3 months

Due over
3 months
but not more than
6 months

Due over
6 months
but not more than
9 months

Due over
9 months
but not more
than
1 year

Due over
1 year
but not more than
2 years

Due over
2 years
but not more than
5 years

Due over
5 years

Total

 
$m

$m

$m

$m

$m

$m

$m

$m

$m

Debt securities issued
7,462

10,110

11,834

6,930

8,043

21,906

43,764

44,164

154,213

- unsecured CDs and CP
691

5,906

5,530

3,152

2,384

242

133

12

18,050

- unsecured senior MTNs
837

1,706

3,727

2,699

3,580

13,626

30,519

36,240

92,934

- unsecured senior structured notes
1,088

1,675

1,389

882

2,066

5,940

8,344

3,885

25,269

- secured covered bonds
1,584

-

295

71

-

207

1,357

2,559

6,073

- secured asset-backed commercial paper
3,196

-

-

-

-

-

-

-

3,196

- secured ABS
11

23

893

126

13

91

908

439

2,504

- others
55

800

-

-

-

1,800

2,503

1,029

6,187

Subordinated liabilities
13

63

145

-

500

1,775

7,292

32,179

41,967

- subordinated debt securities
13

63

145

-

500

1,775

6,881

30,425

39,802

- preferred securities
-

-

-

-

-

-

411

1,754

2,165

At 31 Dec 2016
7,475

10,173

11,979

6,930

8,543

23,681

51,056

76,343

196,180

 
 
 
 
 
 
 
 
 
 
Debt securities issued
19,447

11,803

20,565

6,712

5,274

20,150

43,463

27,398

154,812

- unsecured CDs and CP
5,830

8,426

11,250

2,944

1,224

955

108

10

30,747

- unsecured senior MTNs
4,229

2,240

7,130

2,687

1,711

10,850

27,239

18,407

74,493

- unsecured senior structured notes
883

964

1,544

875

2,166

4,158

9,741

5,262

25,593

- secured covered bonds
-

-

-

-

-

2,074

1,619

2,577

6,270

- secured asset-backed commercial paper
8,414

-

-

-

-

-

-

-

8,414

- secured ABS
20

173

195

206

173

313

1,554

114

2,748

- others
71

-

446

-

-

1,800

3,202

1,028

6,547

Subordinated liabilities
-

816

-

-

34

648

6,826

34,423

42,747

- subordinated debt securities
-

-

-

-

34

648

6,338

32,494

39,514

- preferred securities
-

816

-

-

-

-

488

1,929

3,233

At 31 Dec 2015
19,447

12,619

20,565

6,712

5,308

20,798

50,289

61,821

197,559

Analysis of on-balance sheet encumbered and unencumbered assets and off-balance sheet collateral
On-balance sheet encumbered and unencumbered assets
The table on page 110, 'Analysis of on-balance sheet encumbered and unencumbered assets', summarises the total on-balance sheet assets capable of supporting future funding and collateral needs, and shows the extent to which they are currently pledged for this purpose. This disclosure aims to facilitate an understanding of available and unrestricted assets that could be used to support potential future funding and collateral needs.
During 2016 cash collateral given and reported within loans and advances to banks and customers, reflecting initial and variable cash margins, was reclassified from 'unencumbered assets' to 'encumbered assets' to align with our Pillar 3 disclosure. Furthermore a portfolio of mortgages, classified as 'unencumbered assets' in 2015 was reclassified to 'Assets positioned at central banks' (i.e. pre-positioned plus encumbered) in 2016. Comparative data have been restated.
Under 'Off-balance sheet collateral' below we discuss the off-balance sheet collateral received and re-pledged, and the level of available unencumbered off-balance sheet collateral.
For a summary of our policy on collateral management and definition of encumbrance, see the Risk Management section on page 68.
 
Off-balance sheet collateral
The fair value of assets accepted as collateral that we are permitted to sell or repledge in the absence of default was $269bn at 31 December 2016 (2015: $228bn). The fair value of any such collateral actually sold or re-pledged was $157bn (2015: $150bn). We are obliged to return equivalent securities. These transactions are conducted under terms that are usual and customary to standard reverse repo, stock borrowing and der
 
ivative transactions.
The fair value of collateral received and re-pledged in relation to reverse repos, stock borrowing and derivatives is reported on a gross basis. The related balance sheet receivables and payables are reported on a net basis where required under IFRS offset criteria. As a consequence of reverse repo, stock borrowing and derivative transactions where the collateral received could be sold or re-pledged but had not been, we held $112bn
(2015: $78bn) of unencumbered collateral available to
support potential future funding and collateral needs at 31 December 2016.
Under the terms of our current collateral obligations under derivative contracts (which are ISDA compliant CSA contracts and contracts entered into for pension obligations), and based on an estimate of the positions at 31 December 2016, we calculate that we could be required to post additional collateral of up to $0.3bn (2015: $0.4bn) in the event of a one-notch downgrade in third-party agencies' credit rating of HSBC's debt.
This would increase to $0.8 bn (2015: $0.7bn) in the event of a two-notch downgrade.

108
HSBC Holdings plc Annual Report and Accounts 2016

Encumbered and unencumbered assets
Definitions of the categories included in the table 'Analysis of on-balance sheet encumbered and unencumbered assets':
•
'Assets encumbered as a result of transactions with counterparties other than central banks as a result of covered bonds' are any assets on our balance sheet pledged against our covered bonds issuance with a counterparty which is not central bank and as a result the assets are unavailable to the bank to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements.
•
'Assets encumbered as a result of transactions with counterparties other than central banks as a result of securitisation' are any assets on our balance sheet pledged against securitisations with a counterparty which is not central bank including asset-backed commercial paper, collateralised debt obligations, residential mortgage-backed securities, or structured investment vehicles paper and as a result the assets are unavailable to the bank to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements.
•
'Assets encumbered as a result of transactions with counterparties other than central banks - Other' are assets on our balance sheet (other than covered bonds and securitisation above) which have been pledged with a counterparty which is not central bank as a collateral against an existing liability, and as a result are assets which are unavailable to the bank to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements. Examples include assets pledged for sale and repurchase and stock lending transactions and certain property assets.
•
'Assets positioned at central banks (i.e. pre-positioned plus encumbered)' are any assets that are eligible for emergency central bank liquidity/funding or under central bank pre-existing arrangements for funding without further due diligence work required. Any transferable customer loan that is central bank eligible such as pre-positioned central bank UK mortgages and US mortgages accepted by the Federal Reserve Bank and assets on our balance sheet which have been pledged with central bank as collateral against an existing liability, and as a result are assets which are unavailable to the bank to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements.
•
'Unencumbered - readily available assets' are assets considered by the bank to be readily available in the normal course of business to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, and are not subject to any restrictions on their use for these purposes.
•
'Unencumbered - other assets capable of being encumbered' are assets where there are no restrictions on their use to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, but they are not readily realisable in the normal course of business in their current form.
•
'Unencumbered - reverse repo/stock borrowing receivables and derivative assets' are assets related specifically to reverse repo, stock borrowing and derivative transactions. They are shown separately as these on-balance sheet assets cannot be pledged but often give rise to the receipt of non-cash assets which are not recognised on the balance sheet, and can additionally be used to raise secured funding, meet additional collateral requirements or be sold.
•
'Unencumbered - cannot be encumbered' are assets that have not been pledged and which we have assessed could not be pledged and therefore could not be used to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements. An example is assets held by the Group's insurance subsidiaries that back liabilities to policyholders and support the solvency of these entities.
Historically, the Group has not recognised any contingent liquidity value for assets other than those assets defined under the LFRF as being liquid assets, and any other negotiable instruments that under stress are assumed to be realisable after three months, even though they may currently be realisable. This approach has generally been driven by our appetite not to place any reliance on central banks. In a few cases, we have recognised the contingent value of discrete pools of assets, but the amounts involved are insignificant. As a result, we have reported the majority of our loans and advances to customers and banks in the category 'Other realisable assets' as management would need to perform additional actions in order to make the assets transferable and readily realisable.

HSBC Holdings plc Annual Report and Accounts 2016
109

Report of the Directors | Risk


Analysis of on-balance sheet encumbered and unencumbered assets
 
Assets encumbered as a result
of transactions with counterparties
other than central banks
Assets
positioned
at central
banks
(i.e. pre-positioned
plus
encumbered)

Unencumbered assets not
positioned at central banks
Total

 
As a
result of
covered bonds

As a
result of
securitisations

Other

Assets readily
available for
encumbrance

Other assets
capable
of being
encumbered

Reverse
repos/stock
borrowing
receivables
and derivative
assets

Assets that
cannot be
encumbered

 
$m

$m

$m

$m

$m

$m

$m

$m

$m

Cash and balances at central banks
-

-

10

82

123,363

326

-

4,228

128,009

Items in the course of collection from other banks
-

-

-

-

-

-

-

5,003

5,003

Hong Kong Government certificates of indebtedness
-

-

-

-

-

-

-

31,228

31,228

Trading assets
-

-

62,962

2,504

131,420

7,419

10,207

20,613

235,125

- treasury and other eligible bills
-

-

981

2,150

11,309

11

-

-

14,451

- debt securities
-

-

34,144

354

59,231

318

-

7

94,054

- equity securities
-

-

2,645

-

59,394

1,565

-

-

63,604

- loans and advances to banks
-

-

10,532

-

1,331

1,910

5,386

5,610

24,769

- loans and advances to customers
-

-

14,660

-

155

3,615

4,821

14,996

38,247

Financial assets designated at fair value
-

-

-

-

835

20

-

23,901

24,756

- treasury and other eligible bills
-

-

-

-

150

-

-

54

204

- debt securities
-

-

-

-

442

-

-

3,747

4,189

- equity securities
-

-

-

-

243

20

-

20,021

20,284

- loans and advances to banks and customers
-

-

-

-

-

-

-

79

79

Derivatives
-

-

-

-

-

-

290,872

-

290,872

Loans and advances to banks
-

1

3,903

6,719

2,051

50,824

2,045

22,583

88,126

Loans and advances to customers
6,258

8,365

10,425

67,208

15,941

732,242

4,027

17,038

861,504

Reverse repurchase agreements - non-trading
-

-

-

-

-

-

160,974

-

160,974

Financial investments
-

-

16,537

17,983

331,154

10,765

-

60,358

436,797

- treasury and other eligible bills
-

-

537

3,766

93,566

1,143

-

214

99,226

- debt securities
-

-

16,000

14,217

236,003

7,904

-

58,780

332,904

- equity securities
-

-

-

-

1,585

1,718

-

1,364

4,667

Prepayments, accrued income and other assets
-

-

2,358

-

8,368

27,099

-

26,084

63,909

Current tax assets
-

-

-

-

-

-

-

1,145

1,145

Interest in associates and joint ventures
-

-

345

-

62

19,329

-

293

20,029

Goodwill and intangible assets
-

-

-

-

-

-

-

21,346

21,346

Deferred tax
-

-

-

-

-

-

-

6,163

6,163

At 31 Dec 2016
6,258

8,366

96,540

94,496

613,194

848,024

468,125

239,983

2,374,986


110
HSBC Holdings plc Annual Report and Accounts 2016

Analysis of on-balance sheet encumbered and unencumbered assets (continued)
 
Assets encumbered as a result
of transactions with counterparties
other than central banks
Assets positioned
at central banks
(i.e. pre- positioned plus encumbered)

Unencumbered assets not
positioned at central banks
Total

 
As a
result of
covered bonds

As a
result of
securitisations

Other

Assets readily
available for
encumbrance

Other assets
capable
of being
encumbered

Reverse
repos/stock
borrowing
receivables
and derivative
assets

Assets that
cannot be
encumbered

 
$m

$m

$m

$m

$m

$m

$m

$m

$m

Cash and balances at central banks
-

-

-

98

95,545

350

-

2,941

98,934

Items in the course of collection from other banks
-

-

-

-

-

-

-

5,768

5,768

Hong Kong Government certificates of indebtedness
-

-

-

-

-

-

-

28,410

28,410

Trading assets
-

-

56,188

1,573

138,070

8,269

7,520

13,217

224,837

- treasury and other eligible bills
-

-

1,099

984

5,618

128

-

-

7,829

- debt securities
-

-

25,890

492

72,377

233

-

46

99,038

- equity securities
-

-

4,616

-

59,430

2,445

-

-

66,491

- loans and advances to banks
-

-

10,410

-

456

2,890

2,763

5,784

22,303

- loans and advances to customers
-

-

14,173

97

189

2,573

4,757

7,387

29,176

Financial assets designated at fair value
-

-

-

-

1,775

1,244

-

20,833

23,852

- treasury and other eligible bills
-

-

-

-

258

-

-

138

396

- debt securities
-

-

-

-

1,327

265

-

2,749

4,341

- equity securities
-

-

-

-

178

979

-

17,838

18,995

- loans and advances to banks and customers
-

-

-

-

12

-

-

108

120

Derivatives
-

-

-

-

-

-

288,476

-

288,476

Loans and advances to banks
-

1,329

2,900

1,702

2,054

61,602

815

19,999

90,401

Loans and advances to customers
6,947

15,288

9,769

64,984

15,730

790,929

1,531

19,276

924,454

Reverse repurchase agreements - non-trading
-

-

-

-

-

-

146,255

-

146,255

Financial investments
-

-

25,078

8,150

325,101

14,753

-

55,873

428,955

- treasury and other eligible bills
-

-

509

3,675

98,866

1,177

-

324

104,551

- debt securities
-

-

24,561

4,475

224,355

11,124

-

54,054

318,569

- equity securities
-

-

8

-

1,880

2,452

-

1,495

5,835

Prepayments, accrued income and other assets
-

-

1,188

-

4,685

65,190

-

27,235

98,298

Current tax assets
-

-

-

-

-

-

-

1,221

1,221

Interest in associates and joint ventures
-

-

-

-

51

18,794

-

294

19,139

Goodwill and intangible assets
-

-

-

-

-

-

-

24,605

24,605

Deferred tax
-

-

-

-

-

-

-

6,051

6,051

At 31 Dec 2015
6,947

16,617

95,123

76,507

583,011

961,131

444,597

225,723

2,409,656

Contractual maturity of financial liabilities
The balances in the table below do not agree directly with those in our consolidated balance sheet as the table incorporates, on an undiscounted basis, all cash flows relating to principal and future coupon payments (except for trading liabilities and derivatives not treated as hedging derivatives). Undiscounted cash flows payable in relation to hedging derivative liabilities are classified according to their contractual maturities. Trading liabilities and derivatives not treated as hedging derivatives are included in the 'On demand' time bucket and not by contractual maturity.
 
A maturity analysis of repos and debt securities in issue included in trading liabilities is presented in Note 29 on the Financial Statements.
In addition, loans and other credit-related commitments, financial guarantees and similar contracts are generally not recognised on our balance sheet. The undiscounted cash flows potentially payable under financial guarantees and similar contracts are classified on the basis of the earliest date they can be called.

HSBC Holdings plc Annual Report and Accounts 2016
111

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Cash flows payable by HSBC under financial liabilities by remaining contractual maturities
(Audited)

On
demand

Due within
3 months

Due between
3 and 12 months

Due between
1 and 5 years

Due after
5 years


$m

$m

$m

$m

$m

Deposits by banks
40,277

10,222

3,284

5,233

1,033

Customer accounts
1,079,866

145,932

38,273

8,676

559

Repurchase agreements - non-trading
18,134

66,801

2,929

1,048

-

Trading liabilities
153,691

-

-

-

-

Financial liabilities designated at fair value
1,307

2,265

5,003

34,707

61,929

Derivatives
274,283

287

1,129

2,472

1,727

Debt securities in issue
9

13,118

19,492

29,487

8,089

Subordinated liabilities
1

400

1,378

10,302

21,552

Other financial liabilities
45,569

15,844

3,050

1,525

843


1,613,137

254,869

74,538

93,450

95,732

Loan and other credit-related commitments
410,950

95,751

63,729

57,019

28,395

Financial guarantees and similar contracts
12,608

4,647

10,301

8,138

1,378

At 31 Dec 2016
2,036,695

355,267

148,568

158,607

125,505

 
 
 
 
 
 
Deposits by banks
42,182

6,643

1,452

4,029

107

Customer accounts
1,076,595

160,368

43,289

10,964

263

Repurchase agreements - non-trading
13,181

64,109

2,144

535

543

Trading liabilities
141,614

-

-

-

-

Financial liabilities designated at fair value
327

4,077

6,149

24,642

41,365

Derivatives
276,141

255

970

1,721

1,652

Debt securities in issue
377

25,910

23,886

35,499

6,993

Subordinated liabilities
-

803

971

10,151

28,132

Other financial liabilities
59,298

17,476

7,226

10,188

1,014


1,609,715

279,641

86,087

97,729

80,069

Loan and other credit-related commitments
425,000

93,149

73,115

60,078

15,089

Financial guarantees and similar contracts
12,579

5,727

15,091

9,915

2,805

At 31 Dec 2015
2,047,294

378,517

174,293

167,722

97,963

HSBC Holdings
Liquidity risk in HSBC Holdings is overseen by Holdings ALCO. This risk arises because of HSBC Holdings' obligation to make payments to debt holders as they fall due. The liquidity risk related to these cash flows is managed by matching external debt obligations with internal loan cash flows and by maintaining an appropriate liquidity buffer that is monitored by Holdings ALCO.
The balances in the table below are not directly comparable with those on the balance sheet of HSBC Holdings as the table incorporates, on an undiscounted basis, all cash flows relating
 
to principal and future coupon payments (except for derivatives not treated as hedging derivatives). Undiscounted cash flows payable in relation to hedging derivative liabilities are classified according to their contractual maturities. Derivatives not treated as hedging derivatives are included in the 'On demand' time bucket.
In addition, loan commitments and financial guarantees and similar contracts are generally not recognised on our balance sheet. The undiscounted cash flows potentially payable under financial guarantees and similar contracts are classified on the basis of the earliest date on which they can be called.

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HSBC Holdings plc Annual Report and Accounts 2016

Cash flows payable by HSBC Holdings under financial liabilities by remaining contractual maturities
(Audited)
 
On
demand

Due within
3 months

Due between
3 and 12 months

Due between
1 and 5 years

Due after
5 years

 
$m

$m

$m

$m

$m

Amounts owed to HSBC undertakings
-

2,051

-

105

-

Financial liabilities designated at fair value
-

314

960

11,964

25,665

Derivatives
3,841

-

-

592

592

Debt securities in issue
-

157

478

8,393

19,164

Subordinated liabilities
-

196

598

4,461

20,899

Other financial liabilities
-

1,343

164

-

-

 
3,841

4,061

2,200

25,515

66,320

Loan commitments
-

-

-

-

-

Financial guarantees and similar contracts
7,619

-

-

-

-

At 31 Dec 2016
11,460

4,061

2,200

25,515

66,320

 
 
 
 
 
 
Amounts owed to HSBC undertakings
257

1,375

424

110

-

Financial liabilities designated at fair value
-

1,145

655

5,202

20,779

Derivatives
2,065

-

-

213

-

Debt securities in issue
-

15

47

250

1,176

Subordinated liabilities
-

229

699

5,149

25,474

Other financial liabilities
-

1,426

152

-

-

 
2,322

4,190

1,977

10,924

47,429

Loan commitments
-

-

-

-

-

Financial guarantees and similar contracts
68,333

-

-

-

-

At 31 Dec 2015
70,655

4,190

1,977

10,924

47,429


HSBC Holdings plc Annual Report and Accounts 2016
113

Report of the Directors | Risk


< td class="oc">
Market risk profile
 
Page

Market risk in 2016
114

Trading portfolios
114

Non-trading portfolios
115

Market risk balance sheet linkages
116

Structural foreign exchange exposures
116

Net interest income sensitivity
117

Sensitivity of capital and reserves
118

Third-party assets in BSM
118

Defined benefit pension schemes
118

Additional market risk measures
applicable only to the parent company
118


Market risk in 2016
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 portfolios; and
•
non-trading portfolios.
Market risk exposures arising from our insurance manufacturing operations are discussed on page 82.
A summary of our current policies and practices regarding the management of market risk is set out on page 77.
Global markets were influenced by the increase in US interest rates in line with market expectation. Bond yields continued to rise and global stock markets continued to be supported by expectations of fiscal expansion in the US in the wake of the new US presidential elections. The US monetary tightening contrasts with the ECB extending its quantitative easing programme, highlighting the divergence in monetary policies
 
during the year.
 
In China, the prospect of a slowdown in the economy in the first half of 2016, and uncertainty around the trade relationship with the US, following the elections, led to further depreciation of the renminbi. Chinese policymakers will attempt to keep this process gradual in order to avoid disruptive capital outflows.
In the UK, following the decision to leave the EU, concerns persist about the upcoming exit negotiations and the ultimate nature of the EU-UK relationship.
Capital flows to the emerging markets remained weak, with some central banks increasing local interest rates to reduce reserve outflows.
Trading value at risk ('VaR') spiked in quarter one, due to higher market volatility impacting the foreign exchange and credit spread asset classes. For the remainder of the year, exposures in all asset classes were managed down. Non-trading VaR increased during the year as higher interest rates, especially in US dollars, caused the duration of non-trading assets to increase.
Trading portfolios
Value at risk of the trading portfolios
Trading VaR predominantly resides within Global Markets. It was relatively stable at 31 December 2016 compared with 31 December 2015. During the year, the trading VaR composition changed in that interest rate trading VaR increased but was offset by decreases in both credit spread and equity trading VaR components.
The daily levels of total trading VaR over the last year are set out in the graph below.
Daily VaR (trading portfolios), 99% 1 day ($m)
 
Trading VaR
IR trading
Equity trading
CS trading
FX trading
Diversification
 
 
 
 
 
 


114
HSBC Holdings plc Annual Report and Accounts 2016

The Group trading VaR for the year is shown in the table below.
 
 
 
 
 
 
 
 
 Trading VaR, 99% 1 day51
 
(Audited)
 
 
 
 
 
 
 
 
Foreign
exchange (FX)
and commodity

Interest
rate (IR)

Equity (EQ)

Credit
spread (CS)

Portfolio diversification52

Total53

 
 
$m

$m

$m

$m

$m

$m

 
Balance at 31 Dec 2016
8.9

49.7

11.8

5.9

(23.5
)
52.8

 
Average
11.1

42.8

20.4

13.5

(30.3
)
57.5

 
Maximum
16.9

64.2

32.4

28.1



91.5

 
Minimum
5.4

31.8

11.8

5.0



42.1

 
 
 
 
 
 
 
 
 
Balance at 31 Dec 2015
8.0

34.9

21.4

13.9

(24.9
)
53.3

 
Average
14.7

46.0

19.6

15.5

(35.7
)
60.1

 
Maximum
25.4

57.0

29.0

23.3



77.9

 
Minimum
6.3

32.6

11.9

9.8



47.5

For footnotes, see page 126.
Back-testing
In 2016, the Group experienced two back-testing exceptions against hypothetical profit and loss: a loss exception in February, driven by Libor against overnight index spread widening on long positions; and a profit exception in June, driven by significant devaluations in sterling and the euro against the US dollar resulting from the UK's referendum on EU membership.
There was no evidence of model errors or control failures.
The back-testing result excludes exceptions due to changes in fair value adjustments.

 
Non-trading portfolios
Value at risk of the non-trading portfolios
Non-trading VaR of the Group includes contributions from all global businesses. There is no commodity risk in the non-trading portfolios. The increase in non-trading VaR during 2016 was due primarily to the lengthening of the duration in the non-trading book from higher interest rates, especially US rates.
The increase in non-trading interest rate was offset by a decrease in the credit spread VaR component and an increase in portfolio diversification effects.
Non-trading VaR includes the interest rate risk in the banking book transferred to and managed by Balance Sheet Management ('BSM') and the non-trading financial instruments held by BSM. The management of interest rate risk in the banking book and the role of BSM are described further in Interest rate risk in the banking book section below.
Non-trading VaR excludes the insurance operations which are discussed further on page 121 and the interest rate risk in the banking book arising from HSBC Holdings.
The daily levels of total non-trading VaR over the last year are set out in the graph below.
Daily VaR (non-trading portfolios), 99% 1 day ($m)
Non-trading VaR
IR non-trading
 
CS non-trading
 
Diversification
 
 
 
 
 
 


HSBC Holdings plc Annual Report and Accounts 2016
115

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The Group non-trading VaR for the year is shown in the table below.
Non-trading VaR, 99% 1 day
(Audited)
 
Interest
rate (IR)

Credit
spread (CS)

Portfolio
diversification52

Total53

 
$m

$m

$m

$m

Balance at 31 Dec 2016
157.0

46.5

(32.1
)
171.4

Average
131.6

52.8

(32.1
)
152.3

Maximum
171.9

82.8



182.1

Minimum
100.2

36.9



123.3

 
 
 
 
 
Balance at 31 Dec 2015
114.1

72.7

(54.0
)
132.8

Average
97.5

65.7

(42.0
)
121.2

Maximum
131.5

89.4

 
156.8

Minimum
70.5

52.1

 
91.5

For footnotes, see page 126.
Non-trading VaR excludes equity risk on available-for-sale securities, structural foreign exchange risk and interest rate risk on fixed-rate securities issued by HSBC Holdings. This section and the sections below describe the scope of HSBC's management of market risks in non-trading books.
Equity securities classified as available for sale
Fair value of equity securities
(Audited)
 
 
2016

2015

 
Footnotes
$bn

$bn

Private equity holdings
54
1.2

1.9

Investment to facilitate ongoing business
55
1.5

1.9

Other strategic investments
 
2.0

2.1

At 31 Dec
 
4.7

5.9

For footnotes, see page 126.
The table above sets out the maximum possible loss on shareholders' equity from available-for-sale equity securities. The fair value of equity securities classified as available for sale reduced from $5.9bn to $4.7bn. The decrease in private equity holdings was largely due to fund distributions and the reclassification of the investment in certain funds as an associate investment. The decrease in business facilitation equities was largely due to the sale of the Visa investment.
Market risk balance sheet linkages
Below are the balance sheet lines in the Group's consolidated position that are subject to market risk.
Trading assets and liabilities
The Group's trading assets and liabilities are in almost all cases originated by GB&M. These assets and liabilities are treated as traded risk for the purposes of market risk management, other than a limited number of exceptions, primarily in Global Banking where the short-term acquisition and disposal of the assets are linked to other non-trading related activities such as loan origination.
Derivative assets and liabilities
We undertake derivative activity for three primary purposes: to create risk management solutions for clients, to manage the portfolio risks arising from client business, and to manage and hedge our own risks. Most of our derivative exposures arise from sales and trading activities within GB&M, and are treated as traded risk for market risk management purposes.
The assets and liabilities included in trading VaR give rise to a large proportion of the income included in net trading income. As set out on page 184, HSBC's net trading income in 2016 was $9,452m (2015: $8,723m). Adjustments to trading income such as valuation adjustments do not feed the trading VaR model.
 
For information on the accounting policies applied to financial instruments at fair value, see Note 13 on the Financial Statements.
Structural foreign exchange exposures
For our policies and procedures for managing structural foreign exchange exposures, see page 78 of the Risk management section.
HSBC's structural foreign exchange exposures are represented by the net asset value of its foreign exchange equity and subordinated debt investments in subsidiaries, branches, joint ventures and associates with non-US dollar functional currencies. Gains or losses on structural foreign exchange exposures are recognised in other comprehensive income.
Net structural foreign exchange exposures
 
2016

2015

 
$m

$m

Currency of structural exposure


Hong Kong dollars
32,472

28,270

Pound sterling1 
27,527

32,701

Chinese renminbi
24,504

24,117

Euros
17,397

19,966

Indian rupees
3,901

3,645

Mexican pesos
3,826

4,228

Canadian dollars
3,734

3,595

Saudi riyals
3,690

3,109

Swiss francs
2,226

2,642

Malaysian ringgit
2,079

1,994

UAE dirhams
2,073

1,898

Singapore dollars
1,995

1,454

Taiwanese dollars
1,753

1,702

Australian dollars
1,667

1,396

Indonesian rupiah
1,439

1,303

Korean won
1,260

1,296

Argentine pesos
860

875

Brazilian real
755

2,865

Turkish lira
734

1,006

Thai baht
736

662

Others, each less than $700m
5,728

6,038

At 31 Dec
140,356

144,762

1
During 2016, we entered into new forward exchange contracts amounting to $1.5bn (2015: $2.6bn) in order to manage our sterling structural foreign exchange exposure.
Shareholders' equity would decrease by $2,247m (2015: $2,633m) if euro and sterling foreign currency exchange rates weakened by 5% relative to the US dollar.


116
HSBC Holdings plc Annual Report and Accounts 2016

Net interest income sensitivity
The following table sets out the assessed impact on our base case projected net interest income ('NII') for 2016
(excluding insurance) of a series of four quarterly parallel shocks of 25 basis points to the current market-implied path of interest rates worldwide at the beginning of each quarter from 1 January 2017.
The sensitivities shown represent our assessment as to the change in expected base case net interest income under the two rate scenarios, assuming that all other non-interest rate risk variables remain constant, and there are no management actions. In deriving our base case net interest income projections, the repricing rates of assets and liabilities used are derived from current yield curves, thereby reflecting current market expectations of the future path of interest rates. The scenarios therefore represent interest rate shocks to the current market implied path of rates.
The NII sensitivities shown are indicative and based on simplified scenarios, including the assumption that the balance sheet size and structure remains static, other than instances where the size of the balances or repricing is deemed interest rate sensitive (non-interest bearing current account migration and fixed rate loan early prepayment) and where non-traded VaR is assumed to contractually run off. The limitations of this analysis are discussed within the 'Risk management' section on page 68.
Assuming no management response, a sequence of such rises ('up-shock') would increase expected net interest income for 2016 by $1,709m (2015: $1,251m), while a sequence of such falls ('down-shock') would decrease planned net interest income by $2,406m (2015: $2,258m).
The NII sensitivity of the Group can be split into three key components: the structural sensitivity arising from the four global businesses excluding BSM and Markets, the sensitivity of the funding of the trading book (Markets) and the sensitivity of BSM.
 
The structural sensitivity is positive in a rising rate environment and negative in a falling rate environment. The sensitivity of
the funding of the trading book is negative in a rising rate environment and positive in a falling rate environment, and in terms of the impact on profit the change in NII would be expected to be offset by a similar change in net trading income. The sensitivity of BSM will depend on its position. Typically, assuming no management response, the sensitivity of BSM is negative in a rising rate environment and positive in a falling rate environment.
The NII sensitivity figures also incorporate the effect of any interest rate behaviouralisation applied and the effect of any assumed repricing across products under the specific interest rate scenario. They do not incorporate the effect of any management decision to change the HSBC balance sheet composition.
The NII sensitivity in BSM arises from a combination of the techniques that BSM use to mitigate the transferred interest rate risk and the methods they use to optimise net revenues in line with their defined risk mandate. The figures in the table below do not incorporate the effect of any management decisions within BSM, but in reality it is likely that there would be some short-term adjustment in BSM positioning to offset the NII effects of the specific interest rate scenario where necessary.
The NII sensitivity arising from the funding of the trading book is comprised of the expense of funding trading assets, while the revenue from these trading assets is reported in net trading income. This leads to an asymmetry in the NII sensitivity figures which is cancelled out in our global business results, where we include both net interest income and net trading income. It is likely, therefore, that the overall effect on profit before tax of the funding of the trading book will be much less pronounced than the figures in the following table.
 
 
 
 
 
 
 
 
 
 Net interest income sensitivity56
 
 
(Audited)
 
 
US dollar
bloc
$m

Rest of
Americas
bloc
$m

Hong Kong
dollar
bloc
$m

Rest of
Asia
bloc
$m

Sterling
bloc
$m

Euro
bloc
$m

Total
$m

 
Change in 2016 net interest income arising from
a shift in yield curves of:














 
+25 basis points at the beginning of each quarter
605

47

504

280

61

212

1,709

 
-25 basis points at the beginning of each quarter
(1,024
)
(41
)
(797
)
(292
)
(261
)
9

(2,406
)
 















 
Change in 2015 net interest income arising from
a shift in yield curves of:














 
+25 basis points at the beginning of each quarter
410

72

217

369

135

49

1,251

 
-25 basis points at the beginning of each quarter
(691
)
(74
)
(645
)
(290
)
(528
)
(30
)
(2,258
)
For footnote, see page 126.
We expect NII to rise in the rising rate scenario and fall in the falling rate scenario. This is due to a structural mismatch between our assets and liabilities (on balance we would expect our assets to reprice more quickly, and to a greater extent, than our liabilities).
Economic value of equity
The table below sets out the assessed impact on our base case economic value of equity ('EVE') of an immediate parallel
 
upward shock of 200 basis points ('bps') (up 200bps) and an immediate parallel downward shock of 200 basis points (down 200bps) to the market-implied path of interest rates worldwide on 1 January 2017.
The economic value of equity remains higher than the book value of equity under base case, up 200bps and down 200bps scenarios.

HSBC Holdings plc Annual Report and Accounts 2016
117

Report of the Directors | Risk


Economic value of equity
 
US dollar
bloc

Rest of
Americas
bloc

Hong Kong
dollar
bloc

Rest of
Asia
bloc

Sterling
bloc

Euro
bloc

Total

 
$m

$m

$m

$m

$m

$m

$m

Change in economic value of equity as at 31 Dec 2016
arising from an immediate shift in yield curves of:







+200 basis points
1,616

(596
)
1,492

(103
)
(684
)
(597
)
1,128

-200 basis points
(7,455
)
531

(2,591
)
(159
)
(792
)
58

(10,408
)
Sensitivity of capital and reserves
Under CRD IV, available-for-sale ('AFS') reserves are included as part of CET1 capital. We measure the potential downside risk to the CET1 ratio due to interest rate and credit spread risk in the AFS portfolio by the portfolio's stressed VaR, using a 99% confidence level and an assumed holding period of one quarter. At December 2016, the stressed VaR of the portfolio was
$3.2bn.
We monitor the sensitivity of reported cash flow hedging reserves to interest rate movements on a monthly basis by
 
assessing the expected reduction in valuation of cash flow hedges due to parallel movements of plus or minus 100bps in all yield curves. These particular exposures form only a part of our overall interest rate exposure.
The following table describes the sensitivity of our cash flow hedge reported reserves to the stipulated movements in yield curves and the maximum and minimum month-end figures during the year. The sensitivities are indicative and based on simplified scenarios.
Sensitivity of cash flow hedging reported reserves to interest rate movements
 
 
Maximum
impact

Minimum
impact

 
$m

$m

$m

At 31 Dec 2016






+100 basis point parallel move in all yield curves
(1,051
)
(1,173
)
(1,051
)
As a percentage of total shareholders' equity
(0.6
)%
(0.7
)%
(0.6
)%
-100 basis point parallel move in all yield curves
1,080

1,080

1,145

As a percentage of total shareholders' equity
0.6
%
0.6
%
0.7
%







At 31 Dec 2015






+100 basis point parallel move in all yield curves
(1,235
)
(1,259
)
(1,137
)
As a percentage of total shareholders' equity
(0.66
)%
(0.67
)%
(0.60
)%
-100 basis point parallel move in all yield curves
1,224

1,232

1,133

As a percentage of total shareholders' equity
0.65
%
0.65
%
0.60
%
Third-party assets in Balance Sheet Management
For our BSM governance framework, see page 79 of 'Risk management'.
Third-party assets in BSM increased by 9% during 2016. Deposits with central banks increased by $28bn, predominantly in North America and Europe, due to deployment of increased commercial surplus, partly offset by decrease in the UK due to foreign exchange movements as sterling depreciated against the US dollar.
Financial investments increased by $17bn due to increases in Europe and Asia, as commercial surplus was deployed into government bonds.
Third-party assets in Balance Sheet Management
 
2016

2015

 
$m

$m

Cash and balances at central banks
98,996

71,116

Trading assets
414

639

Loans and advances:


- to banks
37,287

42,059

- to customers
2,564

2,773

Reverse repurchase agreements
35,143

29,760

Financial investments
352,419

335,543

Other
4,555

4,277

At 31 Dec
531,378

486,167


 
Defined benefit pension schemes
Market risk arises within our defined benefit pension schemes to the extent that the obligations of the schemes are not fully matched by assets with determinable cash flows.
For details of our defined benefit schemes, including asset allocation, see Note 5 on the Financial Statements, and for pension risk management see page 84.
Additional market risk measures applicable only to the parent company
The principal tools used in the management of market risk are VaR for foreign exchange rate risk and the projected sensitivity of HSBC Holdings' net interest income to future changes in yield curves and interest rate gap repricing tables for interest rate risk.
Foreign exchange risk
Total foreign exchange VaR arising within HSBC Holdings in 2016 was as follows:
HSBC Holdings - foreign exchange VaR
 
2016

2015

 
$m

$m

At 31 Dec
32.1

45.6

Average
44.4

42.3

Minimum
32.1

32.9

Maximum
58.2

47.1

The foreign exchange risk largely arises from loans to subsidiaries of a capital nature that are not denominated in the functional currency of either the provider or the recipient and which are accounted for as financial assets. Changes in the carrying amount of these loans due to foreign exchange rate differences are taken directly to HSBC Holdings' income

118
HSBC Holdings plc Annual Report and Accounts 2016

statement. These loans, and most of the associated foreign exchange exposures, are eliminated on consolidation.
Sensitivity of net interest income
HSBC Holdings monitors NII sensitivity over a five-year time horizon reflecting the longer-term perspective on interest rate risk management appropriate to a financial services holding company. These sensitivities assume that any issuance where HSBC Holdings has an option to reimburse at a future call date is called at this date. The table below sets out the effect on
 
HSBC Holdings' future NII over a five-year time horizon of incremental 25 basis point parallel falls or rises in all yield curves worldwide at the beginning of each quarter during the 12 months from 1 January 2016.
Assuming no management actions, a sequence of such rises would increase planned NII for the next five years by $746m (2015: increase of $247m), while a sequence of such falls would decrease planned NII by $723m (2015: decrease of $266m).
 
 
 
 
 
 
 Sensitivity of HSBC Holdings' net interest income to interest rate movements56
 
 
 
US dollar bloc

Sterling bloc

Euro bloc

Total

 
 
$m

$m

$m

$m

 
Change in projected net interest income as at 31 Dec
arising from a shift in yield curves
 
 
 
 
 
2016
 
 
 
 
 
of +25 basis points at the beginning of each quarter








 
0-1 year
84

6

0

90

 
2-3 years
299

20

6

325

 
4-5 years
304

20

8

332

 
of -25 basis points at the beginning of each quarter








 
0-1 year
(84
)
(4
)
-

(88
)
 
2-3 years
(299
)
(13
)
-

(312
)
 
4-5 years
(304
)
(19
)
(1
)
(324
)
 
 
 
 
 
 
 
2015
 
 
 
 
 
of +25 basis points at the beginning of each quarter
 
 
 
 
 
0-1 year
57

15

-

72

 
2-3 years
118

43

7

168

 
4-5 years
(23
)
43

(12
)
8

 
of -25 basis points at the beginning of each quarter








 
0-1 year
(57
)
(14
)
(6
)
(77
)
 
2-3 years
(118
)
(43
)
(22
)
(183
)
 
4-5 years
23

(43
)
15

(5
)
For footnote, see page 126.
The interest rate sensitivities tabulated above are indicative and based on simplified scenarios. The figures represent hypothetical movements in NII based on our projected yield curve scenarios, HSBC Holdings' current interest rate risk profile and assumed changes to that profile during the next five years.
 
Changes to assumptions concerning the risk profile over the next five years can have a significant impact on the NII sensitivity for that period. However, the figures do not take into account the effect of actions that could be taken to mitigate this interest rate risk.

HSBC Holdings plc Annual Report and Accounts 2016
119

Report of the Directors | Risk


Interest rate repricing gap table
The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included within the Group VaR but is managed
 
on a repricing gap basis. The interest rate repricing gap table below analyses the full-term structure of interest rate mismatches within HSBC Holdings' balance sheet.
Repricing gap analysis of HSBC Holdings
 
Total

Up to
1 year

From over 1
to 5 years

From over 5
to 10 years

More than
10 years

Non-interest
 bearing

 
$m

$m

$m

$m

$m

$m

Cash at bank and in hand:
 
 
 
 
 
 
- balances with HSBC undertakings
-

-

-

-

-

-

Derivatives
2,184

-

-

-

-

2,184

Loans and advances to HSBC undertakings
77,680

72,288

279

405

-

4,708

Financial investments in HSBC undertakings
3,555

2,675

731

8

-

141

Investments in subsidiaries
96,183

-

-

-

-

96,183

Other assets
1,488

-

105

-

-

1,383

Total assets
181,090

74,963

1,115

413

-

104,599

Amounts owed to HSBC undertakings
(2,157
)
(105
)
 
 
 
(2,052
)
Financial liabilities designated at fair values
(30,145
)
(1,109
)
(7,344
)
(12,588
)
(6,422
)
(2,682
)
Derivatives
(5,018
)
-

-

-

-

(5,018
)
Debt securities in issue
(21,824
)
(4,199
)
(2,997
)
(11,708
)
(3,916
)
996

Other liabilities
(1,628
)
-

-

-

-

(1,628
)
Subordinated liabilities
(15,200
)
-

(3,267
)
(2,000
)
(9,445
)
(488
)
Total equity
(105,118
)
-

-

-

-

(105,118
)
Total liabilities and equity
(181,090
)
(5,413
)
(13,608
)
(26,296
)
(19,783
)
(115,990
)
Off-balance sheet items attracting interest rate sensitivity
 
(57,089
)
13,608

26,296

13,441

3,743

Net interest rate risk gap at 31 Dec 2016
 
12,461

1,115

413

(6,342
)
(7,647
)
Cumulative interest rate gap
 
12,461

13,576

13,989

7,647

-

 
 
 
 
 
 
 
Cash at bank and in hand:
 
 
 
 
 
 
- balances with HSBC undertakings
242

242

-

-

-

-

Derivatives
2,467

-

-

-

-

2,467

Loans and advances to HSBC undertakings
44,350

42,661

279

405

-

1,005

Financial investments in HSBC undertakings
4,285

2,985

-

731

-

569

Investments in subsidiaries
97,770

-

-

-

-

97,770

Other assets
1,080

-

109

-

-

971

Total assets
150,194

45,888

388

1,136

 
102,782

Amounts owed to HSBC undertakings
(2,152
)
(781
)
-

-

-

(1,371
)
Financial liabilities designated at fair values
(19,853
)
(1,741
)
(3,239
)
(7,032
)
(4,312
)
(3,628
)
Derivatives
(2,278
)
-

-

-

-

(2,278
)
Debt securities in issue
(960
)
-

-

(963
)
-

3

Other liabilities
(15,895
)
-

(3,374
)
(3,500
)
(9,119
)
98

Subordinated liabilities
(1,642
)
-

-

-

-

(1,642
)
Total equity
(107,414
)
-

-

-

-

(107,414
)
Total liabilities and equity
(150,194
)
(2,522
)
(6,613
)
(11,495
)
(13,332
)
(116,232
)
Off-balance sheet items attracting interest rate sensitivity
-

(22,748
)
5,351

10,722

5,763

912

Net interest rate risk gap at 31 Dec 2015
-

20,618

(874
)
363

(7,569
)
(12,538
)
Cumulative interest rate gap
-

20,618

19,744

20,107

12,538

-


120
HSBC Holdings plc Annual Report and Accounts 2016

Operational risk profile
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. It arises from day-to-day operations or external events, and is relevant to every aspect of our business.
Responsibility for minimising operational risk lies with HSBC's staff. All staff are required to manage the operational risks of the business and operational activities for which they are responsible.
A summary of our current policies and practices regarding the management of operational risk is set out on page 80.
Operational risk exposures in 2016
HSBC continued to strengthen those controls that manage our most material risks in 2016. Among other measures, we:
•
further embedded Global Standards into the operational risk management framework to ensure that we know our customers, ask the right questions and escalate concerns to prevent financial crime;
•
implemented a number of initiatives to raise our standards in relation to the conduct of our business, as described on page 81 of the 'Regulatory compliance risk management' section;
•
increased monitoring and enhanced detective controls to manage those fraud risks which arise from new technologies and new ways of banking;
•
strengthened internal security controls to prevent cyber-attacks;
•
improved controls and security to protect customers when using digital channels; and
•
enhanced third-party risk management capability to enable the consistent risk assessment of any third-party service.
Further information on the nature of these risks is provided in 'Top and emerging risks' on page 64.
Operational risk losses in 2016
Operational risk losses in 2016 are lower than in 2015, reflecting a reduction in losses incurred relating to large legacy conduct-related events. Conduct-related costs included in significant items are outlined on page 62. The profile of operational risk losses below shows the distribution of losses for 2015 and 2016 against event types.
Operational risk losses
 
 
 
2016

2015

 
%

%

Business disruption and system failures
-

-

Clients, products and business practices
57

74

Damage to physical assets
-

-

Employee practices and workplace safety
1

1

Execution, delivery and process management
34

13

External fraud
8

11

Internal fraud
-

1

Total
100

100


 
Insurance manufacturing operations risk profile
 
Page

Insurance manufacturing operations risk in 2016
121

HSBC's bancassurance model
121

Measurement
121

Key risk types
123

Market risk
123

Credit risk
124

Liquidity risk
124

Insurance risk
125


Insurance manufacturing operations risk in 2016
The majority of the risk in our insurance business derives from manufacturing activities and can be categorised as financial risk or insurance risk. Financial risks include market risk, credit risk and liquidity risk. Insurance risk is the risk, other than financial risk, of loss transferred from the holder of the insurance contract to the issuer (HSBC).
A summary of our current policies and practices regarding the management of insurance risk is set out on page 82.
HSBC's bancassurance model
We operate an integrated bancassurance model that provides insurance products principally for customers with whom we have a banking relationship.
The insurance contracts we sell relate to the underlying needs of our banking customers, which we can identify from our point-of-sale contacts and customer knowledge. The majority of sales are of savings and investment products and term and credit life contracts.
By focusing largely on personal and SME lines of business, we are able to optimise volumes and diversify individual insurance risks. We choose to manufacture these insurance products in HSBC subsidiaries based on an assessment of operational scale and risk appetite. Manufacturing insurance allows us to retain the risks and rewards associated with writing insurance contracts by keeping part of the underwriting profit and investment income within the Group.
We have life insurance manufacturing subsidiaries in nine countries (Argentina, mainland China, France, Hong Kong, Malaysia, Malta, Mexico, Singapore and the UK). We also have life insurance manufacturing associates in Saudi Arabia and India.
Where we do not have the risk appetite or operational scale to be an effective insurance manufacturer, we engage with a handful of leading external insurance companies in order to provide insurance products to our customers through our banking network and direct channels. These arrangements are generally structured with our exclusive strategic partners and earn the Group a combination of commissions, fees and a share of profits. We distribute insurance products in all of our geographical regions.
Insurance products are sold through all global businesses, but predominantly by RBWM and CMB through our branches and direct channels worldwide.
The sale of our Brazilian insurance operations completed on 1 July 2016. These operations were reported as part of the disposal group held for sale at 31 December 2015.
Measurement
(Audited)
The risk profile of our insurance manufacturing businesses is measured using an economic capital approach. Assets and liabilities are measured on a market value basis, and a capital requirement is defined to ensure that there is a less than one in

HSBC Holdings plc Annual Report and Accounts 2016
121

Report of the Directors | Risk


200 chance of insolvency over a one-year time horizon, given the risks that the businesses are exposed to. The methodology for the economic capital calculation is largely aligned to the pan-European Solvency II insurance capital regulations, which were applicable from January 2016. The economic capital coverage ratio (economic net asset value divided by the economic capital requirement) is a key risk appetite measure.
 
The business has a current appetite to remain above 140% with a tolerance of 110%. In addition to economic capital, the regulatory solvency ratio is also a metric used to manage risk appetite on an entity basis.
The tables below show the composition of assets and liabilities by contract type and by geographical region.
 
 
 
 
 
 
 
 
Balance sheet of insurance manufacturing subsidiaries by type of contract63
 
(Audited)
 
 
 
 
 
 
 
 
 
With
DPF

Unit-linked

Other contracts57

Shareholder
assets and liabilities58

Total

 
 
Footnotes
$m

$m

$m

$m

$m

 
Financial assets
 
57,004

8,877

13,021

5,141

84,043

 
- trading assets
 
-

-

2

-

2

 
- financial assets designated at fair value
 
12,134

8,592

2,889

684

24,299

 
- derivatives
 
212

2

13

46

273

 
- financial investments - HTM
59
25,867

-

5,329

2,919

34,115

 
- financial investments - AFS
59
14,359

-

4,206

1,355

19,920

 
- other financial assets
60
4,432

283

582

137

5,434

 
Reinsurance assets
 
498

322

1,048

-

1,868

 
PVIF
61
-

-

-

6,502

6,502

 
Other assets and investment properties
 
1,716

5

171

525

2,417

 
Total assets
 
59,218

9,204

14,240

12,168

94,830

 
Liabilities under investment contracts designated at fair value
 
-

2,197

3,805

-

6,002

 
Liabilities under insurance contracts
 
58,800

6,949

9,524

-

75,273

 
Deferred tax
62
13

3

7

1,166

1,189

 
Other liabilities
 
-

-

-

1,805

1,805

 
Total liabilities
 
58,813

9,149

13,336

2,971

84,269

 
Total equity
 
-

-

-

10,561

10,561

 
Total liabilities and equity at 31 Dec 2016
 
58,813

9,149

13,336

13,532

94,830

Financial assets
 
53,521

8,840

11,691

5,531

79,583

- trading assets
 
-

-

2

-

2

- financial assets designated at fair value
 
11,119

8,435

2,718

1,015

23,287

- derivatives
 
160

1

33

62

256

- financial investments - HTM
59
22,840

-

4,189

3,050

30,079

- financial investments - AFS
59
15,077

-

4,020

1,233

20,330

- other financial assets
60
4,325

404

729

171

5,629

Reinsurance assets
 
202

264

951

-

1,417

PVIF
61
-

-

-

5,685

5,685

Other assets and investment properties
 
1,726

7

139

4,576

6,448

Total assets
 
55,449

9,111

12,781

15,792

93,133

Liabilities under investment contracts designated at fair value
 
-

2,256

3,771

-

6,027

Liabilities under insurance contracts
 
55,023

6,791

8,124

-

69,938

Deferred tax
62
11

-

14

1,056

1,081

Other liabilities
 
-

-

-

5,553

5,553

Total liabilities
 
55,034

9,047

11,909

6,609

82,599

Total equity
 
-

-

-

10,534

10,534

Total liabilities and equity at 31 Dec 2015
 
55,034

9,047

11,909

17,143

93,133

For footnotes, see page 126.

122
HSBC Holdings plc Annual Report and Accounts 2016

 
 
 
 
 
 
 
 Balance sheet of insurance manufacturing subsidiaries by geographical region63, 64
 
 
(Audited)
 
 
 
Europe

Asia

Latin
America

Total

 
 
Footnotes
$m

$m

$m

$m

 
Financial assets
 
26,238

56,371

1,434

84,043

 
- trading assets
 
-

-

2

2

 
- financial assets designated at fair value
 
10,171

13,618

510

24,299

 
- derivatives
 
187

86

-

273

 
- financial investments - HTM
59
-

33,624

491

34,115

 
- financial investments - AFS
59
13,812

5,735

373

19,920

 
- other financial assets
60
2,068

3,308

58

5,434

 
Reinsurance assets
 
362

1,499

7

1,868

 
PVIF
61
711

5,682

109

6,502

 
Other assets and investment properties
 
871

1,493

53

2,417

 
Total assets
 
28,182

65,045

1,603

94,830

 
Liabilities under investment contracts designated at fair value
 
1,321

4,681

-

6,002

 
Liabilities under insurance contracts
 
24,310

49,793

1,170

75,273

 
Deferred tax
62
238

919

32

1,189

 
Other liabilities
 
841

914

50

1,805

 
Total liabilities
 
26,710

56,307

1,252

84,269

 
Total equity
 
1,472

8,738

351

10,561

 
Total liabilities and equity at 31 Dec 2016
 
28,182

65,045

1,603

94,830

 
 
 
 
 
 
 
 
Financial assets
 
26,897

51,087

1,599

79,583

 
- trading assets
 
-

-

2

2

 
- financial assets designated at fair value
 
9,987

12,668

632

23,287

 
- derivatives
 
163

93

-

256

 
- financial investments - HTM
59
-

29,496

583

30,079

 
- financial investments - AFS
59
14,525

5,503

302

20,330

 
- other financial assets
60
2,222

3,327

80

5,629

 
Reinsurance assets
 
287

1,122

8

1,417

 
PVIF
61
807

4,761

117

5,685

 
Other assets and investment properties
 
919

1,358

4,171

6,448

 
Total assets
 
28,910

58,328

5,895

93,133

 
Liabilities under investment contracts designated at fair value
 
1,376

4,651

-

6,027

 
Liabilities under insurance contracts
 
24,699

43,975

1,264

69,938

 
Deferred tax
62
274

767

40

1,081

 
Other liabilities
 
832

974

3,747

5,553

 
Total liabilities
 
27,181

50,367

5,051

82,599

 
Total equity
 
1,729

7,961

844

10,534

 
Total liabilities and equity at 31 Dec 2015
 
28,910

58,328

5,895

93,133

For footnotes, see page 126.
Key risk types
The key risk for the insurance operation is market risk, followed by insurance risk. Credit and liquidity risk, while significant for the bank, are minor for our insurance operations.
Market risk
(Audited)
Description and exposure
Market risk is the risk of changes in market factors affecting HSBC's capital or profit. Market factors include interest rates, equity and growth assets, spread risk and foreign exchange rates.
Our exposure varies depending on the type of contract issued. Our most significant life insurance products are contracts with discretionary participating features ('DPF') issued in France and Hong Kong. These products typically include some form of capital guarantee or guaranteed return on the sums invested by the policyholders, to which discretionary bonuses are added if allowed by the overall performance of the funds. These funds are primarily invested in bonds, with a proportion allocated to other asset classes to provide customers with the potential for enhanced returns.
DPF products expose HSBC to the risk of variation in asset returns, which will impact our participation in the investment
 
performance. In addition, in some scenarios the asset returns can become insufficient to cover the policyholders' financial guarantees, in which case the shortfall has to be met by HSBC. Reserves are held against the cost of such guarantees, calculated by stochastic modelling.
Where local rules require, these reserves are held as part of liabilities under insurance contracts. Any remainder is accounted for as a deduction from the present value of in-force ('PVIF') long-term insurance business on the relevant product. The table below shows the total reserve held for the cost of guarantees, the range of investment returns on assets supporting these products and the implied investment return that would enable the business to meet the guarantees.
The cost of guarantees decreased to $625m (2015: $748m) primarily due to changes to the profit-sharing mechanism on DPF contracts with guarantees in Hong Kong, which primarily reduced the cost of guarantees on portfolios reported in the 2.1% to 4.0% category. In addition, there was a movement in cost of guarantees from the 2.1% to 4.0% category, to the 0.1% to 2.0% category due to reducing average guarantees on certain portfolios. The real annual return guarantees reported in 2015 relate to insurance operations in Brazil, which were sold on 1 July 2016.

HSBC Holdings plc Annual Report and Accounts 2016
123

Report of the Directors | Risk


For unit-linked contracts, market risk is substantially borne by the policyholder, but some market risk exposure typically
 
remains, as fees earned are related to the market value of the linked assets.
 
 
 
 
 
 
 
 
 
 Financial return guarantees63
 
(Audited)
 
 
 
2016
2015
 
 
 
Investment
returns
implied by
guarantee
Current
yields
Cost of
guarantees

Investment
returns
implied by
guarantee
Current
yields
Cost of guarantees

 
 
Footnotes
%
%
$m

%
%
$m

 
Capital
 
0.0
0.0 - 3.0
59

0.0
0.0 - 3.8
85

 
Nominal annual return
 
0.1 - 2.0
3.7 - 3.8
64

0.1 - 1.9
3.9 - 3.9
4

 
Nominal annual return
65
2.1 - 4.0
3.0 - 4.4
426

2.0 - 4.0
3.8 - 4.0
603

 
Nominal annual return
 
4.1 - 5.0
3.0 - 4.1
76

4.1 - 5.0
3.8 - 4.1
28

 
Real annual return
66
n/a
n/a
n/a

0.0 - 6.0
5.9 - 6.1
28

 
At 31 Dec
 


625



748

For footnotes, see page 126.
Sensitivities
Changes in financial market factors, from the economic assumptions in place at the start of the year, had a negative impact on reported profit before tax of $386m (2015: $13m negative). The following table illustrates the effects of selected interest rate, equity price and foreign exchange rate scenarios on our profit for the year and the total equity of our insurance manufacturing subsidiaries.
Where appropriate, the effects of the sensitivity tests on profit after tax and equity incorporate the impact of the stress on the PVIF. The relationship between the profit and total equity and the risk factors is non-linear, therefore the results disclosed should not be extrapolated to measure sensitivities to different levels of stress. For the same reason, the impact of the stress is
 
not symmetrical on the upside and downside. The sensitivities are stated before allowance for management actions which may mitigate the effect of changes in the market environment. The sensitivities presented allow for adverse changes in policyholder behaviour that may arise in response to changes in market rates.
Interest rate movements have a greater impact on total equity as changes in market value of available-for-sale bonds are not recognised in profit after tax.
Changes in sensitivity compared to 2015 were primarily driven by the impact of decreasing yields in France on the projected cost of options and guarantees and by the adoption of a more market-aligned PVIF methodology in Singapore.
Sensitivity of HSBC's insurance manufacturing subsidiaries to market risk factors
(Audited)
 
 
2016
2015
 
 
Effect on
profit after tax

Effect on
total equity

Effect on profit
after tax

Effect on
total equity

 
Footnote
$m

$m

$m

$m

+100 basis point parallel shift in yield curves
 
63

(494
)
39

(474
)
-100 basis point parallel shift in yield curves
67
(182
)
490

(213
)
404

10% increase in equity prices
 
189

190

176

176

10% decrease in equity prices
 
(191
)
(191
)
(158
)
(158
)
10% increase in US dollar exchange rate compared with all currencies
 
19

19

16

16

10% decrease in US dollar exchange rate compared with all currencies
 
(19
)
(19
)
(16
)
(16
)
For footnote, see page 126.
Credit risk
(Audited)
Description and exposure
Credit risk is the risk of financial loss if a customer or counterparty fails to meet their obligation under a contract. It arises in two main areas for our insurance manufacturers:
•
risk of default by debt security counterparties after investing premiums to generate a return for policyholders and shareholders; and
•
risk of default by reinsurance counterparties and non-reimbursement for claims made after ceding insurance risk.
The amounts outstanding at the balance sheet date in respect of these items are shown in the table on page 122.
The credit quality of the reinsurers' share of liabilities under insurance contracts is assessed as 'satisfactory' or higher (as defined on page 74), with 100% of the exposure being neither past due nor impaired (2015: 100%).
Credit risk on assets supporting unit-linked liabilities is predominantly borne by the policyholder; therefore, our
 
exposure is primarily related to liabilities under non-linked insurance and investment contracts and shareholders' funds. The credit quality of insurance financial assets is included in the table on page 88.
Liquidity risk
(Audited)
Description and exposure
Liquidity risk is the risk that an insurance operation, though solvent, either does not have sufficient financial resources available to meet its obligations when they fall due, or can secure them only at excessive cost.
The following table shows the expected undiscounted cash flows for insurance liabilities at 31 December 2016. The liquidity risk exposure is wholly borne by the policyholder in the case of unit-linked business and is shared with the policyholder for non-linked insurance.

124
HSBC Holdings plc Annual Report and Accounts 2016

The profile of the expected maturity of insurance contracts at 31 December 2016 remained comparable with 2015.
 
The remaining contractual maturity of investment contract liabilities is included in Note 29.
 
 
 
 
 
 
 
Expected maturity of insurance contract liabilities63
 
(Audited)
 
 
Expected cash flows (undiscounted)
 
 
Within 1 year

1-5 years

5-15 years

Over 15 years

Total

 
 
$m

$m

$m

$m

$m

 
Unit-linked
630

2,468

5,101

9,513

17,712

 
With DPF and Other contracts
5,582

23,136

40,621

40,447

109,786

 
At 31 Dec 2016
6,212

25,604

45,722

49,960

127,498

 
 
 
 
 
 
 
 
Unit-linked
549

2,164

5,945

11,080

19,738

 
With DPF and Other contracts
5,356

22,796

37,585

38,649

104,386

 
At 31 Dec 2015
5,905

24,960

43,530

49,729

124,124

For footnotes, see page 126.
Insurance risk
Description and exposure
Insurance risk is the risk of loss through adverse experience, in either timing or amount, of insurance underwriting parameters (non-economic assumptions). These parameters include mortality, morbidity, longevity, lapses and unit costs.
The principal risk we face is that, over time, the cost of the contract, including claims and benefits, may exceed the total amount of premiums and investment income received.
The tables on pages 122 and 123 analyse our life insurance risk exposures by type of contract and by geographical region.
The insurance risk profile and related exposures remain largely consistent with those observed at 31 December 2015.
Sensitivities
(Audited)
The table below shows the sensitivity of profit and total equity to reasonably possible changes in non-economic assumptions across all our insurance manufacturing subsidiaries.
Mortality and morbidity risk is typically associated with life insurance contracts. The effect on profit of an increase in mortality or morbidity depends on the type of business being written. Our largest exposures to mortality and morbidity risk exist in Hong Kong and Singapore.
 
Sensitivity to lapse rates depends on the type of contracts being written. For a portfolio of term assurance, an increase in lapse rates typically has a negative effect on profit due to the loss of future income on the lapsed policies. However, some contract lapses have a positive effect on profit due to the existence of policy surrender charges. We are most sensitive to a change in lapse rates on unit-linked and universal life contracts in Hong Kong and Singapore, and DPF contracts in France.
Expense rate risk is the exposure to a change in the cost of administering insurance contracts. To the extent that increased expenses cannot be passed on to policyholders, an increase in expense rates will have a negative effect on our profits.
Sensitivity analysis
(Audited)
 
2016

2015

 
$m

$m

Effect on profit after tax and total equity
at 31 Dec
 
 
10% increase in mortality and/or morbidity rates
(71
)
(70
)
10% decrease in mortality and/or morbidity rates
75

75

10% increase in lapse rates
(80
)
(90
)
10% decrease in lapse rates
93

102

10% increase in expense rates
(89
)
(85
)
10% decrease in expense rates
87

83


HSBC Holdings plc Annual Report and Accounts 2016
125

Report of the Directors | Risk / Capital

Footnotes to Risk
Liquidity and funding
47

The HSBC UK Liquidity Group shown comprises four legal entities: HSBC Bank plc (including all overseas branches, and SPEs consolidated by HSBC Bank plc for Financial Statement purposes), Marks and Spencer Financial Services plc, HSBC Private Bank (UK) Ltd and HSBC Trust Company (UK) Limited, managed as a single operating entity, in line with the application of UK liquidity regulation as agreed with the UK PRA.
48

The Hongkong and Shanghai Banking Corporation - Hong Kong branch and The Hongkong and Shanghai Banking Corporation - Singapore branch represent the material activities of the Hongkong and Shanghai Banking Corporation. Each branch is monitored and controlled for liquidity and funding risk purposes as a stand-alone operating entity.
49

HSBC France and HSBC Canada represent the consolidated banking operations of the Group in France and Canada, respectively. HSBC France and HSBC Canada are each managed as single distinct operating entities for liquidity purposes.
50

The total shown for other principal HSBC operating entities represents the combined position of all the other operating entities overseen directly by the Risk Management Meeting of the GMB.
Market risk
51

Trading portfolios comprise positions arising from the market-making and warehousing of customer-derived positions.
52

Portfolio diversification is the market risk dispersion effect of holding a portfolio containing different risk types. It represents the reduction in unsystematic market risk that occurs when combining a number of different risk types; for example, interest rate, equity and foreign exchange, together in one portfolio. It is measured as the difference between the sum of the VaR by individual risk type and the combined total VaR. A negative number represents the benefit of portfolio diversification. As the maximum and minimum occurs on different days for different risk types, it is not meaningful to calculate a portfolio diversification benefit for these measures.
53

The total VaR is non-additive across risk types due to diversification effects.
54

Investments in private equity are primarily made through managed funds that are subject to limits on the amount of investment. Potential new commitments are subject to risk appraisal to ensure that industry and geographical concentrations remain within acceptable levels for the portfolio as a whole. Regular reviews are performed to substantiate the valuation of the investments within the portfolio.
55

Investments held to facilitate ongoing business include holdings in government-sponsored enterprises and local stock exchanges.
56

Instead of assuming that all interest rates move together, we group our interest rate exposures into currency blocs whose rates are considered likely to move together. See page 281, 'Cautionary statement regarding forward-looking statements'.
Risk management of insurance operations
57

'Other Contracts' includes term assurance, credit life insurance, universal life insurance and investment contracts not included in the 'Unit-linked' or 'With DPF' columns.
58

At 31 December 2015, 'Shareholder assets and liabilities' included assets and liabilities classified as held for sale in respect of the disposal of operations in Brazil, which was completed on 1 July 2016. The assets, comprising mainly debt and equity securities and PVIF, were reported within 'Other assets and investment properties' and totalled $4.1bn. The liabilities classified as held for sale, comprising mainly liabilities under insurance contracts and liabilities under investment contracts, were reported within 'Other liabilities' and totalled $3.7bn. No assets and liabilities relating to insurance businesses were held for sale at 31 December 2016.
59

Financial investments held to maturity ('HTM') and available for sale ('AFS').
60

Comprise mainly loans and advances to banks, cash and inter-company balances with other non-insurance legal entities.
61

Present value of in-force long-term insurance business.
62

'Deferred tax' includes the deferred tax liabilities arising on recognition of PVIF.
63

Does not include associated insurance companies SABB Takaful Company and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.
64

HSBC has no insurance manufacturing subsidiaries in Middle East and North Africa or North America.
65

A block of contracts in France with guaranteed nominal annual returns in the range 1.25%-3.72% is reported entirely in the 2.1%-4.0% category in line with the average guaranteed return of 2.6% offered to policyholders by these contracts.
66

Real annual return guarantees provide the policyholder a guaranteed return in excess of the rate of inflation, and are supported by inflation-linked debt securities with yields that are also expressed in real terms.
67

Where a -100 basis point parallel shift in the yield curve would result in a negative interest rate, the effects on profit after tax and total equity have been calculated using a minimum rate of 0%.

126
HSBC Holdings plc Annual Report and Accounts 2016

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