Annual Financial Report - 35 of 56

RNS Number : 6328S

HSBC Holdings PLC

18 March 2016



Capital overview	228		Capital ratios	228

Capital management		243	Total regulatory capital and risk-weighted assets	228
Approach and policy		243
Stress testing		243
Risks to capital		243
Risk-weighted asset plans		244
Capital generation		244

Capital measurement and allocation		244
Regulatory capital		244
Pillar 1 capital requirements		244
Pillar 2 capital requirements		245
Pillar 3 disclosure requirements		246

Movements by major drivers	228		Capital and RWA movements by major driver - CRD IV end point basis	228

Risk-weighted assets	229		RWAs by risk type	229
			RWAs by global businesses	229
			RWAs by geographical regions	229
Credit risk RWAs	229		Credit risk exposure - RWAs by geographical region	229
			Credit risk exposure - RWAs by global businesses	230
			RWA movement by geographical regions by key driver - credit risk - IRB only	230
			RWA movement by global businesses by key driver - credit risk - IRB only	231
Counterparty credit risk and market risk RWAs	232		Counterparty credit risk RWAs	232
			RWA movement by key driver - counterparty credit risk - advanced approach	232
			Market risk RWAs	232
			RWA movement by key driver - market risk - internal model based	232
Operational risk RWAs	232

RWA movement by key driver - basis of preparation and supporting notes		247
Credit risk drivers - definitions and quantifications		247
Counterparty risk drivers - definitions and quantifications		248
Market risk drivers - definitions and quantifications		248

Capital	233		Source and application of total regulatory capital	233
			Composition of regulatory capital	234
			Reconciliation of regulatory capital from transitional basis to an estimated CRD IV end point basis	235

Regulatory balance sheet	236
Regulatory and accounting consolidations	236		Reconciliation of balance sheets - financial accounting to regulatory scope of consolidation	236

Leverage ratio	239		Leverage ratio	239

Regulatory developments	239
Regulatory capital requirements	239		Capital requirements framework	240
Regulatory stress testing	241
RWA developments	241
UK leverage ratio framework	241
Total loss absorbing capacity proposals	242
Structural reform and recovery and resolution planning	242

1. Appendix to Capital.

Our objective in the management of Group capital is to maintain appropriate levels of capital to support our business strategy and meet our regulatory and stress testing related requirements.

Capital highlights

· Our end point common equity tier 1 ('CET1') ratio of 11.9% was up from 11.1% at the end of 2014.

· We continue to generate capital from profit and our progress to achieve targeted RWA initiatives strengthened our CET1 ratio, creating capacity for growth.

· Our leverage ratio remained strong at 5.0%.

Capital overview

Capital ratios

	At 31 December
	2015	2014
	%	%
CRD IV end point
Common equity tier 1 ratio¹	11.9	11.1

CRD IV transitional
Common equity tier 1 ratio¹	11.9	10.9
Tier 1 ratio	13.9	12.5
Total capital ratio	17.2	15.6

Total regulatory capital and risk-weighted assets

	At 31 December
	2015	2014
	$m	$m
CRD IV end point
Common equity tier 1 capital¹	130,863	135,953

CRD IV transitional
Common equity tier 1 capital¹	130,863	133,200
Additional tier 1 capital	22,440	19,539
Tier 2 capital	36,530	37,991

Total regulatory capital	189,833	190,730

Risk-weighted assets	1,102,995	1,219,765

For footnote, see page 243.

We manage Group capital to ensure that we exceed current regulatory requirements and that we respect the payment priority of our capital providers. Throughout 2015, we complied with the Prudential Regulation Authority's ('PRAs') regulatory capital adequacy requirements, including those relating to stress testing. We are also well placed to meet our expected future capital requirements.

We continue to manage Group capital to meet a medium-term target for return on equity of more than 10% by 2017. This is modelled on a CET1 ratio on an end point basis in the range of 12% to 13%, which takes into account known and quantifiable end-point CET1 requirements and includes a regulatory and management buffer in the range of 1% to 2%, based on our estimate of the additional CET1 we will need to hold to cover the new time-varying buffers and other factors. The CET1 regulatory and management buffer will be kept under review until the details of the regulatory framework are finalised.

Capital and RWAs are calculated and presented according to the Group's interpretation of CRD IV legislation and the PRA's rules as set out in the PRA Rulebook.

Despite the rules published to date, there remains continued uncertainty around the amount of capital that UK banks will be required to hold. In December 2015, the Financial Policy Committee ('FPC') published its view of the capital framework as applicable to UK banks, which set out expectations in relation to CET1 and tier 1 capital across the industry. However, requirements applicable to individual banks are subject to the PRA's determination. While there is emerging clarity around the interaction of the capital buffers and the PRA's Pillar 2 framework, uncertainty remains around the broader capital framework, including revisions to the RWA requirements, capital floors, and global systemically important bank ('G-SIB') developments. Furthermore, there remain a number of draft and unpublished European Banking Authority ('EBA') technical and implementation standards due in 2016.

A summary of our policies and practices regarding capital management, measurement and allocation is provided in the Appendix to Capital on page 243.

Movements by major drivers

Capital and RWA movements by major driver - CRD IV end point basis

	CET1 capital	RWAs
	$bn	$bn

CRD IV end point basis at 1 January 2015	136.0	1,219.8
Capital generation from profit	3.4
- consolidated profits attributable to shareholders of the parent company (including regulatory adjustments)	11.3
- dividends net of scrip²	(7.9)

RWA initiatives		(123.8)
Business growth including associates		48.7
Foreign currency translation differences³	(7.9)	(52.2)
Other movements	(0.6)	10.5

CRD IV end point basis at 31 December 2015	130.9	1,103.0

For footnotes, see page 243.

Our CET1 capital was reduced by foreign currency translation differences of $7.9bn. This was partly offset by capital of $3.4bn generated from profits net of dividends (including the fourth interim dividend after planned scrip).

Included in profits was a $1.4bn gain on the partial sale of our shareholding in Industrial Bank. This included fair value gains reclassified to the income statement that has already been included in CET1 capital, resulting in no further impact. An additional impact on CET1 capital from the partial sale of our shareholding in Industrial Bank was lower allowable non-controlling interest.

Substantial progress has been made in achieving the Group's 2017 RWA target. After foreign currency translation differences, RWAs reduced by $65bn in 2015, primarily driven by specific initiatives that saved $124bn of RWAs. The saving was partially offset by business growth of $49bn.

The following comments describe the key RWA movements excluding foreign currency translation differences.

RWA initiatives

The main drivers were:

· $38bn from reduced exposures, the partial disposal of our investment in Industrial Bank, a decrease in trading positions subject to the Incremental Risk Charge, client facility reductions and trade compressions;

· $30bn from refining our calculations, including the further application of the small and medium-sized enterprise ('SME') supporting factor, a more refined application of credit conversion factors ('CCFs'), increased usage of internal ratings-based ('IRB') models and the move of certain exposures from residual to cash flow weighted maturity;

· $25bn from process improvements such as better linking of collateral and guarantees to facilities, enhanced risk parameters and the use of more granular data resulting in lower CCFs for off-balance sheet items; and

· $30bn through the continued reduction in the GB&M legacy credit and US run-off portfolios.

Business growth

Business growth increased RWAs by $49bn, principally in:

· CMB, from higher term lending to corporate customers, principally in Europe, North America and Asia, $23bn;

· our associates, Bank of Communications and The Saudi British Bank, $14bn; and

· GB&M, from higher general lending to corporates which increased RWAs by $10bn, mainly in Europe.

Risk-weighted assets

RWAs by risk type

	2015	2014
	$bn	$bn

Credit risk	875.9	955.3
- standardised approach	332.7	356.9
- IRB foundation approach	27.4	16.8
- IRB advanced approach	515.8	581.6

Counterparty credit risk	69.2	90.7
- standardised approach	19.1	25.2
- advanced approach	50.1	65.5

Market risk	42.5	56.0
- internal model based	34.9	44.6
- standardised approach	7.6	11.4

Operational risk	115.4	117.8

At 31 December 2015	1,103.0	1,219.8

Of which:
Run-off portfolios	69.3	99.2
- legacy credit in GB&M	29.8	44.1
- US CML and Other	39.5	55.1

RWAs by global businesses

	2015	2014
	$bn	$bn

Retail Banking and Wealth Management⁴	189.5	207.2
Commercial Banking⁴	421.0	430.3
Global Banking and Markets	440.6	516.1
Global Private Banking	19.3	20.8
Other	32.6	45.4

At 31 December 2015	1,103.0	1,219.8

RWAs by geographical regions⁵

	2015	2014
	$bn	$bn

Europe	337.4	375.4
Asia	459.7	499.8
Middle East and North Africa	60.4	63.0
North America	191.6	221.4
Latin America	73.4	88.8

At 31 December 2015	1,103.0	1,219.8

For footnotes, see page 243

Credit risk RWAs

Credit risk exposure - RWAs by geographical region

	Europe	Asia	MENA	North America	Latin America	Total
	$bn	$bn	$bn	$bn	$bn	$bn

IRB approach	192.6	195.9	19.4	122.5	12.8	543.2
- IRB advanced approach	175.1	195.9	9.5	122.5	12.8	515.8
- IRB foundation approach	17.5	-	9.9	-	-	27.4
Standardised approach	46.8	177.7	32.0	33.9	42.3	332.7

RWAs at 31 December 2015	239.4	373.6	51.4	156.4	55.1	875.9

IRB approach	216.1	213.1	15.6	142.0	11.6	598.4
- IRB advanced approach	203.3	213.1	11.6	142.0	11.6	581.6
- IRB foundation approach	12.8	-	4.0	-	-	16.8
Standardised approach	47.1	186.0	39.0	29.6	55.2	356.9

RWAs at 31 December 2014	263.2	399.1	54.6	171.6	66.8	955.3

Credit risk exposure - RWAs by global businesses

	Principal⁴ RBWM	RBWM (US run-off portfolio)	Total RBWM	CMB⁴	GB&M	GPB	Other	Total
	$bn	$bn	$bn	$bn	$bn	$bn	$bn	$bn

IRB approach	59.0	33.2	92.2	218.0	214.8	8.5	9.7	543.2
- IRB advanced approach	59.0	33.2	92.2	199.0	207.5	8.4	8.7	515.8
- IRB foundation approach	-	-	-	19.0	7.3	0.1	1.0	27.4

Standardised approach	57.6	3.8	61.4	172.0	69.7	7.2	22.4	332.7

RWAs at 31 December 2015	116.6	37.0	153.6	390.0	284.5	15.7	32.1	875.9

IRB approach	56.1	47.3	103.4	217.2	255.6	10.2	12.0	598.4
- IRB advanced approach	56.1	47.3	103.4	209.2	248.1	10.0	10.9	581.6
- IRB foundation approach	-	-	-	8.0	7.5	0.2	1.1	16.8
Standardised approach	61.2	4.8	66.0	181.0	70.1	6.6	33.2	356.9

RWAs at 31 December 2014	117.3	52.1	169.4	398.2	325.7	16.8	45.2	955.3

For footnotes, see page 243.

Credit risk RWAs are calculated using three approaches, as permitted by the PRA. For consolidated Group reporting, we have adopted the advanced IRB approach for the
majority of our business, with a small proportion being on the foundation IRB approach and the remaining portfolios on the standardised approach.

RWA movement by geographical regions by key driver - credit risk - IRB only⁶

	Europe	Asia	MENA	North America	Latin America	Total
	$bn	$bn	$bn	$bn	$bn	$bn

RWAs at 1 January 2015	216.1	213.1	15.6	142.0	11.6	598.4

Foreign exchange movement	(10.4)	(7.2)	(0.6)	(4.7)	(3.4)	(26.3)
Acquisitions and disposals	(14.1)	-	(0.1)	(4.9)	-	(19.1)
Book size	11.4	2.9	(0.5)	(2.8)	0.4	11.4
Book quality	(8.0)	(6.9)	(1.4)	0.7	3.9	(11.7)
Model updates	1.2	(2.6)	4.7	0.2	0.1	3.6
- portfolios moving onto IRB approach	(0.1)	-	4.7	0.2	0.1	4.9
- new/updated models	1.3	(2.6)	-	-	-	(1.3)

Methodology and policy	(3.6)	(3.4)	1.7	(8.0)	0.2	(13.1)
- internal updates	(6.2)	(5.4)	1.6	(8.0)	0.2	(17.8)
- external updates - regulatory	2.6	2.0	0.1	-	-	4.7


Total RWA movement	(23.5)	(17.2)	3.8	(19.5)	1.2	(55.2)

RWAs at 31 December 2015	192.6	195.9	19.4	122.5	12.8	543.2

RWAs at 1 January 2014 on Basel 2.5 basis	166.9	182.9	15.0	161.5	8.5	534.8

Foreign exchange movement	(11.6)	(4.0)	(0.2)	(2.4)	(1.9)	(20.1)
Acquisitions and disposals	(3.5)	-	(0.7)	(4.2)	(0.1)	(8.5)
Book size	11.4	19.5	1.8	2.9	2.0	37.6
Book quality	(1.5)	-	(0.8)	(10.3)	1.4	(11.2)
Model updates	19.4	0.3	-	(6.1)	-	13.6

Methodology and policy	35.0	14.4	0.5	0.6	1.7	52.2
- internal updates	(11.7)	(5.2)	(0.2)	(6.4)	(0.1)	(23.6)
- external updates - regulatory	2.2	8.5	(0.2)	0.7	0.1	11.3
- CRD IV impact	37.0	5.7	0.4	4.9	0.2	48.2
- NCOA moving from STD to IRB	7.5	5.4	0.5	1.4	1.5	16.3


Total RWA movement	49.2	30.2	0.6	(19.5)	3.1	63.6

RWAs at 31 December 2014 on CRD IV basis	216.1	213.1	15.6	142.0	11.6	598.4

For footnote, see page 243.

RWA movement by global businesses by key driver - credit risk - IRB only⁶

	Principal⁴ RBWM	RBWM (US run-off )	Total RBWM	CMB⁴	GB&M	GPB	Other	Total
	$bn	$bn	$bn	$bn	$bn	$bn	$bn	$bn

RWAs at 1 January 2015	56.1	47.3	103.4	217.2	255.6	10.2	12.0	598.4
Foreign exchange movement	(2.9)	-	(2.9)	(11.7)	(11.0)	(0.3)	(0.4)	(26.3)
Acquisitions and disposals	-	(4.9)	(4.9)	-	(14.2)	-	-	(19.1)
Book size	3.7	(5.6)	(1.9)	15.8	(0.8)	(0.5)	(1.2)	11.4
Book quality	(2.8)	(3.7)	(6.5)	6.0	(10.5)	(0.1)	(0.6)	(11.7)
Model updates	0.4	-	0.4	5.6	(2.3)	(0.1)	-	3.6
- portfolios moving onto IRB approach	-	-	-	4.1	0.9	(0.1)	-	4.9
- new/updated models	0.4	-	0.4	1.5	(3.2)	-	-	(1.3)

Methodology and policy	4.5	0.1	4.6	(14.9)	(2.0)	(0.7)	(0.1)	(13.1)
- internal updates	2.5	0.1	2.6	(14.9)	(4.7)	(0.7)	(0.1)	(17.8)
- external updates - regulatory	2.0	-	2.0	-	2.7	-	-	4.7

Total RWA movement	2.9	(14.1)	(11.2)	0.8	(40.8)	(1.7)	(2.3)	(55.2)

RWAs at 31 December 2015	59.0	33.2	92.2	218.0	214.8	8.5	9.7	543.2

RWAs at 1 January 2014 on Basel 2.5 basis	58.5	72.6	131.1	189.4	198.5	10.6	5.2	534.8
Foreign exchange movement	(2.6)	-	(2.6)	(8.7)	(8.1)	(0.2)	(0.5)	(20.1)
Acquisitions and disposals	-	-	-	-	(8.2)	-	(0.3)	(8.5)
Book size	1.9	(6.9)	(5.0)	23.1	21.1	(0.5)	(1.1)	37.6
Book quality	(5.7)	(8.6)	(14.3)	2.8	(0.2)	(0.3)	0.8	(11.2)
Model updates	0.6	(6.2)	(5.6)	12.2	7.0	-	-	13.6

Methodology and policy	3.4	(3.6)	(0.2)	(1.6)	45.5	0.6	7.9	52.2
- internal updates	(3.0)	(3.9)	(6.9)	(5.0)	(11.2)	(0.5)	-	(23.6)
- external updates - regulatory	1.8	-	1.8	2.5	6.3	0.5	0.2	11.3
- CRD IV impact	-	-	-	(0.7)	48.6	0.2	0.1	48.2
- NCOA moving from STD to IRB	4.6	0.3	4.9	1.6	1.8	0.4	7.6	16.3

Total RWA movement	(2.4)	(25.3)	(27.7)	27.8	57.1	(0.4)	6.8	63.6

RWAs at 31 December 2014 on CRD IV basis	56.1	47.3	103.4	217.2	255.6	10.2	12.0	598.4

For footnotes, see page 243.

Internal ratings-based approach

For portfolios treated under the IRB approach, credit risk RWAs decreased by $55bn, which included a reduction of $26bn due to foreign exchange movements.

Acquisitions and disposals

· The disposal of US mortgage portfolios reduced RWAs by $4.9bn; and

· the sale of securitisation positions in the GB&M legacy credit portfolio resulted in a RWA decrease of $14bn.

Book size

· The book size grew from higher corporate lending, including term and trade-related lending which increased RWAs by $16bn, mainly in Europe and Asia for CMB.

· In North America, in RBWM, the continued run-off of the US CML retail mortgage portfolios resulted in an RWA reduction of $5.6bn.

Book quality

· RWAs reduced by $3.7bn in the US run-off portfolio, primarily due to continued run-off which led to an
improvement in the book quality of the residual portfolio;

· book quality improvements in the Principal RBWM business of $2.8bn mainly related to credit quality improvements in Europe;

· in CMB, RWAs increased by $6.0bn, primarily as a result of corporate downgrades in Europe;

· in GB&M, a decrease in RWAs of $10bn was mainly due to the implementation of netting agreements to new corporate counterparties in Europe, the securitisation of corporate loans and rating upgrades of institutions in Asia; and

· the downgrade of Brazil's rating increased RWAs by $3.7bn across businesses.

Methodology and policy changes

· RWA initiatives were the main driver for the reduction of RWAs driven by changes in 'internal updates'. Further details are provided on page 229.

· They were offset by the change in RWA calculation on defaulted exposures in RBWM increasing RWAs by $2.0bn, the implementation of a risk-weight floor on mortgages in Hong Kong with an RWA impact of $2.0bn, and the implementation of a 1.06 scaling factor on securitisation positions risk-weighted at 1,250% which increased RWAs by $2.1bn.

Standardised approach

For portfolios treated under the standardised approach, credit risk RWAs decreased by $24bn, which included a reduction of $27bn due to foreign exchange movements.

· RWAs increased by $23bn across all regions as a result of higher lending. Growth in our associate, BoCom, accounted for $15bn.

· This was offset by RWA initiatives reducing RWAs by $29bn, mainly comprising portfolios moving to an IRB approach (reducing the standardised approach by $10.2bn and increasing the IRB approach by $7.2bn) and partial disposal of our investment in Industrial Bank reducing RWAs by $12.4bn.

Counterparty credit risk and market risk RWAs

Counterparty credit risk RWAs

	2015	2014
	$bn	$bn

Advanced approach	50.1	65.5
- CCR IRB approach	46.8	62.0
- credit valuation adjustment	3.3	3.5

Standardised approach	19.1	25.2
- CCR standardised approach	4.7	4.4
- credit valuation adjustment	12.2	18.0
- central counterparty	2.2	2.8


At 31 December	69.2	90.7

RWA movement by key driver - counterparty credit risk - advanced approach

	2015	2014
	$bn	$bn

RWAs at 1 January	65.5	42.2

Book size	(10.2)	1.6
Book quality	(0.8)	(0.6)
Model updates	-	0.1
Methodology and policy	(4.4)	22.2
- internal updates	(4.4)	(3.8)
- external updates - regulatory	-	9.0
- CRD IV impact	-	17.0

Total RWA movement	(15.4)	23.3

RWAs at 31 December	50.1	65.5

Market risk RWAs

	2015	2014
	$bn	$bn
Internal model based	34.9	44.6
- VaR	7.7	7.3
- stressed VaR	9.8	10.4
- incremental risk charge	11.4	20.1
- other VaR and stressed VaR	6.0	6.8

Standardised approach	7.6	11.4

At 31 December	42.5	56.0

RWA movement by key driver - market risk - internal model based

	2015	2014
	$bn	$bn

RWAs at 1 January	44.6	52.2

Acquisitions and disposals	-	(2.2)
Movement in risk levels	(5.5)	(4.2)
Methodology and policy	(4.2)	(1.2)
- internal updates	(4.2)	(3.8)
- external updates - regulatory	-	2.6

	-
Total RWA movement	(9.7)	(7.6)

RWAs at 31 December	34.9	44.6

Counterparty credit risk RWAs

Counterparty credit risk RWAs reduced by $21bn during 2015.

Standardised approach

A reduction of $6.1bn in RWAs in the standardised portfolio was mostly due to the impact of market movements and position reductions for derivatives held with counterparties eligible for the standardised credit value adjustment ('CVA') charge.

Advanced approach

The book size reduced by $10bn, mainly driven by market movements, particularly in foreign exchange derivatives, trade compression and portfolio management activities.

Further reductions in 'Methodology and policy' were mainly driven by savings from RWA initiatives.

Market risk RWAs

Total market risk RWAs decreased by $13bn in 2015.

Standardised approach

The market risk RWAs in the standardised portfolio fell by $3.8bn, mainly driven by the reduction in the legacy credit portfolio.

Internal model based

The reduction in RWAs due to movements in risk levels of $5.5bn was driven by a combination of active management of the book and market movements, in particular within the incremental risk charge. In addition to these movements, there were savings of $4.2bn in 'Methodology and policy' due to the refinement of models used for the calculation of the incremental risk charge and risks not in VaR.

Operational risk RWAs

The reduction in operational risk RWAs of $2.4bn was mainly the result of currency exchange differences and a decline in income in Latin America.

Capital

Source and application of total regulatory capital

	Year to 31 December
	2015 $m	2014 $m
Movement in total regulatory capital
Opening common equity tier 1 capital on a transitional basis⁷	133,200	131,233
Transitional adjustments	2,753
- unrealised gains arising from revaluation of property	1,375
- unrealised gains in available-for-sale debt and equities	1,378


Opening common equity tier 1 capital on an end point basis¹	135,953
Contribution to common equity tier 1 capital from profit for the period	11,302	12,678
- consolidated profits attributable to shareholders of the parent company	13,522	13,688
- removal of own credit spread net of tax	(912)	(328)
- debit valuation adjustment	(139)	254
- deconsolidation of insurance entities and SPEs	(1,169)	(936)

Net dividends including foreseeable net dividends²	(7,853)	(7,541)
- dividends net of scrip	(4,136)	(4,179)
- fourth interim dividend net of planned scrip	(3,717)	(3,362)

Increase in goodwill and intangible assets deducted³	(227)	2,424
Ordinary shares issued	147	267
Foreign currency translation differences³	(7,887)	(8,356)
Other, including regulatory adjustments	(572)	2,495

Closing common equity tier 1 capital	130,863	133,200

Opening additional tier 1 capital on a transitional basis⁷	19,539	14,408
Movement in additional tier 1 securities	2,272	4,961
- new issuance	3,580	5,681
- grandfathering adjustments	(1,308)	(720)
Other, including regulatory adjustments	629	170

Closing tier 1 capital on a transitional basis	153,303	152,739

Opening other tier 2 capital on a transitional basis⁷	37,991	35,538
Movement in tier 2 securities	(1,276)	2,414
- new issuance	3,180	3,500
- grandfathering adjustments	(2,996)	-
- foreign currency transitional differences	(887)	(1,066)
- other movements	(573)	(20)
Other, including regulatory adjustments	(185)	39

Closing total regulatory capital on a transitional basis	189,833	190,730

For footnotes, see page 243.

Composition of regulatory capital

(Audited)

		At 31 December
		2015	2014
	Ref	$m	$m
Common equity tier 1 capital
Shareholders' equity		160,664	166,617
- shareholders' equity per balance sheet⁸	a	188,460	190,447
- foreseeable interim dividend²		(3,717)	(3,362)
- preference share premium	b	(1,405)	(1,405)
- other equity instruments	c	(15,112)	(11,532)
- deconsolidation of special purpose entities⁹	a	(91)	(323)
- deconsolidation of insurance entities	a, h	(7,471)	(7,208)

Non-controlling interests		3,519	4,640
- non-controlling interests per balance sheet	d	9,058	9,531
- preference share non-controlling interests	e	(2,077)	(2,127)
- non-controlling interests transferred to tier 2 capital	f	-	(473)
- non-controlling interests in deconsolidated subsidiaries	d	(933)	(851)
- surplus non-controlling interests disallowed in CET1		(2,529)	(1,440)

Regulatory adjustments to the accounting basis		(4,556)	(3,556)
- own credit spread¹⁰		(159)	767
- debit valuation adjustment		(336)	(197)
- defined benefit pension fund adjustment	g	(4,009)	(4,069)
- cash flow hedging reserve		(52)	(57)

Deductions		(28,764)	(31,748)
- goodwill and intangible assets	h	(20,650)	(22,475)
- deferred tax assets that rely on future profitability (excludes those arising from temporary differences)	n	(1,204)	(1,036)
- additional valuation adjustment (referred to as PVA)		(1,151)	(1,341)
- investments in own shares through the holding of composite products of which HSBC is a component (exchange traded funds, derivatives and index stock)		(839)	(1,083)
- negative amounts resulting from the calculation of expected loss amounts	i	(4,920)	(5,813)
			-
Common equity tier 1 capital on an end point basis		130,863	135,953

Tier 1 and tier 2 capital on a transitional basis
Common equity tier 1 capital on an end point basis		130,863	135,953
Transitional adjustments			(2,753)
- unrealised gains arising from revaluation of property			(1,375)
- unrealised gains in available-for-sale debt and equities			(1,378)
			-
Common equity tier 1 capital on a transitional basis		130,863	133,200

Additional tier 1 capital on a transitional basis
Other tier 1 capital before deductions		22,621	19,687
- preference share premium	b	1,015	1,160
- preference share non-controlling interests	e	1,711	1,955
- allowable non-controlling interest in AT1	d	1,546	884
- Hybrid capital securities	j	18,349	15,688

Deductions		(181)	(148)
- unconsolidated investments¹¹		(121)	(148)
- holding of own additional tier 1 instruments		(60)	-

Tier 1 capital on a transitional basis		153,303	152,739

Tier 2 capital on a transitional basis
Total qualifying tier 2 capital before deductions		36,852	38,213
- allowable non-controlling interest in tier 2	d	14	99
- perpetual subordinated debt	l	1,941	2,218
- term subordinated debt	m	34,897	35,656
- non-controlling interests in tier 2 capital	f	-	240
			240
Total deductions other than from tier 1 capital		(322)	(222)
- unconsolidated investments¹¹		(282)	(222)
- holding of own tier 2 instruments		(40)	-


Total regulatory capital on a transitional basis		189,833	190,730

For footnotes, see page 243.

The references (a) - (n) identify balance sheet components on page 236 which are used in the calculation of regulatory capital.

Reconciliation of regulatory capital from transitional basis to an estimated CRD IV end point basis

	At 31 December
	2015	2014
	$m	$m

Common equity tier 1 capital on a transitional basis	130,863	133,200
Unrealised gains arising from revaluation of property		1,375
Unrealised gains in available-for-sale debt and equities		1,378

Common equity tier 1 capital on an end point basis	130,863	135,953

Additional tier 1 capital on a transitional basis	22,440	19,539
Grandfathered instruments: Preference share premium	(1,015)	(1,160)
Preference share non-controlling interests	(1,711)	(1,955)
Hybrid capital securities	(9,088)	(10,007)
Transitional provisions:
Allowable non-controlling interest in AT1	(1,377)	(487)
Unconsolidated investments¹¹	121	148

Additional tier 1 capital end point basis	9,370	6,078

Tier 1 capital on an end point basis	140,233	142,031

Tier 2 capital on a transitional basis	36,530	37,991
Grandfathered instruments:
Perpetual subordinated debt	(1,941)	(2,218)
Term subordinated debt	(19,034)	(21,513)
Transitional provisions:
Non-controlling interest in tier 2 capital	-	(240)
Allowable non-controlling interest in tier 2	21	396
Unconsolidated investments¹¹	(121)	(148)

Tier 2 capital on an end point basis	15,455	14,268

Total regulatory capital on an end point basis	155,688	156,299

For footnote, see page 243.

The capital position presented on a CRD IV transitional basis follows the Group's interpretation of CRD IV legislation and the PRA's rules as set out in the PRA Rulebook.

The effects of draft EBA technical standards are not generally captured in our numbers.

While CRD IV allows for the majority of regulatory adjustments and deductions from CET1 to be implemented on a gradual basis from 1 January 2014 to 1 January 2018, the PRA has largely decided not to make use of these transitional provisions. From 1 January 2015, unrealised gains on investment property and available-for-sale securities were recognised in CET1 capital. As a result our end point and transitional CET1 capital and ratios are now aligned.

For additional tier 1 and tier 2 capital, the PRA has followed the transitional provisions timing as set out in CRD IV to apply the necessary regulatory adjustments and deductions. The effect of these adjustments is being phased in at 20% per annum from 1 January 2014 to 1 January 2018.

Non-CRD IV compliant additional tier 1 and tier 2 instruments also benefit from a grandfathering period. This progressively reduces the eligible amount by 10% annually, following an initial reduction of 20% on 1 January 2014, until they are fully phased out by 1 January 2022.

Under CRD IV, as implemented in the UK, banks are required to meet a minimum CET1 ratio of 4.5% of RWAs, a minimum tier 1 ratio of 6% of RWAs and a total capital ratio of 8% of RWAs. In addition to the Pillar 1 minimum ratios, the PRA sets Pillar 2A capital requirements, which together are considered the minimum level of regulatory capital to be maintained at all times. Pillar 2A is to be met with at least 56% CET1 capital and the remaining with non-common equity capital.

In addition to minimum requirements, CRD IV establishes a number of capital buffers to be met with CET1 capital, which largely phase-in from 1 January 2016. To the extent our CET1 capital is insufficient to meet these buffer requirements, the Group would suffer automatic restrictions on capital distributions.

Going forward, as the grandfathering provisions fall away, we intend to meet our overall regulatory minima in an economically efficient manner by issuing non-common equity capital as necessary. At 31 December 2015, the Group had $25.1bn of CRD IV compliant non-common equity capital instruments, of which $3.2bn of tier 2 and $3.6bn of additional tier 1 were issued during the year (for details on the additional tier 1 instruments issued during the year see Note 35 on the Financial Statements). At 31 December 2015, the Group also had $32.8bn of non-common equity capital instruments qualifying as eligible capital under CRD IV by virtue of the application of the grandfathering provisions, after applying a 30% reduction as outlined above.

Regulatory balance sheet

Regulatory and accounting consolidations

The basis of consolidation for the purpose of financial accounting under IFRS, described in Note 1 on the Financial Statements, differs from that used for regulatory purposes as described in 'Structure of the regulatory group' on page 12 of the Pillar 3 Disclosures 2015 report. The table below provides a reconciliation of the financial accounting balance sheet to the regulatory scope of consolidation.

Interests in banking associates are equity accounted in the financial accounting consolidation, whereas their exposures are proportionally consolidated for regulatory purposes by including our share of assets, liabilities, profit and loss and RWAs in accordance with the PRA's application of CRD IV.

Subsidiaries engaged in insurance activities are excluded from the regulatory consolidation by excluding assets, liabilities and post-acquisition reserves, leaving the investment of these insurance subsidiaries to be recorded at cost and deducted from CET1 (subject to thresholds).

The regulatory consolidation also excludes special purpose entities ('SPEs') where significant risk has been transferred to third parties. Exposures to these SPEs are risk-weighted as securitisation positions for regulatory purposes.

Entities in respect of which the basis of consolidation for financial accounting purposes differs from that used for regulatory purposes can be found in table 5 of the Pillar 3 Disclosures 2015 report.

Reconciliation of balance sheets - financial accounting to regulatory scope of consolidation

		Accounting balance sheet	Deconsolidation of insurance/ other entities	Consolidation of banking associates	Regulatory balance sheet
	Ref	$m	$m	$m	$m
Assets
Cash and balances at central banks		98,934	(2)	28,784	127,716
Items in the course of collection from other banks		5,768	-	22	5,790
Hong Kong Government certificates of indebtedness		28,410	-	-	28,410
Trading assets		224,837	340	4,390	229,567
Financial assets designated at fair value		23,852	(23,521)	2,034	2,365
Derivatives		288,476	(146)	495	288,825
Loans and advances to banks		90,401	(3,008)	16,413	103,806
Loans and advances to customers		924,454	(7,427)	120,016	1,037,043
of which:
- impairment allowances on IRB portfolios	i	(6,291)	-	-	(6,291)
- impairment allowances on standardised portfolios		(3,263)	-	(2,780)	(6,043)
Reverse repurchase agreements - non-trading		146,255	711	5,935	152,901
Financial investments		428,955	(51,684)	42,732	420,003
Assets held for sale		43,900	(4,107)	-	39,793
of which:
- goodwill and intangible assets	h	1,680	(219)	-	1,461
- impairment allowances of disposal groups held for sale		(1,454)	-	-	(1,454)
of which:
- IRB portfolios	i	(7)	-	-	(7)
- standardised portfolios		(1,447)	-	-	(1,447)
Capital invested in insurance and other entities		-	2,371	-	2,371
Current tax assets		1,221	(15)	-	1,206
Prepayments, accrued income and other assets		54,398	(2,539)	9,692	61,551
of which:
- retirement benefit assets	g	5,272	-	-	5,272
Interests in associates and joint ventures		19,139	-	(18,571)	568
of which:
- positive goodwill on acquisition	h	593	-	(579)	14

Goodwill and intangible assets	h	24,605	(6,068)	623	19,160
Deferred tax assets	n	6,051	195	518	6,764

Total assets at 31 December 2015		2,409,656	(94,900)	213,083	2,527,839

Liabilities and equity
Hong Kong currency notes in circulation		28,410	-	-	28,410
Deposits by banks		54,371	(97)	50,005	104,279
Customer accounts		1,289,586	(119)	147,522	1,436,989
Repurchase agreements - non-trading		80,400	-	-	80,400
Items in course of transmission to other banks		5,638	-	-	5,638
Trading liabilities		141,614	(66)	59	141,607
Financial liabilities designated at fair value		66,408	(6,046)	-	60,362
of which:
- term subordinated debt included in tier 2 capital	m	21,168	-	-	21,168
- hybrid capital securities included in tier 1 capital	j	1,342	-	-	1,342

		Accounting balance sheet	Deconsolidation of insurance/ other entities	Consolidation of banking associates	Regulatory balance sheet
	Ref	$m	$m	$m	$m
Derivatives		281,071	87	508	281,666
Debt securities in issue		88,949	(7,885)	5,065	86,129
Liabilities of disposal groups held for sale		36,840	(3,690)	-	33,150
Current tax liabilities		783	(84)	409	1,108
Liabilities under insurance contracts		69,938	(69,938)	-	-
Accruals, deferred income and other liabilities		38,116	2,326	6,669	47,111
of which:
- retirement benefit liabilities		2,809	(2)	61	2,868
Provisions		5,552	(25)	-	5,527
of which:
- contingent liabilities and contractual commitments		240	-	-	240
of which:
- credit-related provisions on IRB portfolios	i	201	-	-	201
- credit-related provisions on standardised portfolios		39	-	-	39
Deferred tax liabilities		1,760	(868)	5	897
Subordinated liabilities		22,702	-	2,841	25,543
of which:
- hybrid capital securities included in tier 1 capital	j	1,929	-	-	1,929
- perpetual subordinated debt included in tier 2 capital	l	2,368	-	-	2,368
- term subordinated debt included in tier 2 capital	m	18,405	-	-	18,405

Total shareholders' equity	a	188,460	(7,562)	-	180,898
of which:
- other equity instruments included in tier 1 capital	c, j	15,112	-	-	15,112
- preference share premium included in tier 1 capital	b	1,405	-	-	1,405

Non-controlling interests	d	9,058	(933)	-	8,125
of which:
- non-cumulative preference shares issued by subsidiaries included in tier 1 capital	e	2,077	-	-	2,077
- non-controlling interests included in tier 2 capital, cumulative preferred stock	f	-	-	-	-
- non-controlling interests attributable to holders of ordinary shares in subsidiaries included in tier 2 capital	f, m	-	-	-	-


Total liabilities and equity at 31 December 2015		2,409,656	(94,900)	213,083	2,527,839

Assets
Cash and balances at central banks		129,957	-	30,731	160,688
Items in the course of collection from other banks		4,927	-	80	5,007
Hong Kong Government certificates of indebtedness		27,674	-	-	27,674
Trading assets		304,193	(720)	2,357	305,830
Financial assets designated at fair value		29,037	(28,791)	3,312	3,558
Derivatives		345,008	(94)	353	345,267
Loans and advances to banks		112,149	(2,727)	7,992	117,414
Loans and advances to customers		974,660	(10,809)	116,484	1,080,335
of which:
- impairment allowances on IRB portfolios	i	(6,942)	-	-	(6,942)
- impairment allowances on standardised portfolios		(5,395)	-	(2,744)	(8,139)
Reverse repurchase agreements - non-trading		161,713	(30)	7,510	169,193
Financial investments		415,467	(50,420)	33,123	398,170
Capital invested in insurance and other entities		-	2,542	-	2,542
Current tax assets		1,309	(16)	-	1,293
Prepayments, accrued income and other assets		75,176	(5,295)	8,501	78,382
of which:
- goodwill and intangible assets of disposal groups held for sale	h	8	-	-	8
- retirement benefit assets	g	5,028	-	-	5,028
- impairment allowances on assets held for sale		(16)	-	-	(16)
of which:
- IRB portfolios	i	(16)	-	-	(16)
- standardised portfolios		-	-	-	-
Interests in associates and joint ventures		18,181	-	(17,479)	702
of which:
- positive goodwill on acquisition	h	621	-	(606)	15

Goodwill and intangible assets	h	27,577	(5,593)	571	22,555
Deferred tax assets	n	7,111	163	474	7,748

Total assets at 31 December 2014		2,634,139	(101,790)	194,009	2,726,358

Reconciliation of balance sheets - financial accounting to regulatory scope of consolidation (continued)

		Accounting balance sheet	Deconsolidation of insurance/ other entities	Consolidation of banking associates	Regulatory balance sheet
	Ref	$m	$m	$m	$m
Liabilities and equity
Hong Kong currency notes in circulation		27,674	-	-	27,674
Deposits by banks		77,426	(21)	40,530	117,935
Customer accounts		1,350,642	(535)	141,858	1,491,965
Repurchase agreements - non-trading		107,432	-	-	107,432
Items in course of transmission to other banks		5,990	(3)	-	5,987
Trading liabilities		190,572	(42)	50	190,580
Financial liabilities designated at fair value		76,153	(6,317)	-	69,836
of which:
- term subordinated debt included in tier 2 capital	m	21,822	-	-	21,822
- hybrid capital securities included in tier 1 capital	j	1,495	-	-	1,495

Derivatives		340,669	37	331	341,037
Debt securities in issue		95,947	(7,797)	3,720	91,870
Current tax liabilities		1,213	(138)	317	1,392
Liabilities under insurance contracts		73,861	(73,861)	-	-
Accruals, deferred income and other liabilities		53,396	(3,659)	5,145	54,882
of which:
- retirement benefit liabilities		3,208	(2)	56	3,262
Provisions		4,998	(63)	-	4,935
of which:
- contingent liabilities and contractual commitments		234	-	-	234
of which:
- credit-related provisions on IRB portfolios	i	132	-	-	132
- credit-related provisions on standardised portfolios		102	-	-	102
Deferred tax liabilities		1,524	(1,009)	2	517
Subordinated liabilities		26,664	-	2,056	28,720
of which:
- hybrid capital securities included in tier 1 capital	j	2,761	-	-	2,761
- perpetual subordinated debt included in tier 2 capital	l	2,773	-	-	2,773
- term subordinated debt included in tier 2 capital	m	21,130	-	-	21,130

Total shareholders' equity	a	190,447	(7,531)	-	182,916
of which:
- other equity instruments included in tier 1 capital	c, j	11,532	-	-	11,532
- preference share premium included in tier 1 capital	b	1,405	-	-	1,405
Non-controlling interests	d	9,531	(851)	-	8,680
of which:
- non-cumulative preference shares issued by subsidiaries included in tier 1 capital	e	2,127	-	-	2,127
- non-controlling interests included in tier 2 capital, cumulative preferred stock	f	300	-	-	300
- non-controlling interests attributable to holders of ordinary shares in subsidiaries included in tier 2 capital	f, m	173	-	-	173


Total liabilities and equity at 31 December 2014		2,634,139	(101,790)	194,009	2,726,358

The references (a) - (n) identify balance sheet components which are used in the calculation of regulatory capital on page 234.

Leverage ratio

	EU Delegated Act basis at 31 December
	2015	2014
	$bn	$bn

Total assets per accounting balance sheet	2,410	2,634
Deconsolidation of insurance/other entities	(95)	(102)
Consolidation of banking associates	213	194

Total assets per regulatory/accounting balance sheet	2,528	2,726
Adjustments to reverse netting of loans and deposits allowable under IFRS	32	38
Reversal of accounting values including assets classified as held for sale:	(456)	(525)
- derivatives	(290)	(345)
- repurchase agreement and securities finance	(166)	(180)

Replaced with the regulatory rules:
Derivatives including assets classified as held for sale:	149	166
- mark-to-market	69	81
- deductions of receivables assets for cash variation margin	(65)	(82)
- add-on amounts for potential future exposure	125	148
- exposure amount resulting from the additional treatment for written credit derivatives	20	19

Repurchase agreement and securities finance including assets classified as held for sale:	173	188
- gross securities financing transactions assets	243	269
- netted amounts of cash payables and cash receivables of gross securities financing transactions assets	(78)	(89)
- measurement of counterparty risk	8	8

Addition of off-balance sheet commitments and guarantees	401	396
- guarantees and contingent liabilities	67	67
- commitments	326	321
- others	8	8
Exclusion of items already deducted from the capital measure	(33)	(36)

Exposure measure after regulatory adjustments	2,794	2,953

Tier 1 capital under CRD IV (end point)	140	142

Leverage ratio	5.0%	4.8%

The numerator of the leverage ratio is calculated using the final CRD IV end point tier 1 capital definition while the exposure measure is now calculated based on the Commission Delegated Regulation (EU) 2015/62, published in January 2015.

Regulatory developments

Regulatory capital requirements

The regulatory capital requirements comprise a Pillar 1 minimum, individual capital guidance ('ICG') set by the PRA in the form of Pillar 2A, a number of capital buffers established by CRD IV and any PRA buffer that the PRA may set in addition to ICG.

The Pillar 1 minimum ratio and the capital conservation buffer ('CCB') rates are certain. The macro-prudential tools, Pillar 2A, the PRA buffer and the systemic buffers are time-varying elements. This uncertainty is reflected in the regulatory and management buffer we have included in the 12% to 13% CET1 range that is used to model our medium-term target for return on equity of more than 10% by 2017. This buffer is currently in the range of 1% to 2%.

In December 2015, the FPC published its end point view of the calibration of the capital framework as applicable to UK
banks. This set out the FPC's final expectations in relation to the levels of capital across the industry, while specific requirements for individual banks will vary at the PRA's determination. These expectations do not include time-varying additional requirements such as the countercyclical capital buffer ('CCyB') and are based on the assumption that existing deficiencies in the definition and measurement of RWAs under Pillar 1 requirements will be addressed over time. These deficiencies in Pillar 1 are currently compensated through additional Pillar 2 requirements. The FPC stated its expectation that by 2019, once such deficiencies were corrected, Pillar 2A requirements would reduce.

In addition to the above, consideration of the finalised Financial Stability Board ('FSB') proposals in relation to total loss absorbing capacity ('TLAC') requirements, and the UK implementation of the EU minimum requirement for own funds and eligible liabilities ('MREL') will also be required.

Based on the known and quantifiable requirements to date, including the announced CCyB rates and current ICG, the overall capital requirements applicable to the Group on an end-point basis (at 1 January 2019) are presented in the table below.

Capital requirements framework (end point)

CRD IV capital buffers

CRD IV established a number of capital buffers, to be met with CET1 capital, broadly aligned with the Basel III framework. In the UK, with the exception of the CCyB which applied with immediate effect, CRD IV capital buffers are being phased in from 1 January 2016.

Automatic restrictions on capital distributions apply if a bank's CET1 capital falls below the level of its CRD IV combined buffer. The CRD IV combined buffer is defined as the total of the CCB, the CCyB, the global systemically important institutions ('G-SII's) buffer and the systemic risk buffer ('SRB'), as these become applicable.

At 31 December 2015, the applicable CCyB rates in force were 1% set by Norway and Sweden. Relevant credit exposures located in Norway and Sweden were $2.4bn and $1.5bn respectively. At 31 December 2015, this resulted in an immaterial Group institution-specific CCyB requirement.

The Hong Kong Monetary Authority ('HKMA') CCyB rate of 0.625% was implemented on 27 January 2016 in respect of Hong Kong exposures, following communication from the FPC. The impact of the HKMA CCyB rate on our Group institution-specific CCyB rate is expected to be 7bps (based on RWAs at 31 December 2015).

The CCyB rates introduced by Norway and Sweden will increase to 1.5% from June 2016. In January 2016, the HKMA also announced that the CCyB rate applied to exposures in Hong Kong will be increased to 1.25% from 1 January 2017.

In December 2015, the FPC maintained a 0% CCyB rate for UK exposures. At the same time, the FPC published the final calibration of the capital framework for UK banks. Within this, the FPC indicated that going forward it would apply a more active use of the CCyB and stated that it intends to publish a revised policy statement on the use of the CCyB in March 2016. The FPC also noted that it expects to set a countercyclical buffer rate for UK exposures, in the region of 1% when risks are judged to be neither subdued nor elevated. The CCyB rate will be informed by the annual UK concurrent stress test of major UK banks. If a rate change is introduced it is expected to come into effect 12 months later.

In December 2015, the PRA confirmed our applicable G-SII buffer as 2.5%. The G-SII buffer together with the CCB of 2.5%, came into effect on 1 January 2016. These are being phased in until 2019 in increments of 25% of the end point buffer requirement. Therefore, as of 1 January 2016, the requirement for each buffer is 0.625% of RWAs.

Alongside CRD IV requirements, since 2014, the PRA has expected major UK banks and building societies to meet a 7% CET1 ratio using the CRD IV end point definition. At 1 January 2016, with the introduction of the G-SII buffer and the CCB, our minimum CET1 capital requirements and combined buffer requirement taken together amount to 7.1% (based on RWAs at 31 December 2015), effectively superseding the previous PRA guidance on the CET1 ratio.

In January 2016, the FPC published a consultation on its proposed framework for the SRB. It is proposed that it will apply to ring-fenced banks and large building societies and will be implemented from 1 January 2019. The buffer to be applied to HSBC's ring-fenced bank has yet to be determined.

Further details of the aforementioned CRD IV buffers are set out in the Appendix to Capital on page 246.

Pillar 2 and the 'PRA buffer'

The Pillar 2 framework requires banks to hold capital in respect of risks not captured in the Pillar 1 framework and to assess risks which banks may become exposed to over a forward-looking planning horizon. The PRA's assessment results in the determination of ICG/Pillar 2A and Pillar 2B, respectively.

Pillar 2A was previously required to be met by total capital but, since 1 January 2015, must be met with at least 56% CET1. Furthermore, the PRA expects firms not to meet the CRD IV buffers with any CET1 required to meet its ICG.

The Pillar 2A requirement is a point in time assessment of the amount of capital the PRA considers that a bank should hold to meet the overall financial adequacy rule. It is therefore subject to change as part of the PRA's supervisory review process. In November 2015, our Pillar 2A requirement was set at 2.3% of RWAs, of which 1.3% is met by CET1.

In July 2015, the PRA published a final policy statement PS17/15, setting out amendments to the PRA Rulebook and Supervisory Statements in relation to the Pillar 2 framework. The revised framework became effective on 1 January 2016. The PRA's Statement of Policy sets out the methodologies that it will use to inform its setting of firms' Pillar 2 capital requirements, including new approaches for determining Pillar 2 requirements for credit risk, operational risk, credit concentration risk and pension obligation risk.

In parallel, in July 2015, the PRA also issued its supervisory statement SS31/15 in which it introduced a PRA buffer to replace the capital planning buffer determined under Pillar 2B, from 1 January 2016. This is to be met in the form of CET1 capital.

The statement sets out that the PRA buffer is intended to avoid duplication with CRD IV buffers and will be set for a particular firm depending on its vulnerability in a stress scenario. In order to address significant weaknesses in risk management and governance, a scalar may be applied to firms' CET1 Pillar 1 and Pillar 2A capital requirements. This will also form part of the PRA Buffer.

Where the PRA considers there is overlap between the CRD IV buffers and the PRA buffer assessment, the PRA buffer will be set as the excess capital required over and above the CRD IV combined buffer. From 1 January 2016, the CCB and the systemic buffers are permitted to offset against the PRA buffer with the exception of any risk management and governance scalar where applicable. The use of the PRA buffer will not result in automatic restrictions to distributions.

Regulatory stress testing

The Group is subject to supervisory stress testing in many jurisdictions. These requirements are increasing in frequency and granularity. As such, stress testing represents a key focus for the Group.

The Bank of England published the results of the 2015 UK stress test in December 2015 confirming that these tests did not reveal any capital inadequacies for HSBC. At the European level, the EBA did not undertake a stress testing exercise in 2015 but instead carried out a transparency exercise, the results of which were published in November 2015.

In July 2015, the EBA also disclosed a timeline for the 2016 EU wide stress test exercise. The EBA expects to publish the 2016 stress test scenario and methodology in the first quarter of 2016, with results published in the third quarter of 2016.

In October 2015, the Bank of England published its approach to stress testing in the UK. This set out that the outcome of the UK stress testing exercise will be considered by the FPC when determining the UK CCyB rate, and will also inform the PRA buffer. Furthermore, from 2016, the applicable hurdle rate which is the amount of capital that banks are expected to maintain under a stress, is to include Pillar 1, Pillar 2A and G-SII buffer requirements.

In 2015, Group entities also participated in regional stress testing exercises. For further details on stress testing exercises, see page 116.

RWA developments

Throughout 2015, UK, EU and international regulators issued a series of consultations designed to revise the various components of the RWA regime and increase related reporting and disclosures. In particular, the Basel Committee on Banking Supervision ('the Basel Committee') published proposals relating to certain Pillar 1 risk types to update standardised, non-modelled approaches for calculating capital requirements. Details of the most significant consultations are set out below.

In December 2015 the Basel Committee published its second consultation paper on a revised standardised approach for credit risk. This included proposals to reintroduce external credit ratings, moderated by internal due diligence, as the basis for calculating risk weights for banks and corporates. The risk weights for other assets are to be determined by a variety of treatments tailored for each exposure class, which are designed to increase risk sensitivity and comparability.

In January 2016, the Basel Committee published the final rules arising from the Fundamental Review of the Trading Book, with implementation planned for 2019. The new regime includes amendments to the trading book boundary and new market risk capital calculations for both the modelled and standardised approaches. The Basel Committee acknowledges that there is considerable ongoing work which could require further revisions to the framework.

The final changes to the CVA capital charge are expected to be published in 2016. Following the finalisation of the CVA capital regime, the EU is expected to review the exemptions to the CVA charge currently applied to corporates, sovereigns and intragroup exposures. In the interim, the EU has consulted upon a methodology for calculating a Pillar 2 charge for excessive CVA risk resulting from exempted transactions.

The revised consultations for standardised operational risk and the design and calibration of a capital floor based on the standardised approaches, are expected by the end of 2016.

All of the Basel Committee's consultations will need to be transposed into EU law before coming into effect. This includes the finalised changes that relate to the counterparty risk and securitisation regimes.

UK leverage ratio framework

Following consultations in 2014, secondary legislation came into force in April 2015 to provide the FPC with direction powers in relation to the UK leverage ratio framework. In July 2015, the FPC published its final policy statement setting out its intention to use its new powers of direction. As a result the PRA issued a consultation paper to introduce requirements for the UK leverage ratio framework. This established a minimum tier 1 leverage ratio of 3%, an additional leverage ratio buffer ('ALRB') for G-SIIs and a countercyclical leverage ratio buffer ('CCLB'), and was implemented on 1 January 2016. The ALRB and CCLB are to be met entirely with CET1 capital and will be set at 35% of the relevant buffers in the risk-weighted capital framework. At 1 January 2016, our minimum leverage ratio requirement of 3% was supplemented with an ALRB of 0.2% and a CCLB which rounds to 0%. We comfortably exceed these leverage requirements.

It is anticipated that a minimum leverage ratio requirement, including potential buffers for G-SIBs, will be consulted upon by the Basel Committee in 2016 and a formal Pillar 1 measure finalised by 1 January 2018.

Total loss absorbing capacity proposals

As part of Recovery and Resolution frameworks both in the EU and internationally, there have been various developments in relation to TLAC. In the EU, the Bank Recovery and Resolution Directive introduces an MREL.

In July 2015, the EBA published a final draft Regulatory Technical Standard ('RTS') for MREL which seeks to provide additional clarity on the criteria that resolution authorities should take into account when setting a firm specific MREL requirement. The EBA notes that it aims to implement the MREL in a way which is consistent with the finalised international standard on TLAC.

In November 2015, the FSB published finalised proposals on TLAC for G-SIBs to be applied in accordance with individual bank resolution strategies. This set out a requirement of 16% of RWAs and a TLAC leverage ratio of 6% to be met from 1 January 2019, increasing to 18% and 6.75% respectively, from 1 January 2022. Existing regulatory capital buffers will need to be met in addition to the minimum TLAC requirement. A breach of TLAC will be treated as severely as a breach of minimum capital requirements.

In November 2015, the Basel Committee also published a consultation on the treatment of banks' holdings of TLAC instruments issued by a G-SIB, which proposed new deductions from regulatory capital. Once finalised, any additional requirements in relation to TLAC are expected to be reflected in MREL and to be implemented in the UK.

In December 2015, the Bank of England published a consultation paper on the UK's implementation of MREL. The Bank of England stated that it intends to set MREL consistent with both TLAC and the final EBA RTS expected to be published later this year. The MREL is expected to comprise a loss absorption amount which reflects existing regulatory capital requirements and a recapitalisation amount which reflects the capital that a firm is likely to need post resolution. The latter can be met with both regulatory capital and eligible liabilities.

While MREL is to be set on an individual basis, the Bank of England generally expects MREL for banks whose appropriate resolution strategy is bail-in, to be equivalent to twice the current minimum capital requirements. A finalised Statement of Policy is expected by mid-2016. The Bank of England is also expected to provide firms with an indication of their prospective 2020 MREL during 2016, and will set MREL on a transitional basis until then. For G-SIBs, MREL is proposed to apply from 2019, consistent with FSB timelines.

In parallel to the above, the PRA separately published a consultation paper on the interaction between MREL and capital buffers and how it would treat a breach of MREL requirements. This proposed that banks should not be able to meet MREL requirements with CET1 used to meet existing capital and leverage ratio buffers.

Structural reform and recovery and resolution planning

Globally there have been a number of developments relating to banking structural reform and the introduction of recovery and resolution regimes. As part of recovery and resolution planning, some regulators and national authorities have also required changes to the corporate structures of banks. These include requiring the local incorporation of banks or ring-fencing of certain businesses.

In 2013 and 2014, UK legislation was enacted requiring large banking groups to ring-fence UK retail and SME banking activity in a separately incorporated banking subsidiary (a 'ring-fenced bank') that is prohibited from engaging in significant trading activity. Ring-fencing is to be completed by 1 January 2019. The legislation also detailed the applicable individual customers to be transferred to the ring-fenced bank. In addition, the legislation places restrictions on the activities and geographical scope of ring-fenced banks. Throughout 2015 the PRA published a number of consultations on the implementation of ring-fencing requirements and the finalisation of rules is expected to continue in 2016.

The key proposals included near final rules published in May 2015 on legal structure, corporate governance, and continuity of services and facilities.

Additionally, in October 2015, the PRA issued a consultation on the application of capital and liquidity rules for ring-fenced banks, management of intra-group exposures, and use of financial market infrastructures. The PRA intends to undertake a further consultation in 2016 in respect of reporting and disclosure, and publish finalised rules and supervisory statements thereafter, with implementation by 1 January 2019.

We are working with our primary regulators to develop and agree a resolution strategy for HSBC. It is our view that a strategy by which the Group breaks up at a subsidiary bank level at the point of resolution (referred to as a Multiple Point of Entry) is the optimal approach, as it is aligned to our existing legal and business structure. Similarly to all G‑SIBs, we are working with our regulators to mitigate or remove critical inter-dependencies between our subsidiaries to further facilitate the resolution of the Group. In particular, in order to remove operational dependencies (where one subsidiary bank provides critical services to another), we are in the process of transferring critical services from our subsidiary banks to a separate internal group of service companies ('ServCo group').

During 2015, more than 18,000 employees performing shared services in the UK were transferred to the ServCo group. Further transfers of employees, critical shared services and assets in the UK, Hong Kong and other jurisdictions will occur in due course.

Footnotes to Capital

1 From 1 January 2015 the CRD IV transitional CET1 and end point CET1 capital ratios became aligned for HSBC Holdings plc due to the recognition of unrealised gains on investment property and available-for-sale securities.

2 This includes dividends on ordinary shares, quarterly dividends on preference shares and coupons on capital securities, classified as equity.

3 The basis of presentation for foreign currency translation differences has changed to reflect the total amount in CET1 capital. Previously this only included foreign currency translation differences recognised in other comprehensive income. The comparative period, where applicable, has not been updated to reflect the change.

4 In the first half of 2015, a portfolio of customers was transferred from CMB to RBWM in Latin America in order to better align the combined banking needs of the customers with our established global businesses. Comparative data have been re-presented accordingly.

5 RWAs are non-additive across geographical regions due to market risk diversification effects within the Group.

6 For the basis of preparation, see page 247.

7 CRD IV balances as at 31 December 2013 were estimated based on the Group's interpretation of final CRD IV legislation and final rules issued by the PRA, details of which can be found in the basis of preparation on page 324 of the Annual Report and Accounts 2013.

8 Includes externally verified profits for the year to 31 December 2015.

9 Mainly comprises unrealised gains/losses in available-for-sale debt securities related to SPEs.

10 Includes own credit spread on trading liabilities.

11 Mainly comprise investments in insurance entities.

Appendix to Capital

Capital management

(Audited)

Approach and policy

Our approach to capital management is driven by our strategic and organisational requirements, taking into account the regulatory, economic and commercial environment in which we operate. Pre-tax return on risk-weighted assets ('RoRWA') is an operational metric by which the global businesses are managed on a day-to-day basis. The metric is calibrated against return on equity and our capital requirements to ensure we are best placed to achieve capital strength and business profitability, combined with regulatory capital efficiency objectives. It is our objective to maintain a strong capital base to support the risks inherent in our business and invest in accordance with our strategy, exceeding both consolidated and local regulatory capital requirements at all times.

Our policy on capital management is underpinned by a capital management framework and our internal capital adequacy assessment process, which enables us to manage our capital in a consistent manner. The framework, which is approved by the Group Management Board ('GMB') annually, incorporates a number of different capital measures including market capitalisation, shareholders' equity, economic capital and regulatory capital. During 2015, we continued to manage Group capital to meet a medium-term target for return on equity of more than 10%. This is modelled on a CET1 ratio on an end point basis in the range of 12% to 13%.

Capital measures

· shareholders' equity is the equity capital invested in HSBC by our shareholders, adjusted for certain reserves and goodwill previously amortised or written-off;

· economic capital is the internally calculated capital requirement which we deem necessary to support the risks to which we are exposed; and

· regulatory capital is the capital which we are required to hold in accordance with the rules established by the PRA for the consolidated Group and by our local regulators for individual Group companies. This comprises common equity tier 1, additional tier 1 and tier 2 capital.

Our assessment of capital adequacy is aligned to our assessment of risks, including: credit, market, operational, interest rate risk in the banking book, pensions, insurance, structural foreign exchange risk and residual risks.

Stress testing

In addition to our annual group internal stress test, the Group is subject to supervisory stress testing in many jurisdictions. Supervisory requirements are increasing in frequency and in the granularity with which the results are required. These exercises include the programmes of the PRA, the FRB, the EBA, the ECB and the HKMA, as well as stress tests undertaken in other jurisdictions. We take into account the results of all such regulatory stress testing and our internal stress test when assessing our internal capital requirements. The outcome of stress testing exercises carried out by the PRA, will also feed into a PRA buffer under the Pillar 2 requirements, where required.

Risks to capital

Outside of the stress-testing framework, a list of top and emerging risks is regularly evaluated for their effect on our CET1 capital ratio. As a result, other risks may be identified which have the potential to affect our RWAs and/or capital position. These risks are also included in the evaluation of risks to capital. The downside or upside scenarios are assessed against our capital management objectives and mitigating actions are assigned as necessary. The responsibility for global capital allocation principles and decisions rests with the GMB. Through our internal governance processes, we seek to maintain discipline over our investment and capital allocation decisions and seek to ensure that returns on investment meet the Group's management objectives. Our strategy is to allocate capital to businesses and entities on the basis of their ability to achieve established RoRWA objectives and their regulatory and economic capital requirements.

Risk-weighted asset plans

RWA plans form part of the Annual Operating Plan that is approved by the Board. Revised forecasts are submitted to the GMB on a monthly basis and reported RWAs are monitored against plan.

Our global businesses are set targets in line with the priorities outlined in last June's strategy update including RWA efficiency and return on RWAs. Business performance against RWA targets is monitored through regular reporting to the Holding Company ALCO as well as the GMB. Performance measures are aligned to the Group's strategic actions. The management of regulatory capital deductions is also addressed in the RWA monitoring framework through additional notional charges for these items.

Analysis is undertaken within the RWA monitoring framework to identify the key drivers of movements. Particular attention is paid to identifying and segmenting items within the day-to-day control of the business and those items that are driven by changes in risk models or regulatory methodology. Analysis is also undertaken to recognise and report specific actions that are targeted RWA reduction initiatives.

Capital generation

HSBC Holdings is the primary provider of equity capital to its subsidiaries and also provides them with non-equity capital where necessary. These investments are substantially funded by HSBC Holdings' own capital issuance and profit retention. As part of its capital management process, HSBC Holdings seeks to maintain a prudent balance between the composition of its capital and its investment in subsidiaries.

Capital measurement and allocation

The PRA supervises HSBC on a consolidated basis and therefore receives information on the capital adequacy of, and sets capital requirements for, the Group as a whole. Individual banking subsidiaries are directly regulated by their local banking supervisors, who set and monitor their capital adequacy requirements. Our capital at Group level is calculated under CRD IV and supplemented by the PRA's rules to effect the transposition of directive requirements.

Our policy and practice in capital measurement and allocation at Group level is underpinned by the CRD IV rules. In most jurisdictions, non-banking financial subsidiaries are also subject to the supervision and capital requirements of local regulatory authorities.

The Basel III framework, similarly to Basel II, is structured around three 'pillars': minimum capital requirements, supervisory review process and market discipline. The CRD IV legislation implemented Basel III in the EU and, in the UK, the 'PRA Rulebook' for CRR Firms transposed the various national discretions under the CRD IV legislation into UK requirements. CRDIV also introduces a number of capital buffers, including the CCB, CCyB, and other systemic buffers such as the G-SII buffer.

Regulatory capital

For regulatory purposes, our capital base is divided into three main categories, namely CET1, additional tier 1 and tier 2, depending on their characteristics.

· CET1 capital is the highest quality form of capital, comprising shareholders' equity and related non-controlling interests (subject to limits). Under CRD IV various capital deductions and regulatory adjustments are made to these items which are treated differently for the purposes of capital adequacy - these include deductions for goodwill and intangible assets, deferred tax assets that rely on future profitability, negative amounts resulting from the calculation of expected loss amounts under IRB, holdings of capital securities of financial sector entities and surplus defined benefit pension fund assets.

· Additional tier 1 capital comprises eligible non-common equity capital securities and any related share premium; it also includes qualifying securities issued by subsidiaries subject to certain limits. Holdings of additional tier 1 securities of financial sector entities are deducted.

· Tier 2 capital comprises eligible capital securities and any related share premium and qualifying tier 2 capital securities issued by subsidiaries subject to limits. Holdings of tier 2 capital securities of financial sector entities are deducted.

Pillar 1 capital requirements

Pillar 1 is comprised of the capital resources requirements for credit risk, market risk and operational risk. Credit risk includes counterparty credit risk and securitisation requirements. These requirements are expressed in terms of RWAs.

Credit risk capital requirements

CRD IV applies three approaches of increasing sophistication to the calculation of Pillar 1 credit risk capital requirements. The most basic, the standardised approach, requires banks to use external credit ratings to determine the risk weightings applied to rated counterparties. Other counterparties are grouped into broad categories and standardised risk weightings are applied to these categories. The next level, the internal ratings-based ('IRB') foundation approach, allows banks to calculate their credit risk capital requirements on the basis of their internal assessment of a counterparty's probability of default ('PD'), but the estimates of exposure at default ('EAD') and loss given default ('LGD') are subject to standard supervisory parameters. Finally, the IRB advanced approach allows banks to use their own internal assessment in both determining PD and quantifying EAD and LGD.

The capital resources requirement, which is intended to cover unexpected losses, is derived from a formula specified in the regulatory rules which incorporates PD, LGD, EAD and other variables such as maturity and correlation. Expected losses are calculated by multiplying PD by EAD and LGD. Expected losses are deducted from capital to the extent that they exceed total accounting impairment allowances. For credit risk we have adopted the IRB advanced approach for the majority of our portfolios, with the remainder on either IRB foundation or standardised approaches.

At the end of 2015, a number of portfolios in Europe, Asia and North America were on the advanced IRB approach as well as our sovereigns, banks and large corporate exposures globally. Others remain on the standardised or foundation approach pending definition of local regulations or model approval, or under exemptions from IRB treatment. In some instances, regulators have allowed us to transition from advanced to standardised approaches for a limited number of portfolios.

· Counterparty credit risk

Counterparty credit risk ('CCR') arises for derivatives and securities financing transactions. It is calculated for both the trading and non-trading books and is the risk that the counterparty to a transaction may default before completing the satisfactory settlement of the transaction. Three approaches to calculating CCR and determining exposure values are defined by CRD IV: mark-to-market, standardised and internal model method. These exposure values are used to determine capital requirements under one of the credit risk approaches: standardised, IRB foundation and IRB advanced.

We use the mark-to-market and internal model method approaches for CCR.

In addition, CRD IV introduced a regulatory capital charge to cover CVA risk, the risk of adverse movements in the credit valuation adjustments taken for expected credit losses on derivative transactions. Where we have both specific risk VaR approval and internal model method approval for a product, the CVA VaR approach has been used to calculate the CVA capital charge. Where we do not hold both approvals, the standardised approach has been applied. Certain counterparty exposures are exempt from CVA, such as non-financial counterparties and sovereigns.

· Securitisation

Securitisation positions are held in both the trading and non-trading books. For non-trading book securitisation positions, CRD IV specifies two methods for calculating credit risk requirements, the standardised and the IRB approaches. Both rely on the mapping of rating agency credit ratings to risk weights, which range from 7% to 1,250%.

Within the IRB approach, we use the ratings-based method for the majority of our non-trading book securitisation positions, and the internal assessment approach for exposures arising from asset-backed commercial paper programmes, mainly related to liquidity facilities and programme wide credit enhancement.

The majority of securitisation positions in the trading book are risk weighted for capital purposes as though they are held in the non-trading book under the standardised or IRB approaches.

Market risk capital requirement

The market risk capital requirement is measured using internal market risk models where approved by the PRA, or the standard rules of CRD IV. Our internal market risk models are VaR, stressed VaR and Incremental Risk. Since the sale of our correlation portfolio in September 2014, there has been no market risk capital requirement associated with the comprehensive risk measure.

Operational risk capital requirement

CRD IV includes a capital requirement for operational risk, again utilising three levels of sophistication. The capital required under the basic indicator approach is a simple percentage of gross revenues, whereas under the standardised approach the calculation is applied to the same measure with varying percentages by business line. Both these approaches use an average of the last three financial years' revenues. Finally, the advanced measurement approach uses banks' own statistical analysis and modelling of operational risk data to determine capital requirements. We have adopted the standardised approach in determining our operational risk capital requirements.

Pillar 2 capital requirements

We conduct an annual internal capital adequacy assessment process ('ICAAP') to determine a forward looking assessment of our capital requirements given our business strategy, risk profile, risk appetite and capital plan. This process incorporates the Group's risk management processes and governance framework. As a part of our ICAAP, we carry out internal stress testing of our base capital plan where both the PRA released stress scenario and concurrent scenario in the context of our business and specific risk drivers are taken into account. These, coupled with our economic capital framework and other risk management practices, are used to assess our internal capital adequacy requirements.

The ICAAP is examined by the PRA as part of its supervisory review and evaluation process ('SREP'), which occurs periodically to enable the regulator to define the individual capital guidance or minimum capital requirements for HSBC and our capital planning buffer where required. Under the revised Pillar 2 PRA regime, which came into effect from 1 January 2016, the capital planning buffer was replaced with a PRA buffer. The PRA states this is not intended to duplicate the CRD IV buffers, and will be set according to vulnerability in a stress scenario, as assessed through the annual PRA stress testing exercise.

CRD IV capital buffers

CRD IV introduced a number of capital buffers which apply in addition to Pillar 1 and Pillar 2 requirements and are broadly aligned with the Basel III framework. This includes the CCB, CCyB, and G-SII which are all currently applicable to the Group. These are to be met with CET1 and, with the exception of the CCyB which applies with immediate effect, are being phased in from 1 January 2016. The CRD IV includes other capital buffers such as the systemic risk buffer which has not yet been fully implemented by the PRA.

· CCB

The CCB is designed to ensure banks build up capital outside periods of stress that can be drawn down when losses are incurred. It is set at 2.5% of RWAs across all banks, and is being phased in from 1 January 2016. At 1 January 2016, our CCB was 0.625%.

· G-SII

The Group is designated as a G-SII by the PRA, and is currently subject to a G-SII buffer of 2.5% of RWAs. This is being phased in from 1 January 2016. The G-SII buffer is intended to address systemic risk, which is assessed on an annual basis according to a number of indicators such as: the size of a bank, its interconnectedness, the lack of readily available substitutes or financial institution infrastructure for the services it provides, its global cross-jurisdictional activity, and the complexity of its business model. At 1 January 2016, our G-SII buffer was 0.625%.

· CCyB

The CCyB is a countercyclical buffer which is set on an institution specific basis and calculated according to the geographic location of relevant exposures. It is designed to protect against future losses where unsustainable levels of leverage, debt or credit growth pose a systemic threat. Our institution-specific CCyB for the Group is calculated as the weighted average of the CCyB rates that apply in the jurisdictions where our relevant credit exposures are located. At 31 December 2015 our institution specific CCyB applicable on a group basis, was close to 0%.

· Combined buffer

As a result of the above requirements, at 1 January 2016, the combined buffer applicable to HSBC Group was estimated as 1.25%.

Leverage ratio requirements

In addition to risk-based capital requirements, the Group is subject to a non-risk sensitive, minimum leverage ratio requirement of 3%, as set by the PRA. This is calculated in accordance with the Commission Delegated Regulation (EU) 2015/62, published in January 2015, which implemented the revised Basel III 2014 exposure measure. Since 1 January 2016, the minimum leverage ratio of 3% has been supplemented with an ALRB for G-SIIs and a CCLB, both of which are set at 35% of the relevant buffers in the risk-weighted capital framework. As a result, at 1 January 2016, our minimum leverage ratio requirement of 3% was supplemented with an ALRB of 0.2% and a CCLB which rounds to 0%.

Pillar 3 disclosure requirements

Pillar 3 of the Basel regulatory framework is related to market discipline and aims to make firms more transparent by requiring publication, at least annually, of wide-ranging information on their risks, capital and management. Our Pillar 3 Disclosures 2015 are published on our website, www.hsbc.com, under Investor Relations.

RWA movement by key driver - basis of preparation and supporting notes

Credit risk drivers - definitions and quantification

The causal analysis of RWA movements splits the total movement in IRB RWAs into six drivers, described below. The first four relate to specific, identifiable and measurable changes. The remaining two, book size and book quality, are derived after accounting for movements in the first four specific drivers.

1. Foreign exchange movements

This is the movement in RWAs as a result of changes in the exchange rate between the functional currency of the HSBC company owning each portfolio and US dollars, being our presentation currency for consolidated reporting. Our structural foreign exchange exposures are managed with the primary objective of ensuring, where practical, that our consolidated capital ratios and the capital ratios of individual banking subsidiaries are largely protected from the effect of changes in exchange rates. This is usually achieved by ensuring that, for each subsidiary bank, the ratio of structural exposures in a given currency to risk-weighted assets denominated in that currency is broadly equal to the capital ratio of the subsidiary in question. We hedge structural foreign exchange exposures only in limited circumstances.

2. Acquisitions and disposals

This is the movement in RWAs as a result of the disposal or acquisition of business operations. This can be whole businesses or parts of a business. The movement in RWAs is quantified based on the credit risk exposures as at the end of the month preceding a disposal or following an acquisition.

3. Model updates

RWA movements arising from the implementation of new models and from changes to existing parameter models are allocated to this driver. This figure will also include changes which arise following review of modelling assumptions. Where a model recalibration reflects an update to more recent performance data, the resulting RWA changes are not assigned here, but instead reported under book quality.

RWA changes are estimated based on the impact assessments made in the testing phase prior to implementation. These values are used to simulate the effect of new or updated models on the portfolio at the point of implementation, assuming there were no major changes in the portfolio from the testing phase to implementation phase.

RWA movement arising from portfolios moving from the standardised approach to the IRB approach are also allocated to this driver. The RWA movement by key driver statement shows the increase in IRB RWAs, but does not show the corresponding reduction in standardised approach RWAs as its scope is limited to IRB only.

The movement in RWAs is quantified at the date at which the IRB approach is applied, and not during the testing phase as with a new/updated model.

4. Methodology and policy

Internal updates

This captures the effect on RWAs of changing the internal treatment of exposures. This may include, but is not limited to, a portfolio or a part of one moving from an existing IRB model onto a standardised model, identification of netting and credit risk mitigation.

External updates - regulatory

This specifies the effect of additional or changing regulatory requirements. This includes, but is not limited to, regulatory-prescribed changes to the RWA calculation. The movement in RWAs is quantified by comparing the RWAs calculated for that portfolio under the old and the new requirements.

5. Book size

RWA movements attributed to this driver are those we would expect to experience for the given movement in exposure, as measured by EAD, assuming a stable risk profile. These RWA movements arise in the normal course of business, such as growth in credit exposures or reduction in book size from run-offs and write-offs.

The RWA movement is quantified as follows:

· RWA and EAD changes captured in the four drivers above are excluded from the total movements to create an adjusted movement in EAD and RWA for the period.

· The average RWA to EAD percentage is calculated for the opening position and is applied to the adjusted movement in EAD. This results in an estimated book size RWA movement based on the assumption that the EAD to RWA percentage is constant throughout the period.

As the calculation relies on averaging, the output is dependent upon the degree of portfolio aggregation and the number of discrete time periods for which the calculation is undertaken. For each quarter of 2015 this calculation was performed for each HSBC company with an IRB portfolio by global businesses, split by the main Basel categories of credit exposures, as described in the table below:


Central governments and central banks	Corporates - Other	Retail - Qualifying revolving
Institutions	Retail - Secured by real estate SME	Retail - Other SME
Corporates - SME	Retail - Secured by retail estate non-SME	Retail - Other non-SME
Corporates - Specialised Lending

The total of the results is shown in book size within the RWA movement by key driver table.

6. Book quality

This represents RWA movements resulting from changes in the underlying credit quality of customers. These are caused by changes to IRB risk parameters which arise from actions such as, but not limited to, model recalibration, change in counterparty external rating, or the influence of new lending on the average quality of the book. The change in RWAs attributable to book quality is calculated as the balance of RWA movements after taking account of all drivers described above.

The RWA movement by key driver statement includes only movements which are calculated under the IRB approach. Certain classes of credit risk exposure are treated as capital deductions and therefore reductions are not shown in this statement. If the treatment of a credit risk exposure changes from RWA to capital deduction in the period, then only the reduction in RWAs would appear in the RWA movement by key driver tables. In this instance, a reduction in RWAs does not necessarily indicate an improvement in the capital position.

Counterparty risk drivers - definitions and quantification

The RWA movement by key driver for counterparty credit risk calculates the credit risk drivers 5 and 6 at a more granular level, by using transaction level details provided by regional sites. 'Foreign exchange movement' is not a reported layer for counterparty risk drivers, as there is cross currency netting across the portfolio.