Annual Financial Report - 48 of 54

RNS Number : 0585I

HSBC Holdings PLC

20 March 2015

12 Trading assets

Accounting policy

Financial assets are classified as held for trading if they have been acquired principally for the purpose of selling in the near term, or form part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent pattern of short-term profit-taking. They are recognised on trade date, when HSBC enters into contractual arrangements with counterparties, and are normally derecognised when sold. They are initially measured at fair value, with transaction costs taken to the income statement. Subsequent changes in their fair values are recognised in the income statement in 'Net trading income'. For trading assets, the interest is shown in 'Net trading income'.

Trading assets

	2014	2013
	US$m	US$m
Trading assets:
- not subject to repledge or resale by counterparties	247,586	201,492
- which may be repledged or resold by counterparties	56,607	101,700

At 31 December	304,193	303,192

Treasury and other eligible bills	16,170	21,584
Debt securities	141,532	141,644
Equity securities	75,249	63,891

Trading securities at fair value	232,951	227,119
Loans and advances to banks¹	27,581	27,885
Loans and advances to customers¹	43,661	48,188

At 31 December	304,193	303,192

1 Loans and advances to banks and customers include reverse repos, settlement accounts, stock borrowing and other amounts.

Trading securities valued at fair value¹

	2014	2013
	US$m	US$m

US Treasury and US Government agencies²	25,880	23,450
UK Government	9,280	11,591
Hong Kong Government	6,946	5,909
Other government	78,774	86,714
Asset-backed securities³	3,494	2,736
Corporate debt and other securities	33,328	32,828
Equity securities	75,249	63,891

At 31 December	232,951	227,119

1 Included within these figures are debt securities issued by banks and other financial institutions of US$22,399m (2013: US$22,989m), of which US$2,949m (2013: US$3,973m) are guaranteed by various governments.

2 Includes securities that are supported by an explicit guarantee issued by the US Government.

3 Excludes asset-backed securities included under US Treasury and US Government agencies.

Trading securities listed on a recognised exchange and unlisted

	Treasury and other eligible bills	Debt securities	Equity securities	Total
	US$m	US$m	US$m	US$m
Fair value
Listed¹	1,311	98,028	74,542	173,881
Unlisted²	14,859	43,504	707	59,070

At 31 December 2014	16,170	141,532	75,249	232,951

Fair value
Listed¹	194	85,821	62,724	148,739
Unlisted²	21,390	55,823	1,167	78,380

At 31 December 2013	21,584	141,644	63,891	227,119

1 Included within listed investments are US$5,956m (2013: US$3,836m) of securities listed in Hong Kong.

2 Unlisted treasury and other eligible bills primarily comprise treasury bills not listed on an exchange but for which there is a liquid market.

13 Fair values of financial instruments carried at fair value

Accounting policy

All financial instruments are recognised initially at fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of a financial instrument on initial recognition is generally its transaction price (that is, the fair value of the consideration given or received). However, sometimes the fair value will be based on other observable current market transactions in the same instrument, without modification or repackaging, or on a valuation technique whose variables include only data from observable markets, such as interest rate yield curves, option volatilities and currency rates. When such evidence exists, HSBC recognises a trading gain or loss at inception ('day 1 gain or loss'), being the difference between the transaction price and the fair value. When significant unobservable parameters are used, the entire day 1 gain or loss is deferred and is recognised in the income statement over the life of the transaction until the transaction matures, is closed out, the valuation inputs become observable or HSBC enters into an offsetting transaction.

The fair value of financial instruments is generally measured on an individual basis. However, in cases where HSBC manages a group of financial assets and liabilities according to its net market or credit risk exposure, HSBC measures the fair value of the group of financial instruments on a net basis but presents the underlying financial assets and liabilities separately in the financial statements, unless they satisfy the IFRS offsetting criteria as described in Note 32.

Critical accounting estimates and judgements

Valuation of financial instruments

The best evidence of fair value is a quoted price in an actively traded principal market. The fair values of financial instruments that are quoted in active markets are based on bid prices for assets held and offer prices for liabilities issued. Where a financial instrument has a quoted price in an active market, the fair value of the total holding of the financial instrument is calculated as the product of the number of units and quoted price. The judgement as to whether a market is active may include, but is not restricted to, the consideration of factors such as the magnitude and frequency of trading activity, the availability of prices and the size of bid/offer spreads. The bid/offer spread represents the difference in prices at which a market participant would be willing to buy compared with the price at which they would be willing to sell. Valuation techniques may incorporate assumptions about factors that other market participants would use in their valuations, including:

· the likelihood and expected timing of future cash flows on the instrument. Judgement may be required to assess the counterparty's ability to service the instrument in accordance with its contractual terms. Future cash flows may be sensitive to changes in market rates;

· selecting an appropriate discount rate for the instrument. Judgement is required to assess what a market participant would regard as the appropriate spread of the rate for an instrument over the appropriate risk-free rate;

· judgement to determine what model to use to calculate fair value in areas where the choice of valuation model is particularly subjective, for example, when valuing complex derivative products.

A range of valuation techniques is employed, dependent on the instrument type and available market data. Most valuation techniques are based upon discounted cash flow analyses, in which expected future cash flows are calculated and discounted to present value using a discounting curve. Prior to considering credit risk, the expected future cash flows may be known, as would be the case for the fixed leg of an interest rate swap, or may be uncertain and require projection, as would be the case for the floating leg of an interest rate swap. 'Projection' utilises market forward curves, if available. In option models, the probability of different potential future outcomes must be considered. In addition, the value of some products is dependent on more than one market factor, and in these cases it will typically be necessary to consider how movements in one market factor may affect the other market factors. The model inputs necessary to perform such calculations include interest rate yield curves, exchange rates, volatilities, correlations, prepayment and default rates. For interest rate derivatives with collateralised counterparties and in significant currencies, HSBC uses a discounting curve that reflects the overnight interest rate ('OIS').

The majority of valuation techniques employ only observable market data. However, certain financial instruments are valued on the basis of valuation techniques that feature one or more significant market inputs that are unobservable, and for them the measurement of fair value is more judgemental. An instrument in its entirety is classified as valued using significant unobservable inputs if, in the opinion of management, a significant proportion of the instrument's inception profit or greater than 5% of the instrument's valuation is driven by unobservable inputs. 'Unobservable' in this context means that there is little or no current market data available from which to determine the price at which an arm's length transaction would be likely to occur. It generally does not mean that there is no data available at all upon which to base a determination of fair value (consensus pricing data may, for example, be used).

Control framework

Fair values are subject to a control framework designed to ensure that they are either determined or validated by a function independent of the risk‑taker.

For all financial instruments where fair values are determined by reference to externally quoted prices or observable pricing inputs to models, independent price determination or validation is utilised. In inactive markets HSBC will source alternative market information to validate the financial instrument's fair value, with greater weight given to information that is considered to be more relevant and reliable. The factors that are considered in this regard are, inter alia:

· the extent to which prices may be expected to represent genuine traded or tradeable prices;

· the degree of similarity between financial instruments;

· the degree of consistency between different sources;

· the process followed by the pricing provider to derive the data;

· the elapsed time between the date to which the market data relates and the balance sheet date; and

· the manner in which the data was sourced.

For fair values determined using valuation models, the control framework may include, as applicable, development or validation by independent support functions of (i) the logic within valuation models; (ii) the inputs to those models; (iii) any adjustments required outside the valuation models; and (iv) where possible, model outputs. Valuation models are subject to a process of due diligence and calibration before becoming operational and are calibrated against external market data on an ongoing basis.

Changes in fair value are generally subject to a profit and loss analysis process. This process disaggregates changes in fair value into three high level categories; (i) portfolio changes, such as new transactions or maturing transactions, (ii) market movements, such as changes in foreign exchange rates or equity prices, and (iii) other, such as changes in fair value adjustments (see further below).

The majority of financial instruments measured at fair value are in GB&M. GB&M's fair value governance structure is illustrated below as an example:

Financial liabilities measured at fair value

In certain circumstances, HSBC records its own debt in issue at fair value, based on quoted prices in an active market for the specific instrument concerned, where available. An example of this is where own debt in issue is hedged with interest rate derivatives. When quoted market prices are unavailable, the own debt in issue is valued using valuation techniques, the inputs for which are either based upon quoted prices in an inactive market for the instrument, or are estimated by comparison with quoted prices in an active market for similar instruments. In both cases, the fair value includes the effect of applying the credit spread which is appropriate to HSBC's liabilities. The change in fair value of issued debt securities attributable to the Group's own credit spread is computed as follows: for each security at each reporting date, an externally verifiable price is obtained or a price is derived using credit spreads for similar securities for the same issuer. Then, using discounted cash flow, each security is valued using a Libor-based discount curve. The difference in the valuations is attributable to the Group's own credit spread. This methodology is applied consistently across all securities.

Structured notes issued and certain other hybrid instrument liabilities are included within trading liabilities and are measured at fair value. The credit spread applied to these instruments is derived from the spreads at which HSBC issues structured notes.

Gains and losses arising from changes in the credit spread of liabilities issued by HSBC reverse over the contractual life of the debt, provided that the debt is not repaid at a premium or a discount.

Fair value hierarchy

Fair values of financial assets and liabilities are determined according to the following hierarchy:

· Level 1 - valuation technique using quoted market price:financial instruments with quoted prices for identical instruments in active markets that HSBC can access at the measurement date.

· Level 2 - valuation technique using observable inputs:financial instruments with quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in inactive markets and financial instruments valued using models where all significant inputs are observable.

· Level 3 - valuation technique with significant unobservable inputs: financial instruments valued using valuation techniques where one or more significant inputs are unobservable.

The following table sets out the financial instruments by fair value hierarchy.

Financial instruments carried at fair value and bases of valuation

		Valuation techniques
	Quoted market price Level 1	Using observable inputs Level 2	With significant unobservable inputs Level 3	Total
	US$m	US$m	US$m	US$m
Recurring fair value measurements at 31 December 2014
Assets
Trading assets	180,446	117,279	6,468	304,193
Financial assets designated at fair value	23,697	4,614	726	29,037
Derivatives	4,366	337,718	2,924	345,008
Financial investments: available for sale	241,464	131,264	4,988	377,716

Liabilities
Trading liabilities	62,385	122,048	6,139	190,572
Financial liabilities designated at fair value	3,792	72,361	-	76,153
Derivatives	4,649	334,113	1,907	340,669

Recurring fair value measurements at 31 December 2013
Assets
Trading assets	182,721	115,124	5,347	303,192
Financial assets designated at fair value	30,173	7,649	608	38,430
Derivatives	2,539	277,224	2,502	282,265
Financial investments: available for sale	262,836	130,760	7,245	400,841

Liabilities
Trading liabilities	88,935	110,576	7,514	207,025
Financial liabilities designated at fair value	10,482	78,602	-	89,084
Derivatives	4,508	267,441	2,335	274,284

The increase in Level 2 derivative balances reflects the overall increase in derivative balances and is discussed in Note 16. There were no other significant movements during 2014.

Transfers between Level 1 and Level 2 fair values

	Assets					Liabilities
	Available for sale	Held for trading	Designated at fair value through profit or loss		Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m	US$m		US$m	US$m	US$m		US$m	US$m
At 31 December 2014
Transfers from Level 1 to Level 2	2,702	18,149		-	-	22,964		-	-
Transfers from Level 2 to Level 1	-	-		-	-	-		-	-

Transfers between levels of the fair value hierarchy are deemed to occur at the end of each semi-annual reporting period. Transfers from Level 1 to Level 2 mainly reflect the reclassification of settlement balances and cash collateral following reassessment of the application of levelling criteria to these balances.

Fair value adjustments

Fair value adjustments are adopted when HSBC considers that there are additional factors that would be considered by a market participant which are not incorporated within the valuation model. HSBC classifies fair value adjustments as either 'risk-related' or 'model-related'. The majority of these adjustments relate to GB&M.

Movements in the level of fair value adjustments do not necessarily result in the recognition of profits or losses within the income statement. For example, as models are enhanced, fair value adjustments may no longer be required. Similarly, fair value adjustments will decrease when the related positions are unwound, but this may not result in profit or loss.

Global Banking and Markets fair value adjustments

	2014	2013
	US$m	US$m
Type of adjustment
Risk-related	1,958	1,565
- bid-offer	539	561
- uncertainty	357	343
- credit valuation adjustment	871	1,274
- debit valuation adjustment	(270)	(616)
- funding fair value adjustment	460	-
- other	1	3

Model-related	57	202
- model limitation	52	199
- other	5	3

Inception profit (Day 1 P&L reserves) (Note 16)	114	167

At 31 December	2,129	1,934

The largest change in recurring fair value adjustments was a decline of US$403m in respect of the credit valuation adjustment, as a result of both reduced derivative counterparty exposures and general narrowing of credit default swap ('CDS') spreads. Narrowing HSBC credit default swap spreads similarly contributed to a reduction in the debit valuation adjustment ('DVA') of US$346m.

Funding fair value adjustment ('FFVA') reflects the potential future cost or benefit of funding the uncollateralised derivative portfolio at rates other than overnight ('OIS') rates. The impact of FFVA adoption in 2014 was a US$263m reduction in net trading income, reflecting the incorporation of a funding spread over Libor. FFVA is measured from an OIS base, and the total FFVA balance of US$460m also reflects the difference between OIS and Libor which had been previously reflected in the fair value of the uncollateralised derivative portfolio.

Risk-related adjustments

Bid-offer

IFRS 13 requires use of the price within the bid-offer spread that is most representative of fair value. Valuation models will typically generate mid-market values. The bid-offer adjustment reflects the extent to which bid-offer costs would be incurred if substantially all residual net portfolio market risks were closed using available hedging instruments or by disposing of or unwinding the position.

Uncertainty

Certain model inputs may be less readily determinable from market data, and/or the choice of model itself may be more subjective. In these circumstances, there exists a range of possible values that the financial instrument or market parameter may assume and an adjustment may be necessary to reflect the likelihood that in estimating the fair value of the financial instrument, market participants would adopt more conservative values for uncertain parameters and/or model assumptions than those used in the valuation model.

Credit valuation adjustment

The CVA is an adjustment to the valuation of OTC derivative contracts to reflect within fair value the possibility that the counterparty may default and that HSBC may not receive the full market value of the transactions (see below).

Debit valuation adjustment

The DVA is an adjustment to the valuation of OTC derivative contracts to reflect within fair value the possibility that HSBC may default, and that HSBC may not pay full market value of the transactions (see below).

Funding fair value adjustment

The funding fair value adjustment is calculated by applying future market funding spreads to the expected future funding exposure of any uncollateralised component of the OTC derivative portfolio. This includes the uncollateralised component of collateralised derivatives in addition to derivatives that are fully uncollateralised. The expected future funding exposure is calculated by a simulation methodology, where available. The expected future funding exposure is adjusted for events that may terminate the exposure such as the default of HSBC or the counterparty. The funding fair value adjustment and debit valuation adjustment are calculated independently.

Model-related adjustments

Model limitation

Models used for portfolio valuation purposes may be based upon a simplifying set of assumptions that do not capture all material market characteristics. Additionally, markets evolve, and models that were adequate in the past may require development to capture all material market characteristics in current market conditions. In these circumstances, model limitation adjustments are adopted. As model development progresses, model limitations are addressed within the valuation models and a model limitation adjustment is no longer needed.

Inception profit (Day 1 P&L reserves)

Inception profit adjustments are adopted when the fair value estimated by a valuation model is based on one or more significant unobservable inputs. The accounting for inception profit adjustments is discussed on page 378. An analysis of the movement in the deferred Day 1 P&L reserve is provided on page 395.

Credit valuation adjustment/debit valuation adjustment methodology

HSBC calculates a separate CVA and DVA for each HSBC legal entity, and within each entity for each counterparty to which the entity has exposure. HSBC calculates the CVA by applying the probability of default ('PD') of the counterparty, conditional on the non-default of HSBC, to HSBC's expected positive exposure to the counterparty and multiplying the result by the loss expected in the event of default. Conversely, HSBC calculates the DVA by applying the PD of HSBC, conditional on the non-default of the counterparty, to the expected positive exposure of the counterparty to HSBC and multiplying the result by the loss expected in the event of default. Both calculations are performed over the life of the potential exposure.

For most products HSBC uses a simulation methodology to calculate the expected positive exposure to a counterparty. This incorporates a range of potential exposures across the portfolio of transactions with the counterparty over the life of the portfolio. The simulation methodology includes credit mitigants such as counterparty netting agreements and collateral agreements with the counterparty. A standard loss given default ('LGD') assumption of 60% is generally adopted for developed market exposures, and 75% for emerging market exposures. Alternative LGD assumptions may be adopted when both the nature of the exposure and the available data support this.

For certain types of exotic derivatives where the products are not currently supported by the simulation, or for derivative exposures in smaller trading locations where the simulation tool is not yet available, HSBC adopts alternative methodologies. These may involve mapping to the results for similar products from the simulation tool or, where the mapping approach is not appropriate, using a simplified methodology which generally follows the same principles as the simulation methodology. The calculation is applied at a trade level, with more limited recognition of credit mitigants such as netting or collateral agreements than is used in the simulation methodology.

The methodologies do not, in general, account for 'wrong-way risk'. Wrong-way risk arises when the underlying value of the derivative prior to any CVA is positively correlated to the probability of default by the counterparty. When there is significant wrong-way risk, a trade-specific approach is applied to reflect the wrong-way risk within the valuation.

With the exception of certain central clearing parties, we include all third-party counterparties in the CVA and DVA calculations and do not net these adjustments across Group entities. We review and refine the CVA and DVA methodologies on an ongoing basis.

Valuation of uncollateralised derivatives

Historically, HSBC has valued uncollateralised derivatives by discounting expected future cash flows at a benchmark interest rate, typically Libor or its equivalent. In line with evolving industry practice, HSBC changed this approach in the second half of 2014. HSBC now views the OIS curve as the base discounting curve for all derivatives, both collateralised and uncollateralised, and has adopted an FFVA to reflect the funding of uncollateralised derivative exposure at rates other than OIS. The impact of adopting the funding fair value adjustment was a reduction in trading revenues of US$263m. This is an area in which a full industry consensus has not yet emerged. HSBC will continue to monitor industry evolution and refine the calculation methodology as necessary.

Fair value valuation bases

Financial instruments measured at fair value using a valuation technique with significant unobservable inputs - Level 3

	Assets						Liabilities
	Available for sale	Held for trading	At fair value¹		Deriv- atives	Total	Held for trading	At fair value¹		Deriv- atives	Total
	US$m	US$m		US$m	US$m	US$m	US$m		US$m	US$m	US$m

Private equity including strategic investments	3,120	164		432	-	3,716	47		-	-	47
Asset-backed securities	1,462	616		-	-	2,078	-		-	-	-
Loans held for securitisation	-	39		-	-	39	-		-	-	-
Structured notes	-	2		-	-	2	6,092		-	-	6,092
Derivatives with monolines	-	-		-	239	239	-		-	1	1
Other derivatives	-	-		-	2,685	2,685	-		-	1,906	1,906
Other portfolios	406	5,647		294	-	6,347	-		-	-	-
		5,		726
At 31 December 2014	4,988	6,468		726	2,924	15,106	6,139		-	1,907	8,046

Private equity including strategic investments	3,729	103		420	-	4,252	-		-	-	-
Asset-backed securities	1,677	643		-	-	2,320	-		-	-	-
Loans held for securitisation	-	83		-	-	83	-		-	-	-
Structured notes	-	14		-	-	14	7,514		-	-	7,514
Derivatives with monolines	-	-		-	320	320	-		-	-	-
Other derivatives	-	-		-	2,182	2,182	-		-	2,335	2,335
Other portfolios	1,839	4,504		188	-	6,531	-		-	-	-

At 31 December 2013	7,245	5,347		608	2,502	15,702	7,514		-	2,335	9,849

1 Designated at fair value through profit or loss.

Level 3 instruments are present in both ongoing and legacy businesses. Loans held for securitisation, derivatives with monolines, certain 'other derivatives' and predominantly all Level 3 asset-backed securities are legacy. HSBC has the capability to hold these positions.

Private equity including strategic investments

HSBC's private equity and strategic investments are generally classified as available for sale and are not traded in active markets. In the absence of an active market, an investment's fair value is estimated on the basis of an analysis of the investee's financial position and results, risk profile, prospects and other factors, as well as by reference to market valuations for similar entities quoted in an active market, or the price at which similar companies have changed ownership.

Asset-backed securities

While quoted market prices are generally used to determine the fair value of these securities, valuation models are used to substantiate the reliability of the limited market data available and to identify whether any adjustments to quoted market prices are required. For ABSs including residential MBSs, the valuation uses an industry standard model and the assumptions relating to prepayment speeds, default rates and loss severity based on collateral type, and performance, as appropriate. The valuations output is benchmarked for consistency against observable data for securities of a similar nature.

Loans, including leveraged finance and loans held for securitisation

Loans held at fair value are valued from broker quotes and/or market data consensus providers when available. In the absence of an observable market, the fair value is determined using alternative valuation techniques. These techniques include discounted cash flow models, which incorporate assumptions regarding an appropriate credit spread for the loan, derived from other market instruments issued by the same or comparable entities.

Structured notes

The fair value of structured notes valued using a valuation technique with significant unobservable inputs is derived from the fair value of the underlying debt security, and the fair value of the embedded derivative is determined as described in the paragraph below on derivatives.

Level 3 structured notes principally comprise equity-linked notes which are issued by HSBC and provide the counterparty with a return that is linked to the performance of certain equity securities, and other portfolios. The notes are classified as Level 3 due to the unobservability of parameters such as long-dated equity volatilities and correlations between equity prices, between equity prices and interest rates and between interest rates and foreign exchange rates.

Derivatives

OTC (i.e. non-exchange traded) derivatives are valued using valuation models. Valuation models calculate the present value of expected future cash flows, based upon 'no-arbitrage' principles. For many vanilla derivative products, such as interest rate swaps and European options, the modelling approaches used are standard across the industry. For more complex derivative products, there may be some differences in market practice. Inputs to valuation models are determined from observable market data wherever possible, including prices available from exchanges, dealers, brokers or providers of consensus pricing. Certain inputs may not be observable in the market directly, but can be determined from observable prices via model calibration procedures or estimated from historical data or other sources. Examples of inputs that may be unobservable include volatility surfaces, in whole or in part, for less commonly traded option products, and correlations between market factors such as foreign exchange rates, interest rates and equity prices.

Derivative products valued using valuation techniques with significant unobservable inputs included certain types of correlation products, such as foreign exchange basket options, equity basket options, foreign exchange interest rate hybrid transactions and long-dated option transactions. Examples of the latter are equity options, interest rate and foreign exchange options and certain credit derivatives. Credit derivatives include certain tranched CDS transactions.

Reconciliation of fair value measurements in Level 3 of the fair value hierarchy

The following table provides a reconciliation of the movement between opening and closing balances of Level 3 financial instruments, measured at fair value using a valuation technique with significant unobservable inputs:

Movement in Level 3 financial instruments

	Assets					Liabilities
	Available for sale	Held for trading	Designated at fair value through profit or loss		Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m	US$m		US$m	US$m	US$m		US$m	US$m

At 1 January 2014	7,245	5,347		608	2,502	7,514		-	2,335
Total gains/(losses) recognised in profit or loss	174	194		56	959	(25)		-	(5)
- ... trading income excluding net interest income	-	194		-	959	(25)		-	(5)
- ....... net income/(expense) from other financial instruments designated at fair value	-	-		56	-	-		-	-
- ........... gains less losses from financial investments	198
- ............. loan impairment charges and other credit risk provisions	(24)

Total gains/(losses) recognised in other comprehensive income¹	126	(178)		(16)	(126)	(123)		-	54
- .......... available-for-sale investments: fair value gains/(losses)	208	-		-	-	-		-	-
- .............. cash flow hedges: fair value gains/(losses)	-	-		-	(9)	-		-	34
- ....................... exchange differences	(82)	(178)		(16)	(117)	(123)		-	20

Purchases	1,505	705		273	-	(31)		-	-
New issuances	-	-		-	-	2,067		-	-
Sales	(1,237)	(481)		(149)	-	-		-	-
Settlements	(1,255)	(49)		(78)	27	(1,655)		-	(69)
Transfers out	(3,027)	(112)		-	(544)	(1,918)		-	(527)
Transfers in	1,457	1,042		32	106	310		-	119

At 31 December 2014	4,988	6,468		726	2,924	6,139		-	1,907

	Assets						Liabilities
	Available for sale		Held for trading	Designated at fair value through profit or loss		Derivatives	Held for trading	Designated at fair value through profit or loss		Derivatives
	US$m		US$m		US$m	US$m	US$m		US$m	US$m
Unrealised gains/(losses) recognised in profit or loss relating to assets and liabilities held at 31 December 2014	(24)		1		46	946	(122)		-	134
- ........ trading income excluding net interest income	-		1		-	946	(122)		-	134
- .. net income/(expense) from other financial instruments designated at fair value	-		-		46	-	-		-	-
- loan impairment charges and other credit risk provisions	(24)	�	-		-	-	-		-	-

At 1 January 2013	8,511		4,378		413	3,059	7,470		-	3,005
Total gains/(losses) recognised in profit or loss	(52)		343		36	(205)	(747)		-	393
- ........... trading income/(expense) excluding net interest income	-		343		-	(205)	(747)		-	393
- .... net income from other financial instruments designated at fair value	-		-		36	-	-		-	-
- ..... gains less losses from financial investments	(66)		-		-	-	-		-	-
- ....... loan impairment charges and other credit risk provisions	14		-		-	-	-		-	-

Total gains/(losses) recognised in other comprehensive income¹	487		20		-	(7)	9		-	57
- .... available-for-sale investments: fair value gains	568		-		-	-	-		-	-
- cash flow hedges: fair value losses	-		-		-	(11)	-		-	-
- ................. exchange differences	(81)		20		-	4	9		-	57

Purchases	1,838		1,293		56	-	(482)		-	-
New issuances	-		-		-	-	3,161		-	-
Sales	(766)		(1,821)		(4)	-	(14)		-	-
Settlements	(756)		(473)		(27)	(311)	(1,150)		-	(1,004)
Transfers out	(3,121)		(385)		(68)	(171)	(1,051)		-	(160)
Transfers in	1,104		1,992		202	137	318		-	44

At 31 December 2013	7,245		5,347		608	2,502	7,514		-	2,335

Unrealised gains/(losses) recognised in profit or loss relating to assets and liabilities held at 31 December 2013	(166)		362		41	(297)	(401)		-	72
- ........ trading income excluding net interest income	-		362		-	(297)	(401)		-	72
- .... net income from other financial instruments designated at fair value	-		-		41	-	-		-	-
- ....... loan impairment charges and other credit risk provisions	(166)	�	-		-	-	-		-	-

1 Included in 'Available-for-sale investments: fair value gains/(losses)' and 'Exchange differences' in the consolidated statement of comprehensive income.

Purchases and sales of Level 3 available-for-sale assets predominantly reflect ABS activity, particularly in the securities investment conduits. Transfers out of Level 3 available-for-sale securities reflect increased confidence in the pricing of certain emerging markets corporate debt, in addition to improved price discovery of some ABSs. Transfers into Level 3 largely relate to other ABSs where price discovery has deteriorated. New issuances of trading liabilities reflect structured note issuances, mainly equity-linked notes. Transfers out of Level 3 trading liabilities principally relate to equity linked notes as certain model inputs became observable. Transfers into Level 3 trading assets primarily relate to loans in the process of syndication.

Effect of changes in significant unobservable assumptions to reasonably possible alternatives

The following table shows the sensitivity of Level 3 fair values to reasonably possible alternative assumptions:

Sensitivity of fair values to reasonably possible alternative assumptions

	Reflected in profit or loss		Reflected in other comprehensive income
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m

Derivatives, trading assets and trading liabilities¹	296	(276)	-	-
Financial assets and liabilities designated at fair value	37	(47)	-	-
Financial investments: available for sale	51	(67)	270	(350)

At 31 December 2014	384	(390)	270	(350)

Derivatives, trading assets and trading liabilities¹	350	(285)	-	-
Financial assets and liabilities designated at fair value	32	(51)	-	-
Financial investments: available for sale	-	-	434	(673)

At 31 December 2013	382	(336)	434	(673)

1 Derivatives, trading assets and trading liabilities are presented as one category to reflect the manner in which these financial instruments are risk-managed.

The reduction in the effect of both favourable and unfavourable changes in significant unobservable inputs in relation to derivatives, trading assets and trading liabilities predominantly reflects greater certainty in some emerging market foreign exchange volatility, as markets have developed. The reduction in the effect of both favourable and unfavourable changes in significant unobservable inputs in relation to available-for-sale assets during the period primarily reflects a decrease in the Level 3 balances.

Sensitivity of fair values to reasonably possible alternative assumptions by Level 3 instrument type

	Reflected in profit or loss		Reflected in other comprehensive income
	Favourable changes	Unfavourable changes	Favourable changes	Unfavourable changes
	US$m	US$m	US$m	US$m

Private equity including strategic investments	77	(110)	172	(255)
Asset-backed securities	49	(22)	60	(55)
Loans held for securitisation	1	(1)	-	-
Structured notes	14	(9)	-	-
Derivatives with monolines	11	(11)	-	-
Other derivatives	129	(155)	-	-
Other portfolios	103	(82)	38	(40)

At 31 December 2014	384	(390)	270	(350)

Private equity including strategic investments	31	(61)	226	(436)
Asset-backed securities	60	(27)	113	(99)
Loans held for securitisation	3	(3)	-	-
Structured notes	16	(9)	-	-
Derivatives with monolines	25	(16)	-	-
Other derivatives	212	(164)	-	-
Other portfolios	35	(56)	95	(138)

At 31 December 2013	382	(336)	434	(673)

Favourable and unfavourable changes are determined on the basis of sensitivity analysis. The sensitivity analysis aims to measure a range of fair values consistent with the application of a 95% confidence interval. Methodologies take account of the nature of the valuation technique employed, as well as the availability and reliability of observable proxy and historical data. When the available data is not amenable to statistical analysis, the quantification of uncertainty is judgemental, but remains guided by the 95% confidence interval.

When the fair value of a financial instrument is affected by more than one unobservable assumption, the above table reflects the most favourable or the most unfavourable change from varying the assumptions individually.

Key unobservable inputs to Level 3 financial instruments

The table below lists key unobservable inputs to Level 3 financial instruments, and provides the range of those inputs as at 31 December 2014. The core range of inputs is the estimated range within which 90% of the inputs fall. A further description of the categories of key unobservable inputs is given below.

Quantitative information about significant unobservable inputs in Level 3 valuations

	Fair value			Key unobservable
	Assets	Liabilities	Valuation technique	inputs	Full range of inputs		Core range of inputs
	US$m	US$m			Lower	Higher	Lower	Higher

Private equity including strategic investments	3,716	47	See notes on page 388	See notes on page 388	n/a	n/a	n/a	n/a

Asset-backed securities	2,078	-
- CLO/CDO¹	1,122	-	Model - Discounted cash flow	Prepayment rate	1%	6%	1%	6%
			Market proxy	Bid quotes	0	100	54	85
Other ABSs	956	-

Loans held for securitisation	39	-

Structured notes	2	6,092
- equity-linked notes	-	4,744	Model - Option model	Equity volatility	0.2%	65%	18%	38%
			Model - Option model	Equity correlation	27%	92%	44%	79%
- fund-linked notes	-	562	Model - Option model	Fund volatility	6%	8%	6%	8%
- FX-linked notes	2	477	Model - Option model	FX volatility	2%	70%	4%	16%
- other	-	309

Derivatives with monolines	239	1	Model - Discounted cash flow	Credit spread	3%	5%	4%	4%

Other derivatives	2,685	1,906
Interest rate derivatives:
- securitisation swaps	449	1,023	Model - Discounted cash flow	Prepayment rate	0%	50%	6%	18%
- long-dated swaptions	1,044	152	Model - Option model	IR volatility	2%	59%	16%	36%
- other	755	151

FX derivatives:
- FX options	89	95	Model - Option model	FX volatility	0.1%	70%	4%	14%
- other	7	7

Equity derivatives:
- long-dated single stock options	192	256	Model - Option model	Equity volatility	9%	65%	16%	40%
- other	34	162

Credit derivatives:
- other	115	60

Other portfolios	6,347	-
- structured certificates	4,420	-	Model - Discounted cash flow	Credit volatility	0.8%	3%	0.8%	3%
- EM corporate debt	372	-	Market proxy	Credit spread	1%	4%	1%	3%
			Market proxy	Bid quotes	58	131	106	130
- other²	1,555	-


At 31 December 2014	15,106	8,046

1 Collateralised loan obligation/collateralised debt obligation.

2 Includes a range of smaller asset holdings.

Private equity including strategic investments

Prepayment rates

Prepayment rates are a measure of the anticipated future speed at which a loan portfolio will be repaid in advance of the due date. Prepayment rates are an important input into modelled values of ABSs. A modelled price may be used where insufficient observable market prices exist to enable a market price to be determined directly. Prepayment rates are also an important input into the valuation of derivatives linked to securitisations. For example, so-called securitisation swaps have a notional value that is linked to the size of the outstanding loan portfolio in a securitisation, which may fall as prepayments occur. Prepayment rates vary according to the nature of the loan portfolio, and expectations of future market conditions. For example, current prepayment rates in US residential MBSs would generally be expected to rise as the US economy improves. Prepayment rates may be estimated using a variety of evidence, such as prepayment rates implied from proxy observable security prices, current or historical prepayment rates and macro-economic modelling.

Market proxy

Market proxy pricing may be used for an instrument for which specific market pricing is not available, but evidence is available in respect of instruments that have some characteristics in common. In some cases it might be possible to identify a specific proxy, but more generally evidence across a wider range of instruments will be used to understand the factors that influence current market pricing and the manner of that influence. For example, in the collateralised loan obligation market it may be possible to establish that A-rated securities exhibit prices in a range, and to isolate key factors that influence position within the range. Applying this to a specific A-rated security within HSBC's portfolio allows assignment of a price.

The range of prices used as inputs into a market proxy pricing methodology may therefore be wide. This range is not indicative of the uncertainty associated with the price derived for an individual security.

Volatility

Volatility is a measure of the anticipated future variability of a market price. Volatility tends to increase in stressed market conditions, and decrease in calmer market conditions. Volatility is an important input in the pricing of options. In general, the higher the volatility, the more expensive the option will be. This reflects both the higher probability of an increased return from the option and the potentially higher costs that HSBC may incur in hedging the risks associated with the option. If option prices become more expensive, this will increase the value of HSBC's long option positions (i.e. the positions in which HSBC has purchased options), while HSBC's short option positions (i.e. the positions in which HSBC has sold options) will suffer losses.

Volatility varies by underlying reference market price, and by strike and maturity of the option. Volatility also varies over time. As a result, it is difficult to make general statements regarding volatility levels. For example, while it is generally the case that foreign exchange volatilities are lower than equity volatilities, there may be examples in particular currency pairs or for particular equities where this is not the case.

Certain volatilities, typically those of a longer-dated nature, are unobservable. The unobservable volatility is then estimated from observable data. For example, longer-dated volatilities may be extrapolated from shorter-dated volatilities. The range of unobservable volatilities quoted in the table on page 387 reflects the wide variation in volatility inputs by reference market price. For example, foreign exchange volatilities for a pegged currency may be very low, whereas for non-managed currencies the foreign exchange volatility may be higher. As a further example, volatilities for deep-in-the-money or deep-out-of-the-money equity options may be significantly higher than at-the-money options. The core range is significantly narrower than the full range because these examples with extreme volatilities occur relatively rarely within the HSBC portfolio. For any single unobservable volatility, the uncertainty in the volatility determination is significantly less than the range quoted above.

Correlation

Correlation is a measure of the inter-relationship between two market prices and is expressed as a number between minus one and one. A positive correlation implies that the two market prices tend to move in the same direction, with a correlation of one implying that they always move in the same direction. A negative correlation implies that the two market prices tend to move in opposite directions, with a correlation of minus one implying that the two market prices always move in opposite directions. Correlation is used to value more complex instruments where the payout is dependent upon more than one market price. For example, an equity basket option has a payout that is dependent upon the performance of a basket of single stocks, and the correlation between the price movements of those stocks will be an input to the valuation. This is referred to as equity-equity correlation. There is a wide range of instruments for which correlation is an input, and consequently a wide range of both same-asset correlations (e.g. equity-equity correlation) and cross-asset correlations (e.g. foreign exchange rate-interest rate correlation) used. In general, the range of same-asset correlations will be narrower than the range of cross-asset correlations.

Correlation may be unobservable. Unobservable correlations may be estimated based upon a range of evidence, including consensus pricing services, HSBC trade prices, proxy correlations and examination of historical price relationships.

The range of unobservable correlations quoted in the table reflects the wide variation in correlation inputs by market price pair. For any single unobservable correlation, the uncertainty in the correlation determination is likely to be less than the range quoted above.

Credit spread

Credit spread is the premium over a benchmark interest rate required by the market to accept lower credit quality. In a discounted cash flow model, the credit spread increases the discount factors applied to future cash flows, thereby reducing the value of an asset. Credit spreads may be implied from market prices. Credit spreads may not be observable in more illiquid markets.

Inter-relationships between key unobservable inputs

Key unobservable inputs to Level 3 financial instruments may not be independent of each other. As described above, market variables may be correlated. This correlation typically reflects the manner in which different markets tend to react to macroeconomic or other events. For example, improving economic conditions may lead to a 'risk on' market, in which prices of risky assets such as equities and high yield bonds rise, while 'safe haven' assets such as gold and US Treasuries decline. Furthermore, the effect of changing market variables upon the HSBC portfolio will depend on HSBC's net risk position in respect of each variable. For example, increasing high-yield bond prices will benefit long high-yield bond positions, but the value of any credit derivative protection held against these bonds will fall.

HSBC Holdings

The following table provides an analysis of the basis for valuing financial assets and financial liabilities measured at fair value in the financial statements:

Basis of valuing HSBC Holdings' financial assets and liabilities measured at fair value

	2014	2013
	US$m	US$m
Valuation technique using observable inputs: Level 2
Assets at 31 December
Derivatives	2,771	2,789
Available for sale	4,073	1,210

Liabilities at 31 December
Designated at fair value	18,679	21,027
Derivatives	1,169	704

14 Fair values of financial instruments not carried at fair value

Fair values of financial instruments not carried at fair value and bases of valuation

		Fair value
			Valuation techniques
	Carrying amount	Quoted market price Level 1	Using observable inputs Level 2	With significant unobservable inputs Level 3	Total
	US$m	US$m	US$m	US$m	US$m
Assets and liabilities not held for sale at 31 December 2014
Assets
Loans and advances to banks¹	112,149	-	109,087	3,046	112,133
Loans and advances to customers¹	974,660	-	13,598	959,239	972,837
Reverse repurchase agreements - non-trading¹	161,713	-	160,600	1,123	161,723
Financial investments: debt securities	37,751	1,418	37,671	74	39,163

Liabilities
Deposits by banks¹	77,426	-	77,300	98	77,398
Customer accounts¹	1,350,642	-	1,336,865	13,730	1,350,595
Repurchase agreements - non-trading¹	107,432	-	107,432	-	107,432
Debt securities in issue	95,947	146	94,325	1,932	96,403
Subordinated liabilities	26,664	-	28,806	1,248	30,054

Assets and liabilities not held for sale at 31 December 2013
Assets
Loans and advances to banks¹	120,046	-	111,297	8,727	120,024
Loans and advances to customers¹	992,089	-	10,762	971,520	982,282
Reverse repurchase agreements - non-trading¹	179,690	-	178,516	1,166	179,682
Financial investments: debt securities	25,084	1,432	23,960	25	25,417

Liabilities
Deposits by banks¹	86,507	-	86,440	51	86,491
Customer accounts¹	1,361,297	-	1,346,343	14,576	1,360,919
Repurchase agreements - non-trading¹	164,220	-	164,173	47	164,220
Debt securities in issue	104,080	166	101,551	2,941	104,658
Subordinated liabilities	28,976	-	29,704	1,309	31,013

1 From 1 January 2014, non-trading reverse repos and repos are presented as separate lines in the balance sheet. Previously, non-trading reverse repos were included within 'Loans and advances to banks' and 'Loans and advances to customers' and non-trading repos were included within 'Deposits by banks' and 'Customer accounts'. Comparative data have been re-presented accordingly. Non-trading reverse repos and repos have been presented as separate lines in the balance sheet to align disclosure with market practice and provide more meaningful information in relation to loans and advances.

Fair values are determined according to the hierarchy set out in Note 13.

Other financial instruments not carried at fair value are typically short-term in nature and reprice to current market rates frequently. Accordingly, their carrying amount is a reasonable approximation of fair value. This includes cash and balances at central banks, items in the course of collection/transmission from/to other banks, Hong Kong Government certificates of indebtedness and Hong Kong currency notes in circulation, all of which are measured at amortised cost.

Carrying amount and fair value of loans and advances to customers by industry sector

	Carrying amount at 31 December
	Not impaired	Impaired	Total
	US$m	US$m	US$m
2014
Loans and advances to customers	954,710	19,950	974,660
- personal	377,154	11,800	388,954
- corporate and commercial	527,168	8,016	535,184
- financial	50,388	134	50,522

2013
Loans and advances to customers	967,181	24,908	992,089
- personal	390,018	14,108	404,126
- corporate and commercial	527,483	10,439	537,922
- financial	49,680	361	50,041

Loans and advances to customers are classified as not impaired or impaired in accordance with the criteria described on page 137.

	Fair value at 31 December
	Not impaired	Impaired	Total
	US$m	US$m	US$m
2014
Loans and advances to customers	954,347	18,490	972,837
- personal	375,615	10,721	386,336
- corporate and commercial	528,361	7,642	536,003
- financial	50,371	127	50,498

2013
Loans and advances to customers	957,695	24,587	982,282
- personal	379,353	13,774	393,127
- corporate and commercial	529,029	10,340	539,369
- financial	49,313	473	49,786

Analysis of loans and advances to customers by geographical segment

	2014		2013
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m
Loans and advances to customers
Europe	409,733	413,373	456,110	453,331
Asia	362,955	361,412	336,897	335,132
Middle East and North Africa	29,063	28,658	27,211	26,891
North America	129,787	126,232	127,953	122,823
Latin America	43,122	43,162	43,918	44,105

At 31 December	974,660	972,837	992,089	982,282

Valuation

The fair value measurement is HSBC's estimate of the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It does not reflect the economic benefits and costs that HSBC expects to flow from the instruments' cash flows over their expected future lives. Other reporting entities may use different valuation methodologies and assumptions in determining fair values for which no observable market prices are available.

Fair values of the following assets and liabilities are estimated for the purpose of disclosure as described below:

Loans and advances to banks and customers

The fair value of loans and advances is based on observable market transactions, where available. In the absence of observable market transactions, fair value is estimated using valuation models that incorporate a range of input assumptions. These assumptions may include value estimates from third-party brokers which reflect over-the-counter trading activity, forward looking discounted cash flow models using assumptions which HSBC believes are consistent with those which would be used by market participants in valuing such loans, and trading inputs from other market participants which include observed primary and secondary trades.

Loans are grouped, as far as possible, into homogeneous groups and stratified by loans with similar characteristics to improve the accuracy of estimated valuation outputs. The stratification of a loan book considers all material factors including vintage, origination period, estimates of future interest rates, prepayment speeds, delinquency rates, loan-to-value ratios, the quality of collateral, default probability, and internal credit risk ratings.

The fair value of a loan reflects both loan impairments at the balance sheet date and estimates of market participants' expectations of credit losses over the life of the loans, and the fair value effect of repricing between origination and the balance sheet date.

The fair value of loans and advances to customers in North America is lower than the carrying amount, primarily in the US, reflecting the market conditions at the balance sheet date. This is due to the challenging economic conditions during the past number of years, including house price depreciation, rising unemployment, changes in consumer behaviour, changes in discount rates and the lack of financing options available to support the purchase of loans and advances. The relative fair values have increased during 2014 largely due to improved conditions in the housing industry driven by increased property values and, to a lesser extent, lower required market yields and increased investor demand for these types of loans and advances.

The fair value of loans and advances to customers in Europe has improved relative to the carrying amount, primarily in the UK mortgage market where increased competition and central bank policies to stimulate lending have reduced interest rates and increased fair values accordingly.

Financial investments

The fair values of listed financial investments are determined using bid market prices. The fair values of unlisted financial investments are determined using valuation techniques that take into consideration the prices and future earnings streams of equivalent quoted securities.

Deposits by banks and customer accounts

Fair values are estimated using discounted cash flows, applying current rates offered for deposits of similar remaining maturities. The fair value of a deposit repayable on demand is approximated by its carrying value.

Debt securities in issue and subordinated liabilities

Fair values are determined using quoted market prices at the balance sheet date where available, or by reference to quoted market prices for similar instruments.

Repurchase and reverse repurchase agreements - non-trading

Fair values are estimated by using discounted cash flows, applying current rates. Fair values approximate carrying amounts as their balances are generally short dated.

HSBC Holdings

The methods used by HSBC Holdings to determine fair values of financial instruments for the purpose of measurement and disclosure are described above.

Fair values of HSBC Holdings' financial instruments not carried at fair value on the balance sheet

	2014		2013
	Carrying amount	Fair value¹	Carrying amount	Fair value¹
	US$m	US$m	US$m	US$m
Assets at 31 December
Loans and advances to HSBC undertakings	43,910	45,091	53,344	55,332

Liabilities at 31 December
Amounts owed to HSBC undertakings	2,892	2,906	11,685	11,868
Debt securities in issue	1,009	1,357	2,791	3,124
Subordinated liabilities	17,255	20,501	14,167	16,633

1 Fair values were determined using valuation techniques with observable inputs (Level 2).

15 Financial assets designated at fair value

Accounting policy

Financial instruments, other than those held for trading, are classified in this category if they meet one or more of the criteria set out below, and are so designated irrevocably at inception. HSBC may designate financial instruments at fair value when the designation:

· eliminates or significantly reduces measurement or recognition inconsistencies that would otherwise arise from measuring financial instruments, or recognising gains and losses on different bases from related positions. Under this criterion, the main class of financial assets designated by HSBC are financial assets under unit-linked insurance and unit-linked investment contracts. Liabilities to customers under linked contracts are determined based on the fair value of the assets held in the linked funds. If no fair value designation was made for the related assets, the assets would be classified as available for sale, with changes in fair value recorded in other comprehensive income. The related financial assets and liabilities are managed and reported to management on a fair value basis. Designation at fair value of the financial assets and related liabilities allows the changes in fair values to be recorded in the income statement and presented in the same line;

· applies to groups of financial instruments that are managed, and their performance evaluated, on a fair value basis in accordance with a documented risk management or investment strategy, and where information about the groups of financial instruments is reported to management on that basis. For example, certain financial assets are held to meet liabilities under non-linked insurance contracts. HSBC has documented risk management and investment strategies designed to manage and monitor market risk of those assets on net basis, after considering non-linked liabilities. Fair value measurement is also consistent with the regulatory reporting requirements under the appropriate regulations for those insurance operations;

· relates to financial instruments containing one or more non-closely related embedded derivatives.

Designated financial assets are recognised at fair value when HSBC enters into contracts with counterparties, which is generally on trade date, and are normally derecognised when sold. Subsequent changes in fair values are recognised in the income statement in 'Net income from financial instruments designated at fair value'.

	2014	2013
	US$m	US$m
Financial assets designated at fair value:
- not subject to repledge or resale by counterparties	28,357	38,062
- which may be repledged or resold by counterparties	680	368

At 31 December	29,037	38,430

Treasury and other eligible bills	56	50
Debt securities	8,891	12,589
Equity securities	20,006	25,711

Securities designated at fair value	28,953	38,350
Loans and advances to banks and customers	84	80

At 31 December	29,037	38,430

Securities designated at fair value¹

	2014	2013
	US$m	US$m

Fair value
US Treasury and US Government agencies²	8	34
UK Government	140	534
Hong Kong Government	40	113
Other government	4,088	4,097
Asset-backed securities³	18	140
Corporate debt and other securities	4,653	7,721
Equities	20,006	25,711

At 31 December	28,953	38,350

1 Included within these figures are debt securities issued by banks and other financial institutions of US$1,388m (2013: US$4,419m), of which US$24m (2013: US$92m) are guaranteed by various governments.

2 Include securities that are supported by an explicit guarantee issued by the US Government.

3 Exclude ABSs included under US Treasury and US Government agencies.

Securities listed on a recognised exchange and unlisted

	Treasury and other eligible bills	Debt securities	Equity securities	Total
	US$m	US$m	US$m	US$m
Fair value
Listed¹	5	2,731	13,837	16,573
Unlisted	51	6,160	6,169	12,380

At 31 December 2014	56	8,891	20,006	28,953

Fair value
Listed¹	−	2,773	18,235	21,008
Unlisted	50	9,816	7,476	17,342

At 31 December 2013	50	12,589	25,711	38,350

1 Included within listed investments are US$1,361m of investments listed on a recognised exchange in Hong Kong (2013: US$1,148m).

16 Derivatives

Accounting policy

Derivatives

Derivatives are financial instruments that derive their value from the price of underlying items such as equities, bonds, interest rates, foreign exchange, credit spreads, commodities and equity or other indices.

Derivatives are recognised initially, and are subsequently measured, at fair value. Fair values of derivatives are obtained either from quoted market prices or by using valuation techniques.

Embedded derivatives are bifurcated from the host contract when their economic characteristics and risks are not clearly and closely related to those of the host non-derivative contract, their contractual terms would otherwise meet the definition of a stand-alone derivative and the combined contract is not held for trading or designated at fair value. The bifurcated embedded derivatives are measured at fair value with changes therein recognised in the income statement.

Derivatives are classified as assets when their fair value is positive, or as liabilities when their fair value is negative.

Derivative assets and liabilities arising from different transactions are only offset for accounting purposes if the offsetting criteria presented in Note 32 are met.

Gains and losses from changes in the fair value of derivatives, including the contractual interest, that do not qualify for hedge accounting are reported in 'Net trading income'. Gains and losses for derivatives managed in conjunction with financial instruments designated at fair value are reported in 'Net income from financial instruments designated at fair value' together with the gains and losses on the economically hedged items. Where the derivatives are managed with debt securities issued by HSBC that are designated at fair value, the contractual interest is shown in 'Interest expense' together with the interest payable on the issued debt.

Hedge accounting

When derivatives are designated as hedges, HSBC classifies them as either: (i) hedges of the change in fair value of recognised assets or liabilities or firm commitments ('fair value hedges'); (ii) hedges of the variability in highly probable future cash flows attributable to a recognised asset or liability, or a forecast transaction ('cash flow hedges'); or (iii) a hedge of a net investment in a foreign operation ('net investment hedges').

At the inception of a hedging relationship, HSBC documents the relationship between the hedging instruments and the hedged items, its risk management objective and its strategy for undertaking the hedge. HSBC requires a documented assessment, both at hedge inception and on an ongoing basis, of whether or not the hedging instruments are highly effective in offsetting the changes attributable to the hedged risks in the fair values or cash flows of the hedged items.

Fair value hedge

Changes in the fair value of derivatives that are designated and qualify as fair value hedging instruments are recorded in the income statement, along with changes in the fair value of the hedged assets, liabilities or group that contain the hedged risk. If a hedging relationship no longer meets the criteria for hedge accounting, the hedge accounting is discontinued; the cumulative adjustment to the carrying amount of the hedged item is amortised to the income statement on a recalculated effective interest rate over the residual period to maturity, unless the hedged item has been derecognised, in which case it is recognised in the income statement immediately.

Cash flow hedge

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other comprehensive income; the ineffective portion of the change in fair value is recognised immediately in the income statement.

The accumulated gains and losses recognised in other comprehensive income are reclassified to the income statement in the periods in which the hedged item affects profit or loss. In hedges of forecasted transactions that result in recognition of a non-financial asset or liability, previous gains and losses recognised in other comprehensive income are included in the initial measurement of the asset or liability.

When a hedging relationship is discontinued, any cumulative gain or loss recognised in other comprehensive income remains in equity until the forecast transaction is recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss previously recognised in other comprehensive income is immediately reclassified to the income statement.

Net investment hedge

Hedges of net investments in foreign operations are accounted for in a similar way to cash flow hedges. A gain or loss on the effective portion of the hedging instrument is recognised in other comprehensive income; the residual change in fair value is recognised immediately in the income statement. Gains and losses previously recognised in other comprehensive income are reclassified to the income statement on the disposal, or part disposal, of the foreign operation.

Hedge effectiveness testing

To qualify for hedge accounting, HSBC requires that at the inception of the hedge and throughout its life each hedge must be expected to be highly effective, both prospectively and retrospectively, on an ongoing basis.

The documentation of each hedging relationship sets out how the effectiveness of the hedge is assessed and the method adopted by an entity to assess hedge effectiveness will depend on its risk management strategy. For prospective effectiveness, the hedging instrument must be expected to be highly effective in offsetting changes in fair value or cash flows attributable to the hedged risk during the period for which the hedge is designated, with the effectiveness range being defined as 80% to 125%. Hedge ineffectiveness is recognised in the income statement in 'Net trading income'.

Derivatives that do not qualify for hedge accounting

Non-qualifying hedges are derivatives entered into as economic hedges of assets and liabilities for which hedge accounting was not applied.

Fair values of derivatives by product contract type held by HSBC

	Assets			Liabilities
	Trading	Hedging	Total	Trading	Hedging	Total
	US$m	US$m	US$m	US$m	US$m	US$m

Foreign exchange	95,584	1,728	97,312	95,187	572	95,759
Interest rate	471,379	1,864	473,243	463,456	4,696	468,152
Equities	11,694	-	11,694	13,654	-	13,654
Credit	9,340	-	9,340	10,061	-	10,061
Commodity and other	3,884	-	3,884	3,508	-	3,508

Gross total fair values	591,881	3,592	595,473	585,866	5,268	591,134

Offset			(250,465)			(250,465)

At 31 December 2014			345,008			340,669

Foreign exchange	78,652	2,262	80,914	75,350	448	75,798
Interest rate	456,282	2,294	458,576	448,434	4,097	452,531
Equities	18,389	-	18,389	22,573	-	22,573
Credit	9,092	-	9,092	8,926	-	8,926
Commodity and other	2,624	-	2,624	1,786	-	1,786

Gross total fair values	565,039	4,556	569,595	557,069	4,545	561,614

Offset			(287,330)			(287,330)

At 31 December 2013			282,265			274,284

Derivative assets increased during 2014, driven by yield curve movements and increased market volatility in foreign exchange. The decline in equity derivative assets and liabilities reflects the inclusion of variation margin on cash-settled exchange-traded equity derivatives within gross fair value rather than 'offsetting'. This change has no impact upon total derivatives assets.

Fair values of derivatives by product contract type held by HSBC Holdings with subsidiaries

	Assets			Liabilities
	Trading	Hedging	Total	Trading	Hedging	Total
	US$m	US$m	US$m	US$m	US$m	US$m

Foreign exchange	680	-	680	1,066	103	1,169
Interest rate	1,607	484	2,091	-	-	-

At 31 December 2014	2,287	484	2,771	1,066	103	1,169

Foreign exchange	1,774	45	1,819	471	-	471
Interest rate	955	15	970	233	-	233

At 31 December 2013	2,729	60	2,789	704	-	704

Use of derivatives

HSBC transacts derivatives 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 HSBC's own risks.

HSBC's derivative activities give rise to significant open positions in portfolios of derivatives. These positions are managed constantly to ensure that they remain within acceptable risk levels. When entering into derivative transactions, HSBC employs the same credit risk management framework to assess and approve potential credit exposures that it uses for traditional lending.

Trading derivatives

Most of HSBC's derivative transactions relate to sales and trading activities. Sales activities include the structuring and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or expected risks. Trading activities include market-making and risk management. Market-making entails quoting bid and offer prices to other market participants for the purpose of generating revenues based on spread and volume. Risk management activity is undertaken to manage the risk arising from client transactions, with the principal purpose of retaining client margin.

Other derivatives classified as held for trading include non-qualifying hedging derivatives, ineffective hedging derivatives and the components of hedging derivatives that are excluded from assessing hedge effectiveness.

Substantially all of HSBC Holdings' derivatives entered into with HSBC undertakings are managed in conjunction with financial liabilities designated at fair value.

The notional contract amounts of derivatives held for trading purposes indicate the nominal value of transactions outstanding at the balance sheet date; they do not represent amounts at risk.

Notional contract amounts of derivatives held for trading purposes by product type

	HSBC		HSBC Holdings
	2014	2013	2014	2013
	US$m	US$m	US$m	US$m

Foreign exchange	5,548,075	5,264,978	15,595	17,280
Interest rate	22,047,278	27,056,367	8,650	10,304
Equities	568,932	589,903	-	-
Credit	550,197	678,256	-	-
Commodity and other	77,565	77,842	-	-

At 31 December	28,792,047	33,667,346	24,245	27,584

The decline in interest rate derivatives notionals during the year reflects participation in industry-wide 'portfolio compression' exercises.

Credit derivatives

HSBC trades credit derivatives through its principal dealing operations and acts as a principal counterparty to a broad range of users, structuring transactions to produce risk management products for its customers, or making markets in certain products. Risk is typically controlled through entering into offsetting credit derivative contracts with other counterparties.

HSBC manages the credit risk arising on buying and selling credit derivative protection by including the related credit exposures within its overall credit limit structure for the relevant counterparty. Trading of credit derivatives is restricted to a small number of offices within the major centres which have the control infrastructure and market skills to manage effectively the credit risk inherent in the products.

Credit derivatives are also deployed to a limited extent for the risk management of the Group's loan portfolios. The notional contract amount of credit derivatives of US$550bn (2013: US$678bn) consisted of protection bought of US$272bn (2013: US$339bn) and protection sold of US$278bn (2013: US$339bn). The credit derivative business operates within the market risk management framework described on page 222.

Derivatives valued using models with unobservable inputs

The difference between the fair value at initial recognition (the transaction price) and the value that would have been derived had valuation techniques used for subsequent measurement been applied at initial recognition, less subsequent releases, is as follows:

Unamortised balance of derivatives valued using models with significant unobservable inputs

	2014	2013
	US$m	US$m

Unamortised balance at 1 January	167	181
Deferral on new transactions	177	206
Recognised in the income statement during the period:	(234)	(221)
- amortisation	(114)	(105)
- subsequent to unobservable inputs becoming observable	(13)	(39)
- maturity, termination or offsetting derivative	(107)	(77)
- risk hedged	-	-

Exchange differences	4	1

Unamortised balance at 31 December¹	114	167

1 This amount is yet to be recognised in the consolidated income statement.

Hedge accounting derivatives

HSBC uses derivatives (principally interest rate swaps) for hedging purposes in the management of its own asset and liability portfolios and structural positions. This enables HSBC to optimise the overall cost to the Group of accessing debt capital markets, and to mitigate the market risk which would otherwise arise from structural imbalances in the maturity and other profiles of its assets and liabilities.

The notional contract amounts of derivatives held for hedge accounting purposes indicate the nominal value of transactions outstanding at the balance sheet date; they do not represent amounts at risk.

Notional contract amounts of derivatives held for hedge accounting purposes by product type

	HSBC				HSBC Holdings
	2014		2013		2014	2013
	Cash flow hedge	Fair value hedge	Cash flow hedge	Fair value hedge	Fair value hedge	Fair value hedge
	US$m	US$m	US$m	US$m	US$m	US$m

Foreign exchange	25,340	-	25,799	226	1,120	1,120
Interest rate	190,902	90,338	201,197	90,354	5,477	1,977

At 31 December	216,242	90,338	226,996	90,580	6,597	3,097

Fair value hedges

HSBC's fair value hedges principally consist of interest rate swaps that are used to protect against changes in the fair value of fixed-rate long-term financial instruments due to movements in market interest rates.

Fair value of derivatives designated as fair value hedges

	2014		2013
	Assets	Liabilities	Assets	Liabilities
	US$m	US$m	US$m	US$m
HSBC
Foreign exchange	-	-	5	-
Interest rate	387	4,012	1,163	2,889

At 31 December	387	4,012	1,168	2,889

HSBC Holdings
Foreign exchange	-	103	45	-
Interest rate	484	-	15	-

At 31 December	484	103	60	-

Gains or losses arising from fair value hedges

	2014	2013	2012
	US$m	US$m	US$m
HSBC
Gains/(losses):
... - on hedging instruments	(2,542)	1,997	(898)
... - on the hedged items attributable to the hedged risk	2,561	(1,932)	871

Year ended 31 December	19	65	(27)

HSBC Holdings
Gains/(losses):
... - on hedging instruments	423	14	-
... - on the hedged items attributable to the hedged risk	(422)	(21)	-

Year ended 31 December	1	(7)	-

The gains and losses on ineffective portions of fair value hedges are recognised immediately in 'Net trading income'.

Cash flow hedges

HSBC's cash flow hedges consist principally of interest rate swaps, futures and cross-currency swaps that are used to protect against exposures to variability in future interest cash flows on non-trading assets and liabilities which bear interest at variable rates or which are expected to be re-funded or reinvested in the future. The amounts and timing of future cash flows, representing both principal and interest flows, are projected for each portfolio of financial assets and liabilities on the basis of their contractual terms and other relevant factors, including estimates of prepayments and defaults. The aggregate principal balances and interest cash flows across all portfolios over time form the basis for identifying gains and losses on the effective portions of derivatives designated as cash flow hedges of forecast transactions.

Fair value of derivatives designated as cash flow hedges

	2014		2013
	Assets	Liabilities	Assets	Liabilities
	US$m	US$m	US$m	US$m

Foreign exchange	1,673	572	2,257	439
Interest rate	1,477	684	1,131	1,208

At 31 December	3,150	1,256	3,388	1,647

Forecast principal balances on which interest cash flows are expected to arise

	3 months or less	More than 3 months but less than 1 year	5 years or less but more than 1 year	More than 5 years
	US$m	US$m	US$m	US$m
Net cash inflows/(outflows) exposure
Assets	131,694	122,728	79,529	959
Liabilities	(60,814)	(46,582)	(36,371)	(8,169)

At 31 December 2014	70,880	76,146	43,158	(7,210)

Net cash inflows/(outflows) exposure
Assets	135,857	124,670	89,405	2,156
Liabilities	(60,402)	(46,990)	(38,406)	(10,221)

At 31 December 2013	75,455	77,680	50,999	(8,065)

This table reflects the interest rate repricing profile of the underlying hedged items.

The gains and losses on ineffective portions of derivatives designated as cash flow hedges are recognised immediately in 'Net trading income'. During the year to 31 December 2014 a gain of US$34m (2013: gain of US$22m; 2012: gain of US$35m) was recognised due to hedge ineffectiveness.

Hedges of net investments in foreign operations

The Group applies hedge accounting in respect of certain consolidated net investments. Hedging is undertaken using forward foreign exchange contracts or by financing with currency borrowings.

At 31 December 2014, the fair values of outstanding financial instruments designated as hedges of net investments in foreign operations were assets of US$55m (2013: US$4m), liabilities of US$1m (2013: US$23m) and notional contract values of US$3,525m (2013: US$2,840m).

Ineffectiveness recognised in 'Net trading income' in the year ended 31 December 2014 was nil (2013 and 2012: nil).

17 Non-trading reverse repurchase and repurchase agreements

Accounting policy

When securities are sold subject to a commitment to repurchase them at a predetermined price ('repos'), they remain on the balance sheet and a liability is recorded in respect of the consideration received. Securities purchased under commitments to resell ('reverse repos') are not recognised on the balance sheet and an asset is recorded in respect of the initial consideration paid.

Non trading repos and reverse repos are measured at amortised cost. The difference between the sale and repurchase price or between the purchase and resale price is treated as interest and recognised in net interest income over the life of the agreement.

Non-trading repos and reverse repos are presented as separate lines in the balance sheet. This separate presentation was adopted with effect from 1 January 2014 and comparatives are re‑presented accordingly. Previously, non-trading reverse repos were included within 'Loans and advances to banks' and 'Loans and advances to customers' and non-trading repos were included within 'Deposits by banks' and 'Customer accounts'.

The extent to which non-trading reverse repos and repos represent amounts with customers and banks is set out below.

	2014	2013
	US$m	US$m
Assets
Banks	95,403	91,475
Customers	66,310	88,215

At 31 December	161,713	179,690

Liabilities
Banks	27,876	42,705
Customers	79,556	121,515

At 31 December	107,432	164,220

18 Financial investments

Accounting policy

Treasury bills, debt securities and equity securities intended to be held on a continuing basis, other than those designated at fair value, are classified as available for sale or held to maturity. They are recognised on trade date when HSBC enters into contractual arrangements to purchase those instruments, and are normally derecognised when either the securities are sold or redeemed.

(i) Available-for-sale financial assets are initially measured at fair value plus direct and incremental transaction costs. They are subsequently remeasured at fair value, and changes therein are recognised in other comprehensive income until they are either sold or become impaired. When available-for-sale financial assets are sold, cumulative gains or losses previously recognised in other comprehensive income are recognised in the income statement as 'Gains less losses from financial investments'.

Interest income is recognised over a debt security's expected life. Premiums and/or discounts arising on the purchase of dated debt securities are included in the interest recognised. Dividends from equity assets are recognised in the income statement when the right to receive payment is established.

(ii) Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that HSBC positively intends and is able to hold to maturity. Held-to-maturity investments are initially recorded at fair value plus any directly attributable transaction costs, and are subsequently measured at amortised cost, less any impairment losses.

The accounting policy relating to impairments of available-for-sale securities is presented in Note 1(k).

Available-for-sale financial assets are reclassified to held to maturity if there is a change in intention or ability to hold those assets to maturity due to a change in the way those assets are managed. The fair value on reclassification becomes the new amortised cost and the assets are subsequently carried at amortised cost rather than fair value.

Financial investments

	2014	2013
	US$m	US$m
Financial investments:
- . not subject to repledge or resale by counterparties	380,419	394,207
- . which may be repledged or resold by counterparties	35,048	31,718

At 31 December	415,467	425,925

Carrying amount and fair value of financial investments

	2014		2013
	Carrying amount	Fair value	Carrying amount	Fair value
	US$m	US$m	US$m	US$m

Treasury and other eligible bills	81,517	81,517	78,111	78,111
-.. available for sale	81,517	81,517	78,111	78,111

Debt securities¹	323,256	324,668	338,674	339,007
-.. available for sale	285,505	285,505	313,590	313,590
-.. held to maturity	37,751	39,163	25,084	25,417

Equity securities	10,694	10,694	9,140	9,140
-.. available for sale	10,694	10,694	9,140	9,140


At 31 December	415,467	416,879	425,925	426,258

1 During the year US$11,043m of available-for-sale debt securities were reclassified to held-to-maturity debt securities.

Financial investments at amortised cost and fair value

	Amortised cost¹	Fair value²
	US$m	US$m

US Treasury	33,931	34,745
US Government agencies³	18,326	18,516
US Government sponsored entities³	9,339	9,761
UK Government	28,680	29,758
Hong Kong Government	43,573	43,574
Other government	159,846	163,401
Asset-backed securities⁴	20,911	19,177
Corporate debt and other securities	84,387	87,252
Equities	7,421	10,694

At 31 December 2014	406,414	416,878

US Treasury	50,369	50,421
US Government agencies³	19,211	18,771
US Government sponsored entities³	5,263	5,445
UK Government	23,565	23,580
Hong Kong Government	49,570	49,579
Other government	153,619	156,208
Asset-backed securities⁴	25,961	24,115
Corporate debt and other securities	87,469	88,999
Equities	8,081	9,140

At 31 December 2013	423,108	426,258

US Treasury	60,657	61,925
US Government agencies³	22,579	23,500
US Government sponsored entities³	5,262	5,907
UK Government	17,018	17,940
Hong Kong Government	42,687	42,711
Other government	146,507	149,179
Asset-backed securities⁴	29,960	26,418
Corporate debt and other securities	86,099	89,777
Equities	4,284	5,789

At 31 December 2012	415,053	423,146

1 Represents the amortised cost or cost basis of the financial investment.

2 Included within these figures are debt securities issued by banks and other financial institutions of US$53,877m (2013: US$55,303m; 2012: US$59,908m), of which US$8,812m (2013: US$8,946m; 2012: US$6,916m) are guaranteed by various governments. The fair value of the debt securities issued by banks and other financial institutions was US$54,375m (2013: US$55,467m; 2012: US$60,616m).

3 Include securities that are supported by an explicit guarantee issued by the US Government.

4 Excludes ABSs included under US Government agencies and sponsored entities.

Financial investments listed on a recognised exchange and unlisted

	Treasury and other eligible bills available for sale	Debt securities available for sale	Debt securities held to maturity	Equity securities available for sale	Total
	US$m	US$m	US$m	US$m	US$m
Carrying amount
Listed¹	4,101	168,879	6,037	5,928	184,945
Unlisted²	77,416	116,626	31,714	4,766	230,522

At 31 December 2014	81,517	285,505	37,751	10,694	415,467

Carrying amount
Listed¹	1,404	134,473	6,176	3,950	146,003
Unlisted²	76,707	179,117	18,908	5,190	279,922

At 31 December 2013	78,111	313,590	25,084	9,140	425,925

1 The fair value of listed held-to-maturity debt securities as at 31 December 2014 was US$6,459m (2013: US$6,281m). Included within listed investments were US$3,752m (2013: US$2,832m) of investments listed on a recognised exchange in Hong Kong.

2 Unlisted treasury and other eligible bills available for sale primarily comprise treasury bills not listed on an exchange but for which there is a liquid market.

Maturities of investments in debt securities at their carrying amount

	1 year or less	5 years or less but over 1 year	10 years or less but over 5 years	Over 10 years	Total
	US$m	US$m	US$m	US$m	US$m

Available for sale	68,344	134,815	44,938	37,408	285,505
Held to maturity	1,396	9,622	7,087	19,646	37,751

At 31 December 2014	69,740	144,437	52,025	57,054	323,256

Available for sale	78,222	146,200	44,556	44,612	313,590
Held to maturity	2,993	8,380	6,442	7,269	25,084

At 31 December 2013	81,215	154,580	50,998	51,881	338,674

Contractual maturities and weighted average yields of investment debt securities

	Within one year		After one year but within five years		After five years but within ten years		After ten years
	Amount	Yield	Amount	Yield	Amount	Yield	Amount	Yield
	US$m	%	US$m	%	US$m	%	US$m	%
Available for sale
US Treasury	4,136	0.8	20,273	1.0	3,961	2.5	1,490	4.1
US Government agencies	-	-	9	4.2	44	3.9	9,704	2.6
US Government-sponsored agencies	-	-	1,939	3.2	1,393	3.3	1,138	3.3
UK Government	281	2.2	12,389	1.0	12,541	1.7	-	-
Hong Kong Government	350	0.4	953	1.0	-	-	-	-
Other governments	46,946	2.2	65,497	2.7	12,806	2.9	2,864	2.4
Asset-backed securities	688	1.3	1,172	1.4	4,003	1.4	15,036	1.1
Corporate debt and other securities	16,392	2.3	30,687	2.1	7,048	2.7	6,459	3.3

Total amortised cost at 31 December 2014	68,793		132,919		41,796		36,691

Total carrying value	68,344		134,815		44,938		37,408

Held to maturity
US Treasury	-	-	75	4.8	44	4.8	115	4.2
US Government agencies	-	-	1	7.6	50	2.6	8,506	2.4
US Government-sponsored agencies	-	-	92	1.4	406	2.9	4,370	3.1
Hong Kong Government	1	0.5	37	1.3	20	1.8	2	1.2
Other governments	95	4.1	278	4.8	202	5.2	722	4.9
Asset-backed securities	-	-	-	-	-	-	11	6.4
Corporate debt and other securities	1,300	3.5	9,139	3.6	6,365	4.0	5,920	4.1

Total amortised cost at 31 December 2014	1,396		9,622		7,087		19,646

Total carrying value	1,396		9,622		7,087		19,646

The maturity distributions of ABSs are presented in the above table on the basis of contractual maturity dates. The weighted average yield for each range of maturities is calculated by dividing the annualised interest income for the year ended 31 December 2014 by the book amount of available-for-sale debt securities at that date. The yields do not include the effect of related derivatives.

19 Assets charged as security for liabilities, assets transferred and collateral accepted as security for assets

Financial assets pledged to secure liabilities

	2014	2013
	US$m	US$m

Treasury bills and other eligible securities	5,170	6,387
Loans and advances to banks	17,294	17,733
Loans and advances to customers	77,960	87,894
Debt securities	138,991	190,095
Equity shares	11,373	8,816
Other	6,079	1,035

Assets pledged at 31 December	256,867	311,960

The table above shows assets where a charge has been granted to secure liabilities on a legal and contractual basis. The amount of such assets may be greater than the book value of assets utilised as collateral for funding purposes or to cover liabilities. This is the case for securitisations and covered bonds where the amount of liabilities issued, plus any mandatory over-collateralisation, is less than the book value of financial assets available for funding or collateral purposes in the relevant pool of assets. This is also the case where financial assets are placed with a custodian or settlement agent which has a floating charge over all the financial assets placed to secure any liabilities under settlement accounts.

These transactions are conducted under terms that are usual and customary to collateralised transactions including, where relevant, standard securities lending and repurchase agreements.

Assets transferred

Accounting policy

Derecognition of financial assets

Financial assets are derecognised when the contractual rights to receive cash flows from the assets has expired; or when HSBC has transferred its contractual right to receive the cash flows of the financial assets, and either:

· substantially all the risks and rewards of ownership have been transferred; or

· HSBC has neither retained nor transferred substantially all the risks and rewards, but has not retained control.

HSBC enters into transactions in the normal course of business by which it transfers financial assets to third parties. Depending on the circumstances, these transfers may either result in these financial assets being derecognised or continuing to be recognised.

The financial assets shown above include amounts transferred to third parties that do not qualify for derecognition, notably debt securities held by counterparties as collateral under repurchase agreements and equity securities lent under securities lending agreements. As the substance of these transactions is secured borrowings, the asset collateral continues to be recognised in full and the related liability reflecting the Group's obligation to repurchase the transferred assets for a fixed price at a future date is recognised on the balance sheet. As a result of these transactions, the Group is unable to use, sell or pledge the transferred assets for the duration of the transaction. The Group remains exposed to interest rate risk and credit risk on these pledged instruments. The counterparty's recourse is not limited to the transferred assets.

Transferred financial assets not qualifying for full derecognition and associated financial liabilities

	Carrying amount of assets before transfer	Carrying amount of transferred assets	Carrying amount of associated liabilities	Fair value of transferred assets	Fair value of associated liabilities	Net position
	US$m	US$m	US$m	US$m	US$m	US$m
At 31 December 2014
Repurchase agreements		78,541	79,141
Securities lending agreements		13,177	10,643
Other sales (recourse to transferred asset only)		3,775	4,049	4,007	4,018	(11)
Securitisations recognised to the extent of continuing involvement	17,427	11	5	11	5	6

At 31 December 2013
Repurchase agreements		125,508	126,175
Securities lending agreements		9,175	8,884
Other sales (recourse to transferred asset only)		6,707	7,019	6,827	6,707	120
Securitisations recognised to the extent of continuing involvement	17,427	16	8	16	8	8

Collateral accepted as security for assets

The fair value of assets accepted as collateral in relation to reverse repo and securities borrowing that HSBC is permitted to sell or repledge in the absence of default is US$269,019m (2013: US$259,617m). The fair value of any such collateral that has been sold or repledged was US$163,342m (2013: US$186,013m). HSBC is obliged to return equivalent securities.

These transactions are conducted under terms that are usual and customary to standard securities borrowing and reverse repurchase agreements.

20 Interests in associates and joint ventures

Accounting policy

Investments in which HSBC, together with one or more parties, has joint control of an arrangement set up to undertake an economic activity are classified as joint ventures. HSBC classifies investments in entities over which it has significant influence, and that are neither subsidiaries (Note 22) nor joint ventures, as associates.

Investments in associates and interests in joint ventures are recognised using the equity method. Under this method, such investments are initially stated at cost, including attributable goodwill, and are adjusted thereafter for the post-acquisition change in HSBC's share of net assets. Goodwill arises on the acquisition of interests in joint ventures and associates when the cost of investment exceeds HSBC's share of the net fair value of the associate's or joint venture's identifiable assets and liabilities.

An investment in an associate is tested for impairment when there is an indication that the investment may be impaired. Goodwill on acquisitions of interests in joint ventures and associates is not tested separately for impairment.

Profits on transactions between HSBC and its associates and joint ventures are eliminated to the extent of HSBC's interest in the respective associates or joint ventures. Losses are also eliminated to the extent of HSBC's interest in the associates or joint ventures unless the transaction provides evidence of an impairment of the asset transferred.

Critical accounting estimates and judgements

Impairment of interests in associates

Impairment testing involves significant judgement in determining the value in use, and in particular estimating the present values of cash flows expected to arise from continuing to hold the investment.

The most significant judgements relate to the impairment testing of our investment in Bank of Communications ('BoCom'). Key assumptions used in estimating BoCom's value in use, the sensitivity of the value in use calculation to different assumptions and a sensitivity analysis that shows the changes in key assumptions that would reduce the excess of value in use over the carrying amount (the 'headroom') to nil are described in the Note below.

Associates

At 31 December 2014, the carrying amount of HSBC's interests in associates was US$17,940m (2013: US$16,417m).

Principal associates of HSBC

	2014		2013
	Carrying amount	Fair value¹	Carrying amount	Fair value¹
	US$m	US$m	US$m	US$m
Listed
Bank of Communications Co., Limited	14,590	13,140	13,412	9,954
The Saudi British Bank	2,811	6,220	2,437	4,693

At 31 December	17,401	19,360	15,849	14,647

1 Principal associates are listed on recognised stock exchanges. The fair values are based on the quoted market prices of the shares held (Level 1 in the fair value hierarchy).

	At 31 December 2014
	Country of incorporation and principal place of business	Principal activity	HSBC's interest in equity capital	Issued equity capital

Bank of Communications Co., Limited	PRC¹	Banking services	19.03%	RMB74,263m
The Saudi British Bank	Saudi Arabia	Banking services	40.00%	SR10,000m

1 People's Republic of China.

Details of all HSBC associates and joint ventures, as required under Section 409 of the Companies Act 2006, will be annexed to the next Annual Return of HSBC Holdings filed with the UK Registrar of Companies.

HSBC had US$14,590m (2013: US$13,412m) of interests in associates listed in Hong Kong.

Bank of Communications Co., Limited ('BoCom')

HSBC's investment in BoCom was equity accounted with effect from August 2004. HSBC's significant influence in BoCom was established as a result of representation on the Board of Directors and, in accordance with the Technical Cooperation and Exchange Programme, HSBC is assisting in the maintenance of financial and operating policies and a number of staff has been seconded to assist in this process.

Impairment testing

At 31 December 2014, the fair value of HSBC's investment in BoCom had been below the carrying amount for approximately 32 months, apart from a short period in 2013. As a result, we performed an impairment test on the carrying amount of the investment in BoCom. The test confirmed that there was no impairment at 31 December 2014. The recoverable amount was US$15.7bn (2013: US$14.0bn), an excess over carrying amount ('headroom') of US$1.1bn at 31 December 2014 (2013: US$0.6bn). The increase in headroom is due to the improved capital position of BoCom.

At 31 December 2014

At 31 December 2013

VIU

Carrying value

Fair
value

VIU

Carrying value

Fair
value

US$bn

Bank of Communications Co., Limited

15.7

14.6

13.1

14.0

13.4

10.0

Basis of recoverable amount

The impairment test was performed by comparing the recoverable amount of BoCom, determined by a value in use ('VIU') calculation, with its carrying amount. The VIU calculation uses discounted cash flow projections based on management's estimates of earnings. Cash flows beyond the short- to medium-term are then extrapolated in perpetuity using a long-term growth rate. An imputed capital maintenance charge ('CMC') is included to meet the expected regulatory capital requirements, and calculated as a deduction from forecast cash flows. The principal inputs to the CMC calculation include estimates of asset growth, the ratio of risk-weighted assets to total assets, and the expected regulatory capital requirements. Management judgement is required in estimating the future cash flows of BoCom.

Key assumptions in VIU calculation

Long-term growth rate: the growth rate used was 5% (2013: 5%) for periods after 2018 and does not exceed forecast GDP growth in China.

Discount rate: the discount rate of 13% (2013: 13%) is derived from a range of values obtained by applying a Capital Asset Pricing Model ('CAPM') calculation for BoCom, using market data. Management supplements this by comparing the rates derived from the CAPM with discount rates available from external sources, and HSBC's discount rate for evaluating investments in China. The discount rate used was within the range of 11.4% to 14.2% (2013: 10.5% to 15.0%) indicated by the CAPM and external sources.

Loan impairment charge as a percentage of customer advances: the ratio used ranges from 0.73% to 1% (2013: 0.64% to 1%) in the short- to medium-term. The long-term ratio was assumed to revert to a historical rate of 0.65% (2013: 0.64%). The rates were within the short- to medium-term range forecasts of 0.51% to 1.08% (2013: 0.55% to 1.20%) disclosed by external analysts.

Risk-weighted assets as a percentage of total assets: the ratio used ranges from 70% to 72% in the short- to medium-term. The long-term ratio reverts to a rate of 70% (2013: 68.7%).

Cost-income ratio: the ratio used ranges from 40.0% to 42.4% (2013: 39.7% to 43.2%) in the short- to medium-term. The ratios were within the short- to medium-term range forecasts of 37.2% to 44.5% (2013: 38.0% to 44.2%) disclosed by external analysts.

Sensitivity analyses were performed on each key assumption to ascertain the impact of reasonably possible changes in assumptions. The following change to each key assumption used on its own in the VIU calculation would reduce the headroom to nil.

Key assumption

Changes to key assumption to reduce headroom to nil

· Long-term growth rate

· Discount rate

· Loan impairment charge as a percentage of customer advances

· Risk-weighted assets as a percentage of total assets

· Cost-income ratio

· Decrease by 43 basis points

· Increase by 53 basis points

· Increase by 8 basis points

· Increase by 3.3%

· Increase by 1.6%

The following table illustrates the effect on VIU of reasonably possible changes to key assumptions. This reflects the sensitivity of VIU to each key assumption on its own and it is possible that more than one favourable and/or unfavourable change will occur at the same time.

	Favourable change		Current model	Unfavourable change
	US$bn	US$bn	US$bn	US$bn	US$bn
At 31 December 2014
Carrying amount: US$14.6bn
Long-term growth rate	+50bp	+100bp	5%	-50bp	-100bp
VIU	17.0	18.6	15.7	14.5	13.4
Increase/(decrease) in VIU	1.3	2.9		(1.2)	(2.3)

Discount rate	-50bp	-100bp	13%	+50bp	+100bp
VIU	16.8	18.1	15.7	14.7	13.9
Increase/(decrease) in VIU	1.1	2.4		(1.0)	(1.8)

Loan impairment charge as a percentage of customer advances	0.65% throughout		2014-18: 0.73% - 1% 2019 onwards: 0.65%	1% from 2014-18 2019 onwards: 0.65%
Loan impairment charge as a percentage of customer advances	0.65% throughout		2014-18: 0.73% - 1% 2019 onwards: 0.65%	1% from 2014-18 2019 onwards: 0.65%
VIU	16.2		15.7	14.9
Increase/(decrease) in VIU	0.5			(0.8)

Risk-weighted assets as a percentage of total assets	-100bp	-200bp	2014-18: 70% - 72% 2019 onwards: 70.0%	+100bp	+200bp
VIU	16.0	16.3	15.7	15.4	15.1
Increase/(decrease) in VIU	0.3	0.6		(0.3)	(0.6)

Cost income ratio	-50bp	-100bp	2014-18: 40.0% - 42.4% 2019 onwards: 42.4%	+50bp	+100bp
VIU	16.0	16.3	15.7	15.4	15.1
Increase/(decrease) in VIU	0.3	0.6		(0.3)	(0.6)

At 31 December 2013
Carrying amount: US$13.4bn
Long-term growth rate	+50bp	+100bp	5%	-50bp	-100bp
VIU	15.4	16.9	14.0	12.9	11.8
Increase/(decrease) in VIU	1.4	2.9		(1.1)	(2.2)

Discount rate	-50bp	-100bp	13%	+50bp	+100bp
VIU	15.6	17.3	14.0	12.7	11.6
Increase/(decrease) in VIU	1.6	3.3		(1.3)	(2.4)

Loan impairment charge as a percentage of customer advances	0.64% throughout		2013-18: 0.64% - 1.00% 2019 onwards: 0.64%	1% from 2014-18
Loan impairment charge as a percentage of customer advances	0.64% throughout		2013-18: 0.64% - 1.00% 2019 onwards: 0.64%	1% from 2014-18
VIU	14.8		14.0	13.5
Increase/(decrease) in VIU	0.8			(0.5)

Risk-weighted assets as a percentage of total assets	-100bp	-200bp	68.7% throughout	+100bp	+200bp
VIU	14.4	14.7	14.0	13.7	13.4
Increase/(decrease) in VIU	0.4	0.7		(0.3)	(0.6)

Cost income ratio	-50bp	-100bp	2013-18: 39.7% - 43.2% 2019 onwards: 43.2%	+50bp	+100bp
VIU	14.3	14.7	14.0	13.7	13.4
Increase/(decrease) in VIU	0.3	0.7		(0.3)	(0.6)

Selected financial information of BoCom

The statutory accounting reference date of BoCom is 31 December. For the year ended 31 December 2014, HSBC included the associate's results on the basis of financial statements made up for the 12 months to 30 September 2014, taking into account changes in the subsequent period from 1 October 2014 to 31 December 2014 that would have materially affected the results.

	At 30 September
	2014	2013
	US$m	US$m
Selected balance sheet information of BoCom
Cash and balances at central banks	150,306	142,209
Loans and advances to banks and other financial institutions	79,960	88,049
Loans and advances to customers	547,706	516,161
Other financial assets	178,883	165,521
Other assets	45,140	34,392

Total assets	1,001,995	946,332

Deposits by banks and other financial institutions	209,935	170,916
Customer accounts	663,745	667,588
Other financial liabilities	28,860	20,564
Other liabilities	25,361	19,655

Total liabilities	927,901	878,723

Total equity	74,094	67,609

	At 30 September
	2014	2013
	US$m	US$m
Reconciliation of BoCom's total shareholders' equity to the carrying amount in HSBC's consolidated financial statements as at 31 December
HSBC's share of total shareholders' equity	14,040	12,810
Add: Goodwill and other intangible assets	550	602

Carrying amount	14,590	13,412

	For the 12 months ended 30 September
	2014	2013
	US$m	US$m
Selected income statement information of BoCom
Net interest income	22,030	20,768
Net fee and commission income	4,792	4,010
Loan impairment charges	(3,509)	(2,811)
Depreciation and amortisation	(920)	(809)
Tax expense	(3,102)	(2,823)
Profit for the year	10,626	10,099
Other comprehensive income	217	(375)
Total comprehensive income	10,843	9,724
Dividends received from BoCom	597	549

Summarised aggregate financial information in respect of all associates excluding BoCom

	2014	2013
	US$m	US$m

Carrying amount	3,350	3,005

HSBC's share of:
- total assets	20,099	21,007
- total liabilities	16,837	18,056
- revenues	801	927
- profit or loss from continuing operations	519	408
- other comprehensive income	2	9
- total comprehensive income	521	417

Joint ventures

At 31 December 2014, the carrying amount of HSBC's interests in joint ventures was US$241m (2013: US$223m).

Associates and joint ventures

For the year ended 31 December 2014, HSBC's share of associates and joint ventures' tax on profit was US$600m (2013: US$556m), which is included within 'Share of profit in associates and joint ventures' in the income statement.

Movements in interests in associates and joint ventures

	2014	2013
	US$m	US$m

At 1 January	16,640	17,834
Additions	30	26
Disposals	(133)	(3,148)
Share of results	2,532	2,325
Dividends	(757)	(694)
Exchange differences	(212)	396
Share of other comprehensive income/(expense) of associates and joint ventures	78	(35)
Other movements	3	(64)

At 31 December¹	18,181	16,640

1 Includes goodwill of US$621m (2013: US$608m).

21 Goodwill and intangible assets

	2014	2013
	US$m	US$m

Goodwill	19,169	21,179
Present value of in-force long-term insurance business	5,307	5,335
Other intangible assets	3,101	3,404

At 31 December	27,577	29,918

Goodwill

Accounting policy

Goodwill arises on the acquisition of subsidiaries, when the aggregate of the fair value of the consideration transferred, the amount of any non-controlling interest and the fair value of any previously held equity interest in the acquiree exceed the amount of the identifiable assets and liabilities acquired. If the amount of the identifiable assets and liabilities acquired is greater, the difference is recognised immediately in the income statement.

Goodwill is allocated to cash-generating units ('CGU's) for the purpose of impairment testing, which is undertaken at the lowest level at which goodwill is monitored for internal management purposes. HSBC's CGU's are based on geographical regions subdivided by global business. Impairment testing is performed at least annually, or whenever there is an indication of impairment, by comparing the recoverable amount of a CGU with its carrying amount. The carrying amount of a CGU is based on its assets and liabilities, including attributable goodwill. The recoverable amount of a CGU is the higher of its fair value less cost to sell and its value in use. VIU is the present value of the expected future CGU cash flows. If the recoverable amount is less than the carrying value, an impairment loss is charged to the income statement. Goodwill is carried on balance sheet at cost less accumulated impairment losses.

At the date of disposal of a business, attributable goodwill is included in HSBC's share of net assets in the calculation of the gain or loss on disposal.

Goodwill is included in a disposal group if the disposal group is a CGU to which goodwill has been allocated or it is an operation within such a CGU. The amount of goodwill included in a disposal group is measured on the basis of the relative values of the operation disposed of and the portion of the CGU retained.

Critical accounting estimates and judgements

Goodwill impairment

The review of goodwill for impairment reflects management's best estimate of the future cash flows of the CGUs and the rates used to discount these cash flows, both of which are subject to uncertain factors as follows:

· the future cash flows of the CGUs are sensitive to the cash flows projected for the periods for which detailed forecasts are available and to assumptions regarding the long-term pattern of sustainable cash flows thereafter. Forecasts are compared with actual performance and verifiable economic data, but they reflect management's view of future business prospects at the time of the assessment; and

· the rates used to discount future expected cash flows can have a significant effect on their valuation and are based on the costs of capital assigned to individual CGUs. The cost of capital percentage is generally derived from a Capital Asset Pricing Model, which incorporates inputs reflecting a number of financial and economic variables, including the risk-free interest rate in the country concerned and a premium for the risk of the business being evaluated. These variables are subject to fluctuations in external market rates and economic conditions beyond management's control, are subject to uncertainty and require the exercise of significant judgement.

A decline in a CGU's expected cash flows and/or an increase in its cost of capital reduces the CGU's estimated recoverable amount. If this is lower than the carrying value of the CGU, a charge for impairment of goodwill is recognised in our income statement for the year.

The accuracy of forecast cash flows is subject to a high degree of uncertainty in volatile market conditions. In such market conditions, management retests goodwill for impairment more frequently than annually to ensure that the assumptions on which the cash flow forecasts are based continue to reflect current market conditions and management's best estimate of future business prospects.

During 2014, no impairment of goodwill was identified (2013: nil). In addition to the annual impairment test which was performed as at 1 July 2014, management reviewed the current and expected performance of the CGUs as at 31 December 2014 and determined that there was no indication of impairment of the goodwill allocated to them.

Reconciliation of goodwill

	Europe	Asia	MENA	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m
Gross amount
At 1 January 2014	14,977	1,016	55	7,861	3,241	27,150
Disposals	(168)	−	−	−	−	(168)
Exchange differences	(1,594)	(30)	(1)	1	(240)	(1,864)
Reclassified to held for sale	(8)	−	−	−	24	16
Other	−	23	−	(47)	(18)	(42)

At 31 December 2014	13,207	1,009	54	7,815	3,007	25,092

Accumulated impairment losses
At 1 January 2014	−	−	−	(5,971)	−	(5,971)
Exchange differences	−	−	−	1	−	1
Other	−	−	−	47	−	47

At 31 December 2014	−	−	−	(5,923)	−	(5,923)

Net carrying amount at 31 December 2014	13,207	1,009	54	1,892	3,007	19,169

Gross amount
At 1 January 2013	14,660	1,134	60	8,339	3,646	27,839
Disposals	-	-	-	-	(1)	(1)
Exchange differences	596	(129)	(5)	(2)	(132)	328
Reclassified to held for sale¹	(611)	-	-	-	(272)	(883)
Reinstated from held for sale	332	-	-	-	-	332
Other	-	11	-	(476)	-	(465)

At 31 December 2013	14,977	1,016	55	7,861	3,241	27,150

Accumulated impairment losses
At 1 January 2013	-	-	-	(6,449)	-	(6,449)
Exchange differences	-	-	-	2	-	2
Other	-	-	-	476	-	476

At 31 December 2013	-	-	-	(5,971)	-	(5,971)

Net carrying amount at 31 December 2013	14,977	1,016	55	1,890	3,241	21,179

1 During 2013, goodwill in Europe amounting to US$611m was reclassified to assets held for sale following the decision to sell the private banking operations of HSBC Private Bank Holdings (Suisse) S.A. in Monaco. On transfer to held for sale, a write down of the disposal group by US$279m was recorded and allocated to goodwill. Following the later decision to retain the operations, the reclassification of the assets and liabilities out of held for sale resulted in the reinstatement of the remaining goodwill.

Impairment testing

Timing of impairment testing

HSBC's impairment test in respect of goodwill allocated to each 'CGU' is performed as at 1 July each year.

Basis of the recoverable amount

The recoverable amount of all CGUs to which goodwill has been allocated was equal to its VIU at each respective testing date for 2013 and 2014.

For each significant CGU, the VIU is calculated by discounting management's cash flow projections for the CGU. The discount rate used is based on the cost of capital HSBC allocates to investments in the countries within which the CGU operates. The long-term growth rate is used to extrapolate the cash flows in perpetuity because of the long-term perspective within the Group of the business units making up the CGUs. For the goodwill impairment test conducted at 1 July 2014, management's cash flow projections until the end of 2018 were used.

Key assumptions in VIU calculation

			Nominal
	Goodwill at 1 July	Discount rate	growth rate beyond initial cash flow projections
	US$m	%		%
Cash-generating unit
Retail Banking and Wealth Management - Europe	4,298	9.1		4.5
Commercial Banking - Europe	3,214	10.1		4.2
Global Private Banking - Europe	3,808	7.1		3.4
Global Banking and Markets - Europe	3,296	11.0		4.2
Retail Banking and Wealth Management - Latin America	1,762	12.8		7.9

2014	16,378

Cash-generating unit
Retail Banking and Wealth Management - Europe	4,135	8.0		3.9
Commercial Banking - Europe	3,062	10.0		3.8
Global Private Banking - Europe	3,607	7.3		3.0
Global Banking and Markets - Europe	3,101	9.9		3.7
Retail Banking and Wealth Management - Latin America	1,812	11.2		8.6

2013	15,717

At 1 July 2014, aggregate goodwill of US$4,526m (1 July 2013: US$4,550m) had been allocated to CGUs that were not considered individually significant. The Group's CGUs do not carry on their balance sheets any significant intangible assets with indefinite useful lives, other than goodwill.

Nominal long-term growth rate: this growth rate reflects GDP and inflation for the countries within which the CGU operates. The rates are based on IMF forecast growth rates as these rates are regarded as the most relevant estimate of likely future trends. The rates used for 2013 and 2014 do not exceed the long-term growth rate for the countries within which the CGU operates.

Discount rate: the discount rate used to discount the cash flows is based on the cost of capital assigned to each CGU, which is derived using a CAPM. The CAPM depends on inputs reflecting a number of financial and economic variables including the risk-free rate and a premium to reflect the inherent risk of the business being evaluated. These variables are based on the market's assessment of the economic variables and management's judgement. For the 1 July 2014 test, the methodology used to determine the discount rate for each CGU was refined to more accurately reflect the rates of inflation for the countries within which the CGU operates. In addition, for the purposes of testing goodwill for impairment, management supplements this process by comparing the discount rates derived using the internally generated CAPM with cost of capital rates produced by external sources. HSBC uses externally-sourced cost of capital rates where, in management's judgement, those rates reflect more accurately the current market and economic conditions. For 2013 and 2014, internal costs of capital rates were consistent with externally-sourced rates.

Management's judgement in estimating the cash flows of a CGU: the cash flow projections for each CGU are based on plans approved by the GMB. The key assumptions in addition to the discount rate and nominal long-term growth rate for each significant CGU are discussed below.

Global Private Banking - Europe: the cash flow forecast for GPB - Europe primarily reflects the repositioning of the business that is underway to concentrate on clients aligned with the Group's priorities. Revenues in GPB - Europe are predominately generated through HSBC's client relationships and the key assumption in the cash flow forecast is the level of assets under management and profitability therein following the strategic repositioning. The cash flow forecast includes increased profitability in GPB - Europe which is dependent on management achieving the planned strategic repositioning, in the context of the external environment.

At 1 July 2014, GPB - Europe had an excess of recoverable amount over carrying amount ('headroom') of US$1.8bn.

The following changes to the key assumptions in the value in use calculation would be necessary in order to reduce headroom to nil:

Key assumption Change to key assumption to reduce headroom to nil

Discount rate Increase by 90 basis points

Long-term growth rate Decrease by 102 basis points

Cash flow projection Decrease by 19.7%

	Favourable change	Current model	Unfavourable change
	US$bn	US$bn	US$bn
At 1 July 2014
Carrying amount of CGU: US$7.3bn

Excess of recoverable amount over carrying amount: $1.8bn
Long-term growth rate	+100bp	3.4%	-100bp
VIU	12.2	9.1	7.4
Increase/(decrease) in VIU	3.1		(1.7)

Discount rate	-100bp	7.1%	+100bp
VIU	12.5	9.1	7.2
Increase/(decrease) in VIU	3.4		(1.9)

Forecast cash flow	+20%	378	-20%
VIU	10.9	9.1	7.3
Increase/(decrease) in VIU	1.8		(1.8)

Retail Banking and Wealth Management - Europe and Commercial Banking - Europe: the assumptions included in the cash flow projections for RBWM - Europe and CMB - Europe reflect the economic environment and financial outlook of the European countries within these two CGUs. Key assumptions include the level of interest rates, nominal GDP growth, competitors' positions within the market and the level and change in unemployment rates. While current economic conditions in Europe continue to be challenging, management's cash flow projections are based primarily on these prevailing conditions. Risks include slower than expected growth and an uncertain regulatory environment. RBWM - Europe is sensitive to further customer remediation and regulatory actions. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions described above would not cause an impairment to be recognised in respect of RBWM - Europe or CMB - Europe.

Global Banking and Markets - Europe: the key assumption included in the cash flow projection for GB&M - Europe is that European markets will continue to recover. Accordingly, recovery in European revenues is assumed to continue over the projection period to 2018. Interest rate fluctuations would put further pressure on European markets revenue recovery. Our ability to achieve the forecast cash flows for GB&M - Europe could be adversely impacted by regulatory change during the forecast period including but not limited to the extent that the recommendations set out in the final report by the Independent Commission on Banking are implemented. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions described above would not cause an impairment to be recognised in respect of GB&M - Europe.

Retail Banking and Wealth Management - Latin America: the assumptions included in the cash flow projections for RBWM - Latin America reflect the economic environment and financial outlook of the countries within this CGU, with Brazil and Mexico being the two largest. Key assumptions include growth in lending and deposit volumes and the credit quality of the loan portfolios. Potential challenges include unfavourable economic conditions restricting client demand and competitor pricing constraining margins. Based on the conditions at the balance sheet date, management determined that a reasonably possible change in any of the key assumptions described above would not cause an impairment to be recognised in respect of RBWM - Latin America.

Intangible assets

Accounting policy

Intangible assets are recognised, and those that are acquired in a business combination are distinguished from goodwill, when they are separable or arise from contractual or other legal rights, and their fair value can be measured reliably.

Intangible assets include the present value of in-force long-term insurance business and long-term investment contracts with discretionary participating features ('PVIF'), computer software, trade names, mortgage servicing rights, customer lists, core deposit relationships, credit card customer relationships and merchant or other loan relationships. Computer software includes both purchased and internally generated software. The cost of internally generated software comprises all directly attributable costs necessary to create, produce and prepare the software to be capable of operating in the manner intended by management. Costs incurred in the ongoing maintenance of software are expensed immediately as incurred.

Intangible assets are subject to impairment review if there are events or changes in circumstances that indicate that the carrying amount may not be recoverable. Where:

· intangible assets have an indefinite useful life, or are not yet ready for use, they are tested for impairment annually. An intangible asset recognised during the current period is tested before the end of the current year; and where

· intangible assets have a finite useful life, except for PVIF, they are stated at cost less amortisation and accumulated impairment losses and are amortised over their estimated useful lives. Estimated useful life is the lower of legal duration and expected useful life. The amortisation of mortgage servicing rights is included within 'Net fee income'.

Intangible assets with finite useful lives are amortised, generally on a straight-line basis, over their useful lives as follows:
Trade names	10 years
Mortgage servicing rights	generally between 5 and 12 years
Internally generated software	between 3 and 5 years
Purchased software	between 3 and 5 years
Customer/merchant relationships	generally between 3 and 10 years
Other	generally 10 years

Present value of in-force long-term insurance business

The value placed on insurance contracts that are classified as long-term insurance business or long-term investment contracts with discretionary participating features ('DPF') and are in force at the balance sheet date is recognised as an asset. The asset represents the present value of the equity holders' interest in the issuing insurance companies' profits expected to emerge from these contracts written at the balance sheet date. The PVIF is determined by discounting the equity holders' interest in future profits expected to emerge from business currently in force using appropriate assumptions in assessing factors such as future mortality, lapse rates and levels of expenses, and a risk discount rate that reflects the risk premium attributable to the respective contracts. The PVIF incorporates allowances for both non-market risk and the value of financial options and guarantees. The PVIF asset is presented gross of attributable tax in the balance sheet and movements in the PVIF asset are included in 'Other operating income' on a gross of tax basis.

Present value of in-force long-term insurance business

Our life insurance business is accounted for using the embedded value approach which, inter alia, provides a risk and valuation framework. The PVIF asset at 31 December 2014 was US$5.3bn (2013: US$5.3bn).

Movements in PVIF

	2014	2013
	US$m	US$m

PVIF at 1 January	5,335	4,847

Value of new business written during the year¹	870	924
Movements arising from in-force business:
- expected return	(545)	(505)
- experience variances²	62	(20)
- changes in operating assumptions	(69)	186
Investment return variances	(34)	42
Changes in investment assumptions	(75)	(120)
Other adjustments	52	18

Change in PVIF of long-term insurance business	261	525

Transfer of assets classified as held for sale³	(122)	-
Exchange differences and other	(167)	(37)

PVIF at 31 December	5,307	5,335

1 Value of new business written during the year is the present value of the projected stream of profits from the business.

2 Experience variances include the effect of the difference between demographic, expense and persistency assumptions used in the previous PVIF calculation and actual experience observed during the year to the extent this affects profits on future business.

3 Relates to the UK Pensions business which was classified as held for sale in the first half of the year. See page 191 for further details.

In the PVIF calculation, expected cash flows are projected after adjusting for a variety of assumptions made by each insurance operation to reflect local market conditions and management's judgement of future trends, and after applying risk margins to reflect any uncertainty in the underlying assumptions. The main assumptions relate to economic and non-economic assumptions and policyholder behaviour. Variations in actual experience and changes to assumptions can contribute to volatility in the results of the insurance business.

The key drivers of the movement in the value of the PVIF asset are the expected cash flows from:

· new business adjusted for anticipated maturities and assumptions relating to policyholder behaviour ('value of new business written during the year');

· unwind of the discount rate less the reversal of expected cash flows for the period ('expected return');

· changes in non-economic operating assumptions such as mortality or lapse rates ('change in operating assumptions');

· the effects of changes in projected future cash flows associated with operating assumption experience variances compared with those assumed at the start of the period ('experience variances');

· changes related to future investment returns ('changes in investment assumptions'); and

· the effect of actual investment experience on existing assets compared with the assumptions at the start of the period ('investment return variances').

The valuation of the PVIF asset includes explicit risk margins for non-economic risks in the projection assumptions and explicit allowances for financial options and guarantees using stochastic methods. Risk discount rates are set on an active basis with reference to market risk-free yields.

Key assumptions used in the computation of PVIF for main life insurance operations

Economic assumptions are either set in a way that is consistent with observable market values or, in certain markets (including those where the risk free curve is not observable at tenors matching the duration of our insurance contract liabilities) we make use of long-term economic assumptions. Setting such assumptions involves the projection of long-term interest rates and the time horizon over which rates in less developed markets will tend towards the norms observed in mature markets. The assumptions are informed by relevant historical data and by research and analysis performed by the Group's Economic Research team and external experts. The valuation of PVIF will be sensitive to any changes in these long-term assumptions in the same way that it is sensitive to observed market movements, and the impact of such changes is included in the sensitivities presented below.

	2014			2013
	UK	Hong Kong	France¹	UK	Hong Kong	France¹
	%	%	%	%	%	%

Weighted average risk free rate	1.65	1.86	1.21	2.45	2.31	2.38
Weighted average risk discount rate	2.15	7.42	1.73	2.95	7.41	4.69
Expense inflation	4.67	3.00	2.00	3.39	3.00	2.00

1 For 2014, the calculation of France's PVIF assumes a risk discount rate of 1.73% plus a risk margin of US$ 63m. For 2013, a composite rate of 4.69% was used. This was equivalent to a rate of 3.08% plus a risk margin of US$64m.

Sensitivity to changes in economic assumptions

The Group sets the risk discount rate applied to the PVIF calculation by starting from a risk-free rate curve and adding explicit allowances for risks not reflected in the best estimate cash flow modelling. Where shareholders provide options and guarantees to policyholders the cost of these options and guarantees is an explicit reduction to PVIF, unless it is already allowed for as an explicit addition to the technical provisions required by regulators. See page 195 for further details of these guarantees.

The following table shows the effect on the PVIF of reasonably possible changes in the main economic assumption, risk‑free rates, across all insurance manufacturing subsidiaries. Due to certain characteristics of the contracts, the relationships are non-linear and the results of the sensitivity testing should not be extrapolated to higher levels of stress. The sensitivities shown are before actions that could be taken by management to mitigate effects and before resultant changes in policyholder behaviour. The sensitivities have increased from 2013 to 2014, driven mainly by falling yields and a flattening of the yield curve in France during 2014. In the low yield environment the PVIF asset is particularly sensitive to yield curve movements driven by the projected cost of options and guarantees described on page 195.

	2014	2013
	US$m	US$m
Effect on PVIF at 31 December of:
+ 100 basis point shift in risk-free rate	320	184
- 100 basis point shift in risk-free rate¹	(589)	(289)

1 Where a -100 basis point parallel shift in the risk-free rate would result in a negative rate, the effect on PVIF has been calculated using a minimum rate of 0%.

Sensitivity to changes in non-economic assumptions

Policyholder liabilities and PVIF for life manufacturers are determined by reference to non-economic assumptions including mortality and/or morbidity, lapse rates and expense rates. The table below shows the sensitivity of PVIF to reasonably possible changes in these non-economic assumptions at that date across all our insurance manufacturing subsidiaries.

	2014	2013
	US$m	US$m
Effect on PVIF at 31 December of:
10% increase in mortality and/or morbidity rates	(66)	(84)
10% decrease in mortality and/or morbidity rates	70	84
10% increase in lapse rates	(146)	(154)
10% decrease in lapse rates	165	173
10% increase in expense rates	(93)	(109)
10% decrease in expense rates	94	110

Other intangible assets

Movement of intangible assets excluding goodwill and the PVIF

		Internally generated software		Other		Total
		US$m		US$m		US$m
Cost
At 1 January 2014		5,999		2,975		8,974
Additions		732		177		909
Disposals		(35)		(80)		(115)
Amount written off		(24)		(53)		(77)
Other changes		(259)		(156)		(415)
				163
At 31 December 2014		6,413		2,863		9,276
				−
Accumulated amortisation
At 1 January 2014		(3,809)		(1,761)		(5,570)
Charge for the year¹		(677)		(261)		(938)
Impairment		(11)		(54)		(65)
Disposals		32		77		109
Amount written off		24		53		77
Other changes		155		57		212
				−
At 31 December 2014		(4,286)		(1,889)		(6,175)
				−
Net carrying amount at 31 December 2014		2,127		974		3,101

Cost
At 1 January 2013	5,703		3,345		9,048
Additions	731		142		873
Disposals	(117)		(196)		(313)
Amount written off	(57)		(47)		(104)
Other changes	(261)		(269)		(530)

At 31 December 2013	5,999		2,975		8,974

Accumulated amortisation
At 1 January 2013	(3,469)		(1,963)		(5,432)
Charge for the year¹	(675)		(179)		(854)
Impairment	(39)		(4)		(43)
Disposals	111		167		278
Amount written off	57		47		104
Other changes	206		171		377

At 31 December 2013	(3,809)		(1,761)		(5,570)

Net carrying amount at 31 December 2013	2,190		1,214		3,404

1 The amortisation charge for the year is recognised within the income statement under 'Amortisation and impairment of intangible assets', with the exception of the amortisation of mortgage servicing rights which is recognised in 'Net fee income'. The revaluation net of amortisation charge for mortgage servicing rights was US$67m in 2014 (2013: credit of US$34m).

22 Investments in subsidiaries

Accounting policy

HSBC classifies investments in entities which it controls as subsidiaries. HSBC consolidation policy is described in Note 1(h). Subsidiaries which are structured entities are covered in Note 39.

HSBC Holdings' investments in subsidiaries are stated at cost less impairment losses. Impairment losses recognised in prior periods are reversed through the income statement if there has been a change in the estimates used to determine the investment's recoverable amount since the last impairment loss was recognised.

This information is provided by RNS

The company news service from the London Stock Exchange

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