HSBC Annual Report 2016 | Quarterlytics

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HSBC Holdings plc Annual Report and Accounts 2016 Connecting customers to opportunities Our purpose is to be where the growth is, enabling businesses to thrive and economies to prosper, and ultimately helping people to fulfil their hopes and realise their ambitions. As a reminder Reporting currency We use US dollars. Adjusted measures We supplement our IFRS figures with adjusted measures used by management internally. These measures are highlighted with the following symbol: Further explanation may be found on page 30. Unless stated otherwise, risk-weighted assets and capital are calculated and presented on a transitional CRD IV basis as implemented by the Prudential Regulation Authority. Our photo competition winners In 2016, we ran a Group- wide photo competition which attracted over 6,200 submissions from 1,100 employees. The joint overall winning photos are featured in this report. The image on the inside front cover shows a rice farmer at harvest time in north-east Vietnam, and the photo on the inside back cover was taken at sunrise at Situ (Lake) Patenggang, West Java, Indonesia. Cover image The Hong Kong-Zhuhai-Macau Bridge is one of the most ambitious infrastructure projects in the Pearl River Delta. It will link three key cities, cutting transport costs and travelling times, and boosting economic development. HSBC has extended a HK$700m receivables finance facility to one of the companies building the bridge. Receivables finance is an area where HSBC has particular expertise, and this facility is the largest it has provided for infrastructure in the region. Contents Strategic Report An overview of how we are structured, what we do and where, our strategic actions, the principal risks we face, and high-level performance information. The section is introduced by both the Group Chairman and the Group Chief Executive, and also explains the role of the Board. This Strategic Report was approved by the Board on 21 February 2017. Highlights Group Chairman’s Statement Group Chief Executive’s Review 2 4 7 10 Our strategy 12 Strategic actions 14 Financial overview 18 Global businesses 20 Regions 22 How we do business 25 Tax 26 Risk overview 28 Remuneration Douglas Flint, Group Chairman Financial Review Detailed reporting of our financial performance, at Group level as well as within our matrix structure. It also includes our full risk report and reporting on how we manage capital. 30 Financial summary 44 Global businesses and geographical regions 64 Risk 127 Capital Corporate Governance Details of our Board of Directors and senior management, and our approach to corporate governance and remuneration. 132 Corporate Governance Report 133 Biographies of Directors and senior management 138 Board of Directors 140 Board committees 145 Internal control 146 Going concern and viability 147 Share capital and other disclosures 150 Employees 153 Directors’ Remuneration Report 173 Directors’ Responsibility Statement Financial Statements Our financial statements and related notes and reports. 174 Report of the Independent Auditors 183 Financial Statements 194 Notes on the Financial Statements 274 Shareholder information 279 Forward-looking statements and Certain defined terms 280 Abbreviations Other Information Important information for our shareholders, including contact information. Like any industry and company, we have our set of abbreviations and terminology. Accordingly, we provide an explanation of the abbreviations used. A glossary of key terms is available online at www.hsbc.com/investor-relations. 1 Strategic ReportFinancial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Highlights We are one of the most international banking and financial services organisations in the world. For year ended 31 Dec 2016 Reported proﬁt before tax ($bn) Adjusted proﬁt before tax ($bn) Reported revenue ($bn) 2016 2015 2014 (2015: $18.9bn) $7.1bn At 31 Dec 2016 Risk-weighted assets ($bn) 2016 2015 2014 (2015: $1,103bn) $857bn 7.1 18.9 18.7 2016 2015 2014 19.3 19.5 21.6 2016 2015 2014 (2015: $19.5bn) $19.3bn (2015: $59.8bn) $48.0bn Common equity tier 1 ratio (%) Total assets ($bn) 857 1,103 1,220 2016 2015 2014 (2015: 11.9%) 13.6% 13.6 11.9 10.9 2016 2015 2014 (2015: $2,410bn) $2,375bn 48.0 59.8 61.2 2,375 2,410 2,634 Our operating model consists of four global businesses, a Corporate Centre and five geographical regions, supported by 11 global functions. During the year, we changed our reportable segments from regions to global businesses. We also moved certain business portfolios and functions into the newly created Corporate Centre. For further details, see page 19. Performance highlights for 2016 Strategy execution – Following our sale of operations in Brazil, we completed a $2.5bn share buy-back. – We further reduced our risk-weighted assets (‘RWAs’) as a result of our sale of operations in Brazil and other management actions. – Investment in costs to achieve of $4.0bn to date has generated annual run rate savings of $3.7bn. – We now expect to deliver annualised cost savings of around $6bn by the end of 2017, around $1bn above the top end of our original target, while continuing to invest in regulatory programmes and compliance. We will invest an equivalent total of around $6bn over the same timeframe. – We increased market share in a number of key markets and international product areas, including trade finance in Hong Kong and Singapore. Financial performance – Reported profit before tax of $7.1bn was $11.8bn lower than in 2015, and was adversely impacted by significant items of $12.2bn. These included a $3.2bn write- off of goodwill in our Global Private Banking (‘GPB’) business in Europe, costs to achieve of $3.1bn, adverse fair value movements of $1.8bn arising from changes in credit spreads on our own debt designated at fair value, and the impact of our sale of operations in Brazil. – Reported revenue of $48.0bn was down $11.8bn. Loan impairment charges and other credit risk provisions (‘LICs’) fell by $0.3bn and reported operating expenses rose by $40m. – Adjusted profit before tax of $19.3bn, down $0.2bn, reflected lower revenue and higher LICs, partly offset by a reduction in operating expenses. In 2016, we achieved positive adjusted jaws of 1.2%. – Adjusted revenue fell by $1.3bn or 2% despite improved performance in Commercial Banking (‘CMB’) and Global Banking and Markets (‘GB&M’). Retail Banking and Wealth Management (‘RBWM’) and GPB were impacted by challenging market conditions. – Adjusted operating expenses fell by $1.2bn or 4%, reflecting our cost-saving initiatives and focus on cost management. We continued to invest in regulatory programmes and compliance. Capital – Our capital position further strengthened during the year, with a common equity tier 1 (‘CET1’) ratio at 31 December 2016 of 13.6%, up from 11.9% at 31 December 2015, mainly due to RWA reduction initiatives and the change in the regulatory treatment of our holding in Bank of Communications Co., Limited (‘BoCom’). 2 GroupStrategic ReportHSBC Holdings plc Annual Report and Accounts 20160.8% Return on equity 1.2% Adjusted jaws (see page 17) $0.51 Dividends per ordinary share in respect of 2016 t r o p e R c g e t a r t S i Retail Banking and Wealth Management (‘RBWM’) Commercial Banking (‘CMB’) Global Banking and Markets (‘GB&M’) Global Private Banking (‘GPB’) We help millions of people across the world to manage their finances, buy their homes, and save and invest for the future. Our Insurance and Asset Management businesses support all our global businesses in meeting their customers’ needs. We support approximately two million business customers in 54 countries with banking products and services to help them operate and grow. Our customers range from small enterprises focused primarily on their domestic markets, through to large companies operating globally. We provide financial services and products to companies, governments and institutions. Our comprehensive range of products and solutions, across capital financing, advisory and transaction banking services, can be combined and customised to meet clients’ specific objectives. Adjusted profit before tax We help high net worth individuals and their families to grow, manage and preserve their wealth. $5.3bn $6.1bn $5.6bn $0.3bn Risk-weighted assets $115.1bn $275.9bn $300.4bn $15.3bn Reported proﬁt/(loss) before tax ($bn) Adjusted proﬁt before tax ($bn) Risk-weighted assets* ($bn) Europe Asia Middle East and North Africa North America Latin America (6.8) 13.8 1.5 0.2 (1.6) 1.6 14.2 1.6 1.3 0.6 1 2 3 4 5 * RWAs are non-additive across geographical regions due to market risk diversification effects within the Group. 298.4 334.0 59.1 150.7 34.3 3 Our global businessesGeographical regionsKey highlightsFinancial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Strategic Report Group Chairman’s Statement The Group has improved its productivity, embraced technological change and continues to reinforce its standards of business conduct. It has a strong capital position and is gaining market share in important areas. The Group’s reported profit before tax amounted to $7.1bn, some 62% lower than the prior year. This decline principally reflected the impact of significant items, most of which had no impact on capital, even though they were material in accounting terms. On the adjusted basis used to measure management and business performance, profit before tax was $19.3bn, broadly in line with the $19.5bn achieved in the prior year. This outcome was largely driven by improved cost performance as prior year initiatives gained traction and substantially offset lower revenues, while loan impairment charges were marginally higher. Earnings per share of $0.07 compared with $0.65 in 2015. The Group’s core capital position improved materially. A change to the regulatory treatment of our associate in mainland China, continued run-off of legacy assets, planned reduction in certain segments of our trading books and inadequately remunerated assets, together with capital released from business disposals, notably our operations in Brazil, drove this improvement. This created the capacity to return $2.5bn of capital by way of a share buy-back, which was completed in December. We met our objective of maintaining the annual dividend in respect of the year at $0.51, as indicated at the interim stage. This was delivered through the declaration today of a fourth interim dividend of $0.21. Reflecting on the strength of the Group’s capital position, the Board also approved a further share buy-back of up to $1bn, which is expected to commence shortly. Strategic actions are now bearing fruit In reviewing performance in 2016, the Board noted with approval the traction now evidenced from management actions to reshape the Group and address the challenges brought about by the continuing low interest rate environment. Greater focus on the trade and investment corridors where HSBC has strong market positioning generated solid market share gains and broader product penetration, particularly in servicing outbound China investment flows. This is recognised in the leading industry awards highlighted in Stuart Gulliver’s review. Douglas Flint Group Chairman 2016 will be long remembered for its significant and largely unexpected economic and political events. These foreshadowed changes to the established geopolitical and economic relationships that have defined interactions within developed economies and between them and the rest of the world. The uncertainties created by such changes temporarily influenced investment activity and contributed to volatile financial market conditions. Against this background, HSBC’s performance in 2016 was broadly satisfactory. Encouragingly, operating performance in the second half of the year was much stronger than expected and compared with the prior year, as businesses and financial markets responded more optimistically than predicted to these events. ‘Greater focus on the trade and investment corridors where HSBC has strong market positioning generated solid market share gains and broader product penetration’ 4 HSBC Holdings plc Annual Report and Accounts 2016Group Chairman’s Statement t r o p e R c g e t a r t S i Significant investment in technology and process redesign is now not only delivering greater cost efficiency but also is poised to markedly enhance our ability to detect and prevent financial crime. In addition, 2017 will see the progressive launch of applications that will materially improve our customers’ digital experience, enhance their online security and bring greater personalisation of product offerings. While there is still a long way to go, it was encouraging to see the significant improvement in performance across all business units in Mexico following the substantial repositioning of the Group’s operations there. This contributed to the Group’s success in replacing substantially all of the revenues given up through continuing run-off of legacy portfolios, risk mitigation in areas exposed to higher threat of financial crime and reduction in trading books. Furthermore, HSBC is safer today from the threat of financial crime because of the investments we have been making in our Global Standards programme. The Board remains fully committed to our work in this area in 2017 and beyond. Regulatory matters It was extremely disappointing that the regulatory community was unable to achieve its targeted completion of the Basel III framework in January 2017 on the consensual basis expected. It is now almost 10 years since the commencement of the global financial crisis and it is time to draw a line under further regulatory changes, particularly since there is no doubt that our industry is more strongly capitalised, better governed and more risk aware than it was a decade ago. Finalisation of the structure and calibration of the capital framework is crucial to give banks certainty over prospective capital allocations in support of lending and market activities. This is particularly important at this time when public policy is focusing on encouraging greater support for longer-dated assets, including infrastructure, and seeking to build out the capital markets of Europe and emerging markets. It is hugely important that regulators and policy makers now move as quickly as possible to finalise the capital framework in line with their stated commitment to deliver that framework without a significant, broad-based increase in capital requirements. Equally important is the avoidance of fragmentation in the global regulatory architecture as the new US administration reconsiders its participation in international regulatory forums. The best outcome would be early global agreement on unresolved issues, followed by an extended period of regulatory stability to allow familiarity and experience to be gained from what has been put in place. We made further progress in 2016 on completing the resolution planning required of us as a global systemically important bank (‘G-SIB’). This involved removing or mitigating residual constraints on the clarity of the Group’s core college of regulators’ approach to winding down the Group, should this ever be necessary. While clearly we do not envisage such circumstances as other than extremely remote, completion of a comprehensive resolution framework is a necessary pillar supporting HSBC’s ability to continue to operate as one of the world’s G-SIBs. Indeed, our strategy is built around maintaining the scale and the reach of our international network, which in 2016 again demonstrated its resilience and competitive advantages. Tangible benefits accrue to our shareholders from the detailed work done with our regulators to demonstrate the strength of our capital position and the effectiveness of our resolution planning. Beyond supporting the maintenance of our dividend, in 2016 management’s efforts created the capacity to return capital to shareholders by way of a share buy-back and demonstrated justification for a reduction in the additional capital buffer applied to HSBC as a G-SIB. UK referendum on EU membership Not a great deal has changed since we reported at the interim stage, given that the UK has still to trigger its formal exit notice and so no negotiations have taken place. We welcomed, however, the additional clarity given to the Government’s position in the recent speech by the Prime Minister. The scale of the challenge of negotiating across the entire economic landscape, as well as addressing the legislative and other public policy adjustments that will be required, has become clearer. We believe there is now, as a consequence, a widely shared recognition that an implementation phase between the current position and the one that is ultimately negotiated will be necessary; we strongly endorse this view. Since the referendum we have focused on advising clients on the implications of leaving the EU for their businesses. We have also been responding to UK Government outreach seeking guidance on which elements of the current EU-based legal and regulatory arrangements it should focus on to preserve the essential role that financial markets based in the UK play in supporting European trade and investment activity. For our own part, we have broadly all the licences and infrastructure needed to continue to support our clients once the UK leaves the EU. This largely derives from our position in France where we are the sixth largest bank with a full range of capabilities. Current contingency planning suggests we may need to relocate some 1,000 roles from London to Paris progressively over the next two years, depending on how negotiations develop. 5 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Strategic Report | Group Chairman’s Statement Board changes We welcomed Jackson Tai to the Board on 12 September last year. Jack brings a rare combination of hands-on banking expertise, top level governance experience and a deep knowledge of Asia and China. These attributes were accumulated in a 25-year career at J.P. Morgan & Co., both in the US and in Asia, and subsequently in senior roles at DBS, the leading Singapore-based regional banking group, where Jack latterly led its regional expansion as Vice Chairman and CEO. Jack was appointed a member of the Financial System Vulnerabilities Committee and the Group Risk Committee. At the forthcoming AGM we shall bid farewell to our two longest-serving independent directors, namely, our Senior Independent Director, Rachel Lomax, and Sam Laidlaw. Rachel during her tenure has served on the Audit, Risk and Nomination Committees, and took responsibility as the first Chair of the Conduct & Values Committee to establish its terms of reference and its agenda. Sam served on, and latterly chaired, both the Remuneration and Nomination Committees. Together, Rachel and Sam have also been leading the process to manage my own succession. Their combined knowledge of regulatory and public policy, business leadership, corporate governance and consumer issues has been invaluable to the Board. On behalf of all shareholders, I want to thank them for their dedication and commitment. Chairman succession In the Circular inviting shareholders to the 2016 AGM, I indicated that the process to find my own successor had been initiated with the intention of having this concluded during 2017. This process remains on track and an announcement will be made in due course. Outlook We have recently upgraded our forecasts for global economic growth reflecting the likelihood of a shift in US fiscal policy and a broader based cyclical recovery. As in recent years, incremental growth is expected to be driven by emerging economies in which HSBC is well represented. Risks to this central scenario, however, remain high. In particular, we highlight the threat of populism impacting policy choices in upcoming European elections, possible protectionist measures from the new US administration impacting global trade, uncertainties facing the UK and the EU as they enter Brexit negotiations, and the impact of a stronger dollar on emerging economies with high debt levels. Countering these factors are signs of a cyclical upturn. Global purchasing manager indices are at their strongest for some time, the US economy looks robust and growth in China has held up well, defying the concerns reflected in the market retrenchment seen in the first quarter of 2016. Additionally, commodity prices have risen, reflecting optimism regarding growth in infrastructure investment as well as agreement reached to cut oil supply. These factors also imply reflation across the major economies and rising interest rates, which would benefit HSBC’s conservative balance sheet structure. ‘We enter 2017 with the restructuring of the Group essentially completed, and with a strong capital position and a conservative balance sheet’ However, it is fair to reflect that the upgrades to economic growth we are now forecasting are largely the partial reversal of downgrades made last year when uncertainty was elevated as a result of the unexpected political events. Forecast global growth remains slightly lower than its long-term trend with risks largely to the downside. We enter 2017 with the restructuring of the Group essentially completed, and with a strong capital position and a conservative balance sheet. We are gaining market share in areas of importance to HSBC as others scale back and our offerings become more competitive. Much of the heavy investment in reshaping the Group to improve productivity, embrace technological change and reinforce global standards of business conduct has been made. As ever, we owe a huge amount to our 235,000 colleagues who have delivered this change at the same time as working tirelessly to meet customers’ expectations of them. On behalf of the Board, I want to thank them all for their dedication and commitment. Douglas Flint Group Chairman 21 February 2017 6 HSBC Holdings plc Annual Report and Accounts 2016Group Chief Executive’s Review Group Chief Executive’s Review The strength of our network gives us an unrivalled ability to help clients navigate complexity and uncover new opportunities. t r o p e R c g e t a r t S i border mergers and acquisitions. HSBC was recognised as the ‘World’s Best Investment Bank’ and ‘World’s Best Bank for Corporates’ at the Euromoney Awards for Excellence 2016. Commercial Banking performed well, particularly in the UK and Hong Kong, growing adjusted revenue in spite of a slow-down in global trade. Gains in Global Liquidity and Cash Management, and Credit and Lending, exceeded the reduction in trade finance revenue. Global Trade and Receivables Finance continued to capture market share in major markets including Hong Kong and Singapore, maintaining our position as the world’s number one trade finance bank. Retail Banking and Wealth Management performance was mixed. Overall adjusted revenue was down, due largely to the impact of reduced client activity in Hong Kong on our Wealth Management businesses. At the same time, strong mortgage balance growth in the UK, Hong Kong and mainland China, and higher current account and savings balances in the UK and Hong Kong, helped increase revenue in Retail Banking. These increased balances should support revenue growth in 2017 and beyond. We have considered it appropriate to write off the remaining goodwill in the European private banking business. This goodwill relates principally to the original purchase of Safra Republic Holdings in 1999. The restructuring of Global Private Banking is now largely complete, and although Global Private Banking is now much smaller than it was three years ago, it is deliberately positioned for sustainable growth with a focus on serving the personal wealth management needs of the leadership and owners of the Group’s corporate clients. Our cost-reduction programmes continue to bring down our adjusted operating expenses. The traction that these programmes have gained in the last 18 months has enabled us to increase the amount of costs that we are able to remove from the business. We now expect to deliver annualised cost savings of around $6bn by the end of 2017, and will invest an equivalent total of around $6bn over the same time-frame in order to achieve this. 7 Stuart Gulliver Group Chief Executive We made good progress in 2016. The implementation of our strategic actions is well advanced and our global universal business model performed well in challenging conditions. Our reported profit before tax reflected a number of large significant items, including a write-off of all the remaining goodwill in Global Private Banking in Europe, an accounting loss on the sale of our Brazil business, and investments to achieve our cost- saving target. Our adjusted profits were broadly unchanged year on year following solid performances by our global businesses. These enabled us to capture market share in strategic product areas and build a platform for future growth. We delivered positive adjusted jaws in 2016. Performance Global Banking and Markets recovered from a sector-wide slow start to generate higher adjusted revenue than for 2015. Our Markets businesses performed well in challenging conditions, particularly in Fixed Income products. Our transaction banking businesses also grew revenue, especially Global Liquidity and Cash Management. We made market share gains in Fixed Income in Europe, and achieved our best ever league table rankings in global debt capital markets and cross- Strategic ReportFinancial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Strategic Report | Group Chief Executive’s Review These savings should more than compensate for additional investment in regulatory programmes and compliance. We continue to make strong progress in implementing our strategic actions to improve returns and gain maximum value from our international network. We are on course to complete the majority of these actions by the end of 2017 (see pages 12 to 13), in line with our targets. Our targeted reduction of risk-weighted assets is 97% complete, and the success of our cost saving programmes means that we now expect to exceed our cost reduction target. The turnaround of our Mexico business continues to accelerate. Improved lending and deposit balances, interest rate rises and better collaboration between businesses helped generate significantly higher profits compared with 2015. We also made significant market share gains, particularly in consumer lending. We have continued to enhance our business in Asia-Pacific, launching our first exclusively HSBC-branded credit card in mainland China, growing assets under management and insurance new business premiums, and increasing loans in the Pearl River Delta. We also extended our leadership of the offshore renminbi bond market and achieved our best ranking for China outbound mergers and acquisitions since 2003. We are better protected from financial crime because of the investment we have made in our Global Standards programme. Our Monitor has raised certain concerns, but we have continued to progress and our commitment remains unwavering. By the end of this year, we are on track to have our anti-money laundering and sanctions policy framework in place and to have introduced major compliance IT systems across the Group. Beyond 2017, we will continue to work to fine tune those systems and to ensure that our improvements are fully integrated into our day-to-day risk management practices. Our strong common equity tier 1 ratio of 13.6% reinforces our ability to support the dividend, invest in the business and manage the continuing uncertain regulatory environment. Delivering value for shareholders In December, we completed the $2.5bn equity buy-back that we commenced at the half-year. We are also now in a position to retire more of the capital that previously supported the Brazil business. Having received the appropriate regulatory clearances, we will therefore execute a further share buy-back of up to $1bn in the first half of 2017. This will bring the total value of shares repurchased since last August to $3.5bn. We will continue to contemplate further share buy-backs as circumstances permit, and we remain confident of sustaining the annual dividend at the current level for the foreseeable future through the long-term earnings capacity of the business. A business fit for the future While our strategic actions are improving our network, we are also anticipating and adapting to the social, economic and technological trends that are changing our operating environment and our customers’ needs and expectations. The adoption of rapidly evolving digital technologies by our customers is arguably the most transformative force for the financial services industry. Through our global network, we are able to identify and respond to digital trends across 70 countries and territories, applying the technologies that provide the greatest benefit to our customers. We are investing $2.1bn in digital transformation in Retail Banking and Wealth Management, Commercial Banking, and Global Banking and Markets between 2015 and the end of 2020, and we have already launched innovative ways to make banking faster, easier and safer. HSBC is now the biggest financial services user of biometrics globally, and we continue to roll out voice recognition and fingerprint technology across our network. In 2016, we enhanced our internet and mobile banking platforms in several of our key markets, including the UK and Hong Kong, and launched innovation labs around the world dedicated to the application of artificial intelligence, data management and improvements in cybersecurity. These labs, together with our fintech partnerships, will help us use technology to deliver better banking for our customers. 8 HSBC Holdings plc Annual Report and Accounts 2016Group Chief Executive’s Review t r o p e R c g e t a r t S i If digital technology is mankind’s greatest opportunity, preventing climate change is its greatest challenge. The Paris Agreement of December 2015 reflected a new consensus on the need to strengthen the global response to climate change. Major injections of capital are now required to finance new technologies, infrastructure and the transition of traditional industries from high to low carbon, and to cover the costs of climate adaptation. As the principal intermediaries between entrepreneurs, businesses and investors, banks have a responsibility to help direct this flow of capital. We are already working with our clients and with investors to help them allocate capital and direct finance towards lower- carbon, carbon-resilient activities, and in 2016 we established a Sustainable Financing Unit to coordinate this work across business lines. Headquartered in London, but with resources in New York and Hong Kong, this new unit will support colleagues tasked with creating and delivering innovative climate products, and help them uncover new sources of sustainable finance. ‘The changes we have made since 2011 have equipped HSBC to improve returns and gain maximum value from our international network’ We are also seeking to influence client practices and to build the data, the tools and the transparency necessary to embed understanding of climate risk into the way that markets function. In 2016, HSBC Global Research expanded its coverage of environment, social and corporate governance factors to give our clients the information they need to inform their investment decisions. This builds on the work of the world- leading HSBC Climate Change Centre for Excellence, which in 2017 celebrates 10 years of delivering market-leading information on climate policy to clients across the globe. Work is also underway to expand the Group’s disclosure of non-financial data to meet the needs of shareholders and other stakeholders. We are investing to adapt to the changing face of trade. As the world’s largest trade finance bank with more than 150 years’ experience at both ends of the world’s busiest trade routes, we are perfectly placed to help modernise and digitise long- standing trade finance methods, many of which would still be recognisable to HSBC’s founders. We are already working with a broad coalition of partners around the world to make the promise of blockchain technology a reality with regards to trade finance. HSBC has already helped develop a blockchain prototype for a letter of credit that confirms the possibility of sharing information between all parties on a private distributed ledger. In early 2017, we signed a memorandum of understanding with six other banks to make domestic and cross-border commerce easier for European SMEs using blockchain technology. We are also seeking to create ways of financing the growing services trade, which we estimate will account for a quarter of global trade by 2030. At a time when international politics threaten to increase rather than decrease the cost of trade, we will continue to invest both time and resources to find ways of making trade finance cheaper, faster, simpler and more secure for our customers. Looking forward We anticipate new challenges in 2017 from geopolitical developments, heightened trade barriers and regulatory uncertainty. However, the changes we have made since 2011 have equipped HSBC to manage the complexity of today’s global business environment. HSBC is a strong and resilient business with a global universal business model geared to find growth opportunities in a low-growth world. If globalisation continues to retreat, as seems likely, we are in a strong position to capitalise on the regional opportunities that this will present, particularly in Asia and Europe. Most importantly, the strength of our network gives us an unrivalled ability to help our clients navigate that same complexity and overcome their own challenges, whether exploring new markets or making the transition to a low-carbon economy. Stuart Gulliver Group Chief Executive 21 February 2017 9 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Our strategy We have developed a long-term strategy that reflects our purpose and enables us to capture value from our international network. Develop our international network To facilitate international trade and capital flows and serve our clients, with potential to help them grow from small enterprises into large multinationals. Invest in wealth and retail businesses with local scale To make the most of global social mobility, wealth creation and long-term demographic changes in our priority markets. Value of the network and our strategy Access to global growth opportunities Our unparalleled network covers countries accounting for more than 90% of global GDP, trade and capital flows. We have a leading presence in large and fast-growing economies. Our priority markets cover both sides of 11 of the world’s 15 largest trade corridors for goods and services forecast for 2030, and represent at least one side of the other four corridors. Six of the 15 corridors are within Asia and five connect countries between two geographical regions. Lower risk profile and volatility from our diversified, universal banking model Our 10-year profit before tax volatility of 0.9x compares favourably with our peers. Transaction banking product revenue of $14.7bn on an adjusted basis leads the industry. More than 45% of our client revenue comes from businesses and individuals with an international presence. Business synergies of $10.5bn, equivalent to 22% of reported revenue reflect products and services provided across our global businesses. Strong capital and funding base CET1 ratio of 13.6%, supported by increased shareholders’ equity to meet new regulatory requirements since the end of 2010. Four interconnected, global businesses share balance sheets and liquidity in addition to strong commercial links. Stable shareholder returns Industry leading dividend – approximately $55bn declared from 2011 to 2016, as well as circa $2.5bn of share repurchases. 10 Two-part long-term strategyStrategic ReportHSBC Holdings plc Annual Report and Accounts 2016Our strategy Long-term trends Our strategy positions us to capitalise on several long-term trends. Increasing connectivity and global flows of trade, finance and data are key drivers of GDP growth. Business to consumer cross-border e-commerce transactions ($tn) 2015 2020 Source: McKinsey Global Institute, Digital globalization: The new era of global flows (2016) t r o p e R c g e t a r t S i 0.3 1.0 Economic weight is shifting to Asian and Middle Eastern economies, which are expected to grow GDP threefold by 2050. Shipping volumes, measured by weight of goods unloaded 1990: 4,126m metric tonnes 2015: 10,033m metric tonnes 33% 62% Key Emerging and transition markets Developed markets Source: United Nations Conference on Trade and Development Size of middle class population (bn) 2010 2020 2030 Key 28% 54% 66% 1.8 3.2 5.0 Asia Rest of the world Source: OECD Development Centre, Emerging Middle Class in Developing Countries (2010) The middle class is expected to grow from one-third to two-thirds of the world’s population by 2030, while the number of people over age 60 is expected to more than double by 2050. Client examples ATN International (‘ATNI’): US, telecommunications and renewable energy International portfolio of businesses in US and elsewhere. ATNI sought out HSBC’s international capabilities while pursuing renewable energy investments in India. In 2016, we helped ATNI with custodian services and provided finance structuring advice for its Singaporean and Indian subsidiaries. We provide ATNI with trade, cash management, foreign exchange and other services. Mubea: Germany, automotive Tangle Teezer: UK, consumer goods Automotive parts manufacturer operating across 20 countries in Europe, Asia and the Americas. HSBC expanded its relationship with Mubea to also serve its subsidiaries in the US and Mexico, and provide centralised international cash and liquidity management. UK-based hairbrush manufacturer with its first product launch in 2008, and a range of products now sold in more than 70 markets. Since 2009, HSBC has helped Tangle Teezer expand internationally through our knowledge and capabilities around the world. In 2016, we assisted it in developing its presence in the US, China and Hong Kong. Grupo Aeroportuario (‘GACM’): Mexico, infrastructure Responsible for the construction, administration and operation of Mexico City’s new international airport. In 2016, we advised and coordinated financing for GACM including a $1bn 30-year green bond issuance, the largest green bond in Latin America, and the first emerging market green bond to receive a Green Bond Assessment grade from Moody’s. 11 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Strategic actions We are well on our way towards achieving the actions outlined in our June 2015 Investor Update. Capturing value from our international network In June 2015, we outlined a series of strategic actions to make the most of our competitive advantages and respond to a changing environment. These actions are focused on improving efficiency in how we use our resources, and on investing for growth in line with our strategy. Each action has targets defined to the end of 2017. The table opposite contains a summary of our progress in 2016 with additional details provided below. Resizing and simplifying our business We have made significant progress in resizing and simplifying our business. In 2016, management actions reduced RWAs in GB&M and legacy credit by $46bn and we completed asset sales totalling $10.1bn from our US consumer and mortgage lending (‘CML’) run-off portfolio. As part of our initiative to optimise our network, we completed the sale of HSBC Bank Brazil on 1 July 2016. We will continue to serve the international and cross-border needs of our large corporate clients in Brazil through HSBC Brasil S.A. – Banco de Investimento. In the NAFTA region, we grew adjusted revenue in Mexico by 18% compared with 2015, supported by market share gains in RBWM across key lending products and a doubling of personal loans issued. In the US, we grew adjusted revenue in GB&M and RBWM compared with 2015 and continued to support our clients internationally. Revenues from international subsidiaries of our US clients increased by 11% compared with 2015. We have made good progress in our cost-saving programme and are on track to exceed our exit rate target set for the end of 2017. We expect to achieve total cost savings of $6.0bn through one-off investments (‘costs to achieve’) of $6.0bn. The additional savings will fund increased costs related to regulatory programmes and compliance. In 2016, operating expenses fell by 4% on an adjusted basis compared with 2015, facilitated by increased efficiency in our processes. For example, we launched a new customer-facing digital portal to standardise and accelerate the onboarding process in 26 markets covering more than 70% of CMB corporate clients, and we decreased the number of manual payments by 80%. Redeploying capital to grow our business At the heart of our business is our international network. We are focusing efforts to grow our businesses by looking at customers’ needs across products, geographies and supply chains. In 2016, revenue from transaction banking products was up 2% despite difficult macroeconomic conditions. We grew revenues in our Global Liquidity and Cash Management (GLCM) business. In 2016, we were named ‘Best Bank for Corporates’ by Euromoney and ‘Best Supply-Chain Finance Bank Global’ by the Trade Finance Awards. We continue to invest for growth in Asia. In December, we launched our own HSBC-branded credit cards in mainland China with a full range of digital features. We increased the number of new RBWM clients in China’s Pearl River Delta by 51% compared with 2015, and grew our mortgage loan books by more than 51%. We grew revenues from international subsidiaries of our ASEAN-region commercial banking clients, and in Singapore our innovation lab is developing cloud-based treasury services for businesses and exploring blockchain technology to support documentary trade transactions. We remain recognised as the leading bank for international renminbi (‘RMB’) products and services. We were the first bank to facilitate overseas institutional investment into the China interbank bond market since access was expanded in early 2016. We were also the first to be appointed custodian bank in the two newly active RMB qualified foreign institutional investor (‘RQFII’) markets of the US and Thailand this year. Finally, we continue to strengthen our efforts to protect customers and the wider financial system from financial crime. In 2016, this included further upgrades to our systems, as well as additional training for our employees. Further detail can be found under the Financial Crime Risk section of www.hsbc.com/financial-crime-risk. Selected awards and recognition 2016 Euromoney Awards for Excellence 2016 Best Bank for Corporates Best Investment Bank Euromoney Cash Management Survey 2016 Best Global Cash Manager (Non-Financial Institutions) #1 Global For All Transactions (Financial Institutions) Trade Finance Awards 2016 Best Supply-Chain Finance Bank Global Asiamoney Offshore RMB Poll 2016 Best Overall Offshore RMB Products / Services 12 Strategic ReportHSBC Holdings plc Annual Report and Accounts 2016Strategic actions Progress against strategic actions Actions to resize and simplify the Group Strategic actions Reduce Group risk-weighted assets (‘RWAs’) by circa $290bn Targeted outcome by the end of 2017 – Group RWA reduction $290bn Group total – Return GB&M to Group target profitability; <1/3 of Group RWAs Progress Key performance indicators Status – Further reduction of $143.2bn in 2016, notably in GB&M – GB&M RWAs of $300.4bn, 37% of the – RWA reduction from management actions: circa $267bn (circa 97% of 2015–17 target on a constant currency basis) Optimise global network – Reduced footprint Rebuild NAFTA region profitability – US profit before tax circa $2bn – Mexico profit before tax circa $0.6bn – Completed our sale of Brazil operations – Present in 70 countries and on 1 July 2016; maintained a Brazil presence to serve large corporate clients’ international needs – Successfully achieved a non-objection to our US capital plan, which includes a dividend payment to HSBC Holdings plc in 2017, as part of the Comprehensive Capital Analysis and Review (‘CCAR’) – Mexico market share gains across key RBWM lending products territories at end of 2016 (down from 73 at end of 2014) – US (excluding CML run-off portfolio) adjusted profit before tax: $0.4bn (down 22% on 2015) – Mexico adjusted profit before tax: $0.3bn (up 354% on 2015) – 1 Set up UK ring- fenced bank – Completed by 2018 – Appointed Chair and CEO of HSBC UK; other senior appointments in progress – Implementation in progress Deliver $4.5-5.0bn of cost savings – 2017 exit rate to equal 2014 operating expenses – Migration of key roles underway with circa 35% of Birmingham positions filled – $2.2bn cost savings realised in 2016 – Positive jaws in 2016 compared with 2015 – FTE reduction of circa 900 in 2016 Actions to redeploy capital and invest – Adjusted costs (excluding Brazil) down 4% on 2015 t r o p e R c g e t a r t S i Deliver growth above GDP from international network – Revenue growth of international network above GDP Investments in Asia – prioritise and accelerate – Market share gains – Circa 10% growth per annum in assets under management in Asia – GLCM revenue up 6% on 2015 driven by growth in deposits and the effect of US rate rises – Global Trade and Receivables Finance (‘GTRF’) revenue down 7% on 2015, reflecting a decline in market conditions – Awarded Asia’s ‘Best Investment Bank’ and Asia’s ‘Best Bank for Financing’ by Euromoney Awards for Excellence 2016 – Transaction banking revenue: $14.7bn (up 2% on 2015) – Revenue synergies: $10.5bn (down 5% on 2015) – Guangdong loans: $4.7bn (up 16% on 2015) – ASEAN adjusted revenue: $3.1bn – Launched digital banking platform (HSBCnet) (down 2% on 2015) for SMEs in Guangdong allowing faster payment services with Hong Kong – Growing business around China’s Belt and Road initiative, including energy sector deals linking China to Malaysia and Egypt – Asset Management assets under management distributed in Asia: $143bn (up 11% on 2015) – Insurance manufacturing annualised new business premiums in Asia: $2.3bn (up 13% on 2015) – RMB internationalisation revenue, from offshore business partly or wholly denominated in RMB as well as selected products in mainland China: $1.25bn (down 25% on 2015) – By end 2017: AML and sanctions policy framework in place; major compliance IT systems introduced across the Group, including for customer due diligence, transaction monitoring and sanctions screening Grow business from renminbi (‘RMB’) internationalisation – $2.0–2.5bn revenue – 52% RQFII custodian market share (in Securities Services); ranked first by market share in all active RQFII markets Global Standards – safeguarding against financial crime3 – Implementation completed – Joint lead manager for China’s Ministry of Finance RMB3bn bond in the UK, the first sovereign RMB bond issued outside China – Continued progress towards putting in place an effective and sustainable AML and sanctions compliance programme, including through the creation of a new Financial Crime Risk function and improvements in technology and systems to manage financial crime risk 1 On track to achieve equivalent profit before tax target on a local currency basis; US dollar target set using the 2014 average exchange rate. 2 As set out under ‘Key performance indicators’. 3 Further detail on the Monitor and the US deferred prosecution agreement and related agreements and consent orders can be found on pages 82 and 66, respectively. – Post-2017: Policy framework and associated operational processes fully integrated in day-to-day financial crime risk management practices in an effective and sustainable way; IT systems continue to be fine-tuned – – 2 13 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Strategic Report Financial overview Reported results This table shows our reported results for the last three years, ended 31 December 2016, 2015 and 2014. Reported profit before tax Reported profit before tax of $7.1bn was $11.8bn or 62% lower than in 2015. This was primarily due to net adverse movements relating to significant items and the unfavourable effects of foreign currency translation, which are described in more detail on page 30. Excluding significant items and currency translation, profit before tax fell by $0.2bn. Reported revenue Reported revenue of $48.0bn was $11.8bn or 20% lower than in 2015, in part due to a net unfavourable movement in significant items of $7.6bn, which included: – adverse fair value movements of $1.8bn arising from changes in credit spreads on our own debt designated at fair value, compared with favourable movements of $1.0bn in 2015; – a $3.6bn reduction in revenue resulting from our sale of operations in Brazil to Banco Bradesco S.A., which includes a $1.7bn accounting loss recognised on the sale; and – the non-recurrence of a $1.4bn gain on the sale of part of our shareholding in Industrial Bank Co. Limited (‘Industrial Bank’) in 2015; partly offset by – a $0.6bn gain on the disposal of our membership interest in Visa Europe in the second quarter of 2016 and a $0.1bn gain on disposal of our membership interest in Visa US in the fourth quarter of 2016. In addition, foreign currency translation differences between the periods had an adverse effect of $3.0bn. These factors contributed to a fall in reported revenue in all our global 14 Reported results Net interest income Net fee income Net trading income Other income Net operating income before loan impairment charges and other credit risk provisions (‘revenue’) Loan impairment charges and other credit risk provisions (‘LICs’) Net operating income Total operating expenses Operating profit Share of profit in associates and joint ventures Profit before tax 2016 $m 2015 $m 2014 $m 29,813 32,531 34,705 12,777 14,705 15,957 9,452 (4,076) 8,723 3,841 6,760 3,826 47,966 59,800 61,248 (3,400) (3,721) (3,851) 44,566 56,079 57,397 (39,808) (39,768) (41,249) 4,758 2,354 16,311 16,148 2,556 2,532 7,112 18,867 18,680 businesses and Corporate Centre. Excluding significant items and the adverse effects of foreign currency translation differences between the periods, revenue fell by $1.3bn or 2%. – costs to achieve of $3.1bn compared with $0.9bn in 2015; partly offset by – a reduction of $1.0bn in settlements and provisions in connection with legal matters. Reported LICs Reported LICs of $3.4bn were $0.3bn lower than in 2015 as reductions in RBWM and CMB more than offset an increase in GB&M. The reduction included favourable effects of foreign currency translation differences between the periods of $0.2bn, and the impact of LICs incurred in the disposed Brazil operations of $0.7bn compared with $0.9bn in 2015. Reported operating expenses Reported operating expenses of $39.8bn were $40m or 0.1% higher than in 2015. This includes favourable effects of currency translation differences of $2.1bn between the periods, and an increase in significant items of $3.3bn, including: – a $3.2bn write-off of goodwill in our GPB business in Europe; and In addition, the reported results include the operating expenses incurred in our Brazil business of $1.1bn compared with $2.5bn in 2015. Excluding significant items and the adverse effects of foreign currency translation differences between the periods, operating expenses fell by $1.2bn. Reductions in all our global businesses reflected the effects of our cost-saving initiatives. Reported income from associates Reported income from associates and joint ventures of $2.4bn decreased by $0.2bn. On 21 February 2017, the Board announced a fourth interim dividend of $0.21 per ordinary share. HSBC Holdings plc Annual Report and Accounts 2016Financial overview t r o p e R c g e t a r t S i Adjusted performance Our reported results are prepared in accordance with IFRSs as detailed in the Financial Statements on page 194. We also present adjusted performance measures to align internal and external reporting, identify and quantify items management believes to be significant, and provide insight into how management assesses period-on-period performance. Adjusted performance measures are highlighted with the following symbol: To derive adjusted performance, we adjust for: – the year-on-year effects of foreign currency translation differences; and – the effect of significant items that distort year-on-year comparisons and are excluded in order to understand better the underlying trends in the business. For reconciliations of our reported results to an adjusted basis, including lists of significant items, see page 47. Adjusted results This table shows our adjusted results for 2016 and 2015. These are discussed in more detail on the following pages. Adjusted results Net operating income before loan impairment charges and other credit risk provisions (revenue) 2016 $m 2015 $m 50,153 51,419 Loan impairment charges and other credit risk provisions (‘LICs’) (2,652) (2,604) Total operating expenses Operating profit Share of profit in associates and joint ventures Profit before tax (30,556) (31,730) 16,945 2,355 17,085 2,443 19,300 19,528 Movement in adjusted proﬁt before tax compared with 2015 2016 ($m) Adverse Favourable (%) Share of proﬁts in associates and joint ventures 2,355 Proﬁt before tax 19,300 50,153 (1,266) (2,652) (30,556) 1,174 (48) (88) (228) Adjusted profit before tax On an adjusted basis, profit before tax of $19.3bn was $0.2bn or 1.2% lower than in 2015. This primarily reflected lower revenue, higher LICs and a reduction in our share of profits from associates. This was partly offset by a decrease in operating expenses. Revenue LICs Operating expenses (2) (2) 4 (4) (1) 15 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Strategic Report | Financial overview Adjusted performance continued Movement in adjusted revenue compared with 2015 2016 $m 18,925 12,887 14,919 1,757 1,665 50,153 2015 $m Variance $m 19,242 12,753 14,566 1,965 2,893 51,419 (317) 134 353 (208) (1,228) (1,266) % (2) 1 2 (11) (42) (2) Asia resulted in a reduction in Equities revenue. – In CMB, revenue rose (up $0.1bn), notably in GLCM reflecting balance growth and wider spreads in Hong Kong. Revenue also increased in Credit and Lending as a result of loan growth in the UK. For further details on the performance of our global businesses, see page 18. Adjusted LICs Adjusted LICs of $2.7bn were $48m higher than in 2015, reflecting increases in GB&M resulting from a small number of individually assessed LICs within the oil and gas, and metals and mining sectors, notably in the first half of 2016 in the US. LICs also increased in RBWM, particularly in Mexico. These increases were largely offset by a reduction in LICs in CMB. Adjusted operating expenses Adjusted operating expenses of $30.6bn were $1.2bn or 4% lower than in 2015. This primarily reflected cost savings of $2.2bn realised in 2016, with run-rate savings of around $3.7bn since the commencement of our cost-saving programme. The fall in operating expenses also included a reduction of $0.5bn in the UK bank levy. These Adjusted operating expenses ($bn) reductions were partly offset by the impact of inflation and our continued investment in regulatory programmes and compliance. Run-the-bank costs of $26.9bn were $0.3bn lower, and change-the-bank costs of $2.7bn were $0.4bn lower, both compared with 2015. Within these, our total expenditure on regulatory programmes and compliance, comprising both run-the-bank and change-the-bank elements, was $3.0bn, up $0.4bn or 14% compared with 2015. This reflected the ongoing implementation of our Global Standards programme to enhance our financial crime risk controls and capabilities, and to meet our external commitments. In the fourth quarter of 2016, our adjusted operating expenses increased compared with the third quarter reflecting a small number of specific items. This included the write-off of software. The number of employees expressed in full-time equivalent staff (‘FTEs’) at 31 December 2016 was 235,175, a decrease of 20,028 from 31 December 2015. This included a 19,145 reduction following our disposal of operations in Brazil. Excluding Brazil, the decrease in FTEs was 883, as a reduction of 17,855 FTEs realised across global businesses and global functions was partly offset by investment in our Global Standards Programme of 5,694 FTEs, costs to achieve FTEs of 8,073 and investment for growth. For further details on the categorisation of run-the-bank and change-the-bank costs, see page 38. Adjusted income from associates and joint ventures Adjusted income from associates and joint ventures of $2.4bn fell by $0.1bn compared with 2015. 2015 $31.7bn 2016 $30.6bn 1.4 30.3 0.9 29.7 7.1 7.6 7.3 1.4 7.6 (0.1) 7.1 7.1 7.0 1.0 7.4 Key Bank levy Adjusted operating expenses (excluding bank levy) 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 2015 2016 RBWM CMB GB&M GPB Corporate Centre Total Adjusted revenue Adjusted revenue of $50.2bn was $1.3bn or 2% lower. The reduction reflected the following: – In RBWM, lower revenue (down $0.3bn) was mainly a result of a fall in income in our Wealth Management business. The reduction resulted from lower investment distribution income compared with a strong performance in 2015, notably in the first half of the year, and adverse market impacts in Insurance Manufacturing. By contrast, revenue grew in savings and deposits, as we grew balances in Hong Kong, the UK and Mexico, and from wider spreads in Hong Kong and Latin America. – In GPB, lower revenue (down $0.2bn) reflected reduced brokerage and trading activity due to the continued repositioning of the business, together with adverse market sentiment and unfavourable market conditions. – In Corporate Centre, revenue fell (down $1.2bn), partly due to the US CML portfolio (down $0.5bn) as a result of continued run-off and portfolio sales. Revenue also fell in Central Treasury as a result of higher adverse fair value movements relating to the economic hedging of our long-term debt ($0.2bn) and higher interest expense on our debt ($0.2bn). These were partly offset: – In GB&M, revenue increased (up $0.4bn) despite adverse movements in credit and funding valuation adjustments of $0.3bn. In Rates and Credit, higher revenue reflected growth in market share in Europe. We also increased revenue in Global Liquidity and Cash Management (‘GLCM’) from balance growth and wider spreads. By contrast lower trading volumes in Europe and 16 HSBC Holdings plc Annual Report and Accounts 2016 Financial overview Balance sheet and capital Balance sheet strength Total reported assets were $2.4tn, 1% lower than at 31 December 2015 on a reported basis, and 5% higher on a constant currency basis. We have maintained the strength of our balance sheet, as targeted asset growth was partly offset by reductions in our legacy portfolios and the completion of our sale of operations in Brazil to Banco Bradesco S.A. We also issued more than $30bn of senior debt during the year from HSBC Holdings plc (‘HSBC Holdings’) to build up the Group’s total loss absorbing capacity in line with anticipated regulatory requirements. t r o p e R c g e t a r t S i Distributable reserves The distributable reserves of HSBC Holdings at 31 December 2016 were $42bn, and at 31 December 2015 were $47bn. The reduction was driven by our share buy-back ($2.5bn) and the effects of dividends paid ($11bn), which more than offset profits of $7bn. Capital strength We manage our capital in an effort to ensure we exceed current regulatory requirements and are well placed to meet those expected in the future. We monitor our position using capital ratios. These measure capital relative to a regulatory assessment of risks taken. We quantify how these risks relate to our businesses using RWAs. Our CET1 ratio at 31 December 2016 was 13.6%, up from 11.9% at 31 December 2015. Details of these risks are included on page 127. Delivery against Group financial targets Return on equity (%) 2016 2015 2014 Return on equity 0.8 7.2 7.3 Our medium-term target is to achieve a return on equity (‘RoE’) of more than 10%. In 2016, we achieved an RoE of 0.8% compared with 7.2% in 2015. In 2016, significant items, which included a write-off of goodwill in GPB in Europe, costs to achieve and adverse fair value movements arising from changes in credit spread on our own debt designated at fair value, had a significant effect on our reported RoE. Together with the UK bank levy, significant items reduced the return achieved by 6.9 percentage points. Adjusted revenue down Adjusted jaws 2.5% Adjusted costs down 3.7% Adjusted jaws +1.2% Jaws measures the difference between the rates of change for revenue and costs. Positive jaws occurs when the figure for the annual percentage change in revenue is higher than, or less negative than, the corresponding rate for costs. We calculate adjusted jaws using adjusted revenue and costs. Our target is to maintain positive adjusted jaws. In 2016, adjusted revenue fell by 2.5%, whereas our adjusted operating expenses reduced by 3.7%. Adjusted jaws was therefore positive 1.2%. Total dividends declared in respect of the year ($bn) 2016 2015 2014 Dividends 10.1 10.0 9.6 In the current uncertain environment, we plan to sustain the annual dividend in respect of the year at its current level for the foreseeable future. Growing our dividend in the future will depend on the overall profitability of the Group, delivering further release of less efficiently deployed capital and meeting regulatory capital requirements in a timely manner. Actions to address these points were core elements of our Investor Update in June 2015. 17 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Global businesses We manage our products and services globally through our global businesses. Retail Banking and Wealth Management (‘RBWM’) RBWM serves close to 36 million customers worldwide through four main business areas: Retail Banking, Wealth Management, Asset Management and Insurance. RBWM provides services to individuals under the HSBC Premier and Advance propositions aimed at mass affluent and emerging affluent customers who value international connectivity and benefit from our global reach and scale. For customers who have simpler everyday banking needs, RBWM offers a full range of banking products and services reflecting local requirements. Higher Retail Banking revenue, but challenging market conditions in Wealth Management – Adjusted profit before tax of $5.3bn was $0.4bn or 6% lower compared with 2015. This was driven by lower revenue in our Wealth Management business, together with higher LICs. By contrast, lower operating expenses reflected our continued focus on cost management. – Adjusted revenue of $18.9bn was $0.3bn or 2% lower, as growth in Retail Banking revenue was more than offset by a fall in Wealth Management. The reduction in Wealth Management (down 0.5bn) was driven by decreased investment distribution revenue as a result of lower mutual fund and retail securities turnover due to weaker market sentiment. This compared with a strong performance in the first half of 2015. In addition, insurance manufacturing revenue fell, reflecting adverse market impacts ($345m), although this was partly offset by the value of new business. However, in Retail Banking revenue rose $0.2bn or 1%, as revenue increased in current accounts and savings (up $0.4bn) from growth in balances, notably in Hong Kong and the UK. We also benefited from wider deposit spreads in Hong Kong and Mexico. By contrast, revenue in personal lending fell (down $0.2bn), despite growth in balances of $9bn or 3%, notably in Hong Kong, the UK and Mexico, driven by spread compression (mainly in the UK). – LICs increased by $0.1bn, notably in Mexico, reflecting growth in unsecured lending balances. – Operating expenses were 1% lower as inflation and investments were more than Commercial Banking (‘CMB’) CMB serves approximately two million customers in 54 countries and territories. Our customers range from small enterprises focused primarily on their domestic markets through to corporates operating globally. It supports our customers with tailored financial products and services to allow them to operate efficiently and to grow. Services provided include working capital, term loans, payment services and international trade facilitation, among other services, as well as expertise in mergers and acquisitions, and access to financial markets. Revenue growth in a challenging market – Adjusted profit before tax of $6.1bn was 12% higher than in 2015 primarily because of lower LICs, and revenue growth despite challenges in global trade. – Adjusted revenue rose by $0.1bn or 1%. This included growth of $0.2bn in GLCM driven by increased balances and wider spreads in Hong Kong. Revenue in Credit and Lending also increased (up $0.1bn), reflecting continued loan growth in the UK. This was partly offset by lower revenue in Global Trade and Receivables Finance (‘GTRF’). – LICs reduced by $0.4bn as 2016 included lower levels of individually assessed LICs, as well as a net release of collective allowances primarily relating to charges made in the fourth quarter of 2015, notably in the oil and gas sector. – Operating expenses reduced compared with 2015 as the effect of inflation was more than offset by ongoing cost discipline and the impact of our transformation initiatives. This helped us achieve positive jaws of 2.1%. – Management initiatives drove a further reduction in RWAs of $23bn in 2016, leading to a cumulative reduction of $46bn since our Investor Update in 2015, $18bn above our target. Commentary is on an adjusted basis, which is the GAAP measure for our global businesses. The comparative period has been restated to reflect changes to reportable segments, as described on page 44. offset by transformation and other cost-saving initiatives. Key events: – Our retail banking revenue rose by 1%, with increases in current account and savings partly offset by falls in credit card and mortgage revenue, reflecting spread compression, mainly in the UK. – In the UK, growth in mortgage balances was facilitated by our expansion into the mortgage intermediary market, with 12 brokers added in 2016, which accounted for 7% of our new mortgage originations during 2016. 5.3 5.7 6.2 Proﬁt before tax ($bn) 2016 2015 2014 Adjusted Change in adjusted profit before tax -6% Key events: – Despite the fall in global trade, we gained market share in key markets, including trade finance in Hong Kong and Singapore, and Receivables Finance in the UK. – HSBC was named ‘2016 Best Trade Bank in the World’ by Trade and Forfaiting Review, and won the ‘Best Global Cash Manager for Non-Financial Institutions’ at the Euromoney Awards 2016. Proﬁt before tax ($bn) 2016 2015 2014 Adjusted Change in adjusted profit before tax +12% 6.1 5.4 6.1 18 Strategic ReportHSBC Holdings plc Annual Report and Accounts 2016Global businesses Global Banking and Markets (‘GB&M’) GB&M serves approximately 4,100 clients in more than 50 countries and territories. It supports major government, corporate and institutional clients worldwide. Our product specialists continue to deliver a comprehensive range of transaction banking, financing, advisory, capital markets and risk management services. Markets revenue up despite challenging market conditions – Adjusted profit before tax of $5.6bn was $63m higher than in 2015, as revenue increased and operating expenses decreased, reflecting transformational cost savings, partly offset by an increase in LICs. – Adjusted revenue of $14.9bn rose $353m or 2%, despite adverse movements in Credit and Funding valuation adjustments compared with favourable movements in 2015 (net effect, down $297m), primarily relating to movements on our own credit spreads on structured liabilities. Excluding these, revenue rose $650m or 5%, mainly in Rates and Credit, as we gained market share in Europe. In GLCM, revenue increased as we grew average balances and benefited from wider spreads. By contrast, revenue fell in Equities, reflecting lower trading volumes in Europe and Asia. – LICs increased (up $0.4bn), predominantly driven by a small number of individually assessed exposures within the oil and gas, and metals and mining sectors, notably in the first half of 2016 in the US. – Operating expenses fell by $93m, reflecting reduced performance-related pay, disciplined cost management, efficiency improvements including technology delivery rationalisation, and FTE reductions. These reductions more than offset the investments we made in the business. Global Private Banking (‘GPB’) GPB serves high net worth individuals and families, including those with international banking needs, through 13 booking centres covering our priority markets. Our products and services include Investment Management, incorporating advisory, discretionary and brokerage services; Private Wealth Solutions, comprising trusts and estate planning, designed to protect wealth and preserve it for future generations; and a full range of private banking services. Lower revenue reflecting repositioning and adverse market conditions – Adjusted profit before tax of $0.3bn fell by $0.1bn as revenue decreased, partly offset by a reduction in costs. – Adjusted revenue of $1.8bn fell by $0.2bn or 11%, as brokerage and trading activity in both Europe and Asia decreased. This reflected the continued impact of client repositioning, in addition to adverse market sentiment and unfavourable market conditions throughout the year. – Operating expenses decreased by $0.1bn, primarily as a result of reduced FTEs and cost-saving initiatives. Key events: – There was negative net new money of $17bn, reflecting the repositioning of the business. However, we attracted positive net new money in key markets targeted for growth, notably in the UK, Channel Islands and Hong Kong. Corporate Centre During 2016, we established the Corporate Centre, to better reflect the way we manage our businesses. Corporate Centre comprises Central Treasury, including Balance Sheet Management (‘BSM’), our legacy businesses, interests in associates and joint ventures, central stewardship costs that support our businesses and the UK bank levy. Lower revenue due to continued disposal of legacy portfolios and Central Treasury, partly offset by a reduction in costs – Adjusted profit before tax of $2.0bn was $0.5bn or 19% lower, driven by a fall in revenue and lower income from associates, partly offset by lower operating expenses, notably a reduced charge relating to the UK bank levy. – Revenue fell by $1.2bn, partly driven by reductions in our US CML portfolio ($0.5bn) as a result of lower average lending balances and portfolio sales. Revenue also fell in Central Treasury as a result of higher adverse fair value movements relating to the economic hedging of our long-term debt ($0.2bn) and higher interest expense ($0.2bn). – LICs were broadly unchanged as increased charges in the US CML portfolio were broadly offset by higher releases of credit risk provisions in the legacy credit portfolio. – Operating expenses were $0.8bn lower, partly reflecting the benefits of transformational savings in our technology, operations and other functions, and a lower UK bank levy charge (down $0.5bn). – Income from associates was $0.1bn lower, primarily in Saudi Arabia. Key events: – Through 2016, we continued to focus on delivery of our RWA reductions, and achieved a reduction of $8bn, which included $39bn through management initiatives, partly offset by business growth. – ‘World’s Best Investment Bank’ – Euromoney Awards for Excellence 2016 t r o p e R c g e t a r t S i Proﬁt before tax ($bn) 2016 2015 2014 Adjusted Change in adjusted profit before tax +1% 5.6 5.5 4.9 – We recognised a $3.2bn write-off relating to the goodwill of the business in Europe, which is not reflected in the adjusted performance. For additional information, refer to Note 20 on page 238. Proﬁt before tax ($bn) 2016 2015 2014 Adjusted Change in adjusted profit before tax -25% Key events: – Completed asset sales of $10bn from our US CML run-off portfolio. As at 31 December 2016, gross lending balances in this portfolio were $5.7bn. Proﬁt before tax ($bn) 2016 2015 2014 Adjusted 0.3 0.4 0.5 2.0 2.5 3.8 Change in adjusted profit before tax -19% For further details on the financial performance of our global businesses, see pages 45 to 51. 19 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Regions We coordinate activities across global businesses and supporting functions through a regional structure. 20 Asia HSBC’s history is founded on financing trade with Asia, and the continent remains central to our strategy. We aim to grow our business in China’s Pearl River Delta and the ASEAN region, and we continue to strengthen our leadership position in the internationalisation of China’s renminbi currency. Lower revenue, notably in Wealth Management, offset by cost management initiatives – Reported profit before tax was $13.8bn, $2.0bn lower than for 2015, notably due to the non-recurrence of a gain of $1.4bn on the disposal of part of our shareholding in Industrial Bank. – On an adjusted basis, profit before tax was broadly unchanged, as a decrease in revenue was offset by a reduction in costs. – Reported revenue fell by $2.0bn, driven by the non-recurrence of the gain on Industrial Bank, as noted above, and the adverse effects of currency translation differences of $0.3bn. Adjusted revenue decreased by $253m (1%). Lower adjusted revenue in RBWM resulted from investment distribution income falling, reflecting weaker market sentiment compared with a strong performance in the first half of 2015. This was partly offset by wider deposit spreads and deposit balance growth. In GB&M, adjusted revenue also declined, mainly in Equities and Foreign Exchange, partly offset by increases in Rates. By contrast, revenue in Corporate Centre increased, notably as income from Balance Sheet Management, within Central Treasury, rose. – Reported costs decreased by $104m, as an increase in costs to achieve of $354m was partly offset by the favourable effects of currency translation differences of $177m. Adjusted costs decreased by $227m (2%), notably as a result of cost management initiatives, which more than offset the effects of inflation and our investment growing our business in China’s Pearl River Delta and the ASEAN region. Europe We serve clients in Europe with a broad range of services, and facilitate international trade and investment. London is the strategic hub for GB&M. Reported loss before tax included significant items of $8.4bn – Reported loss before tax was $6.8bn. This compared with a reported profit before tax of $688m in 2015, with the fall driven by a net adverse movement in significant items, including and the write-off of goodwill relating to our GPB business, adverse fair value movements arising from changes in credit spreads on our own debt designated at fair value compared with favourable movements in 2015, and higher costs to achieve. – On an adjusted basis, profit before tax of $1.6bn fell by $0.5bn or 26%, as revenue decreased by $0.9bn (5%), partly offset by lower costs (down by $369m or 2%), which included a reduction of $0.5bn related to the UK bank levy, and a reduction in LICs of $37m (8%). – Reported revenue fell by $5.0bn, primarily as a result of adverse movements of $1.8bn arising from changes in credit spread on our own debt, compared with favourable movements of $0.8bn in 2015, and the adverse effects of currency translation differences ($1.6bn). Adjusted revenue fell by $945m or 5%, reflecting a reduction in RBWM of $465m (7%), notably in life insurance manufacturing in France as a result of adverse market updates, and in GPB reflecting the repositioning of the business. In Corporate Centre, lower adjusted revenue (down $0.8bn), partly reflected higher adverse fair value movements of $0.2bn relating to the economic hedging of our long-term debt, and higher interest expense of $0.2bn. These reductions were partly offset by growth in revenue in GB&M ($0.2bn), notably in Rates, GLCM and Global Banking, and in CMB ($0.2bn), in Credit and Lending. – Reported costs rose by $2.6bn, primarily reflecting a write-off of goodwill relating to our GPB business of $3.2bn and an increase of $1.5bn in costs to achieve, partly offset by the favourable effects of currency translation of $1.3bn. Adjusted costs fell by $0.4bn (2%). Excluding the reduction in the UK bank levy ($0.5bn), costs rose by 1% driven by higher charges from our global service and technology centres due to increased transformation activities relating to IT transformation and process improvement. Proﬁt before tax ($bn) 2016 2015 Proﬁt before tax ($bn) 2016 2015 Reported Adjusted (6.8) 0.7 1.6 2.1 Reported Adjusted 13.8 15.8 14.2 14.2 Strategic ReportHSBC Holdings plc Annual Report and Accounts 2016Regions t r o p e R c g e t a r t S i Middle East and North Africa HSBC is the longest-serving international bank in the region, with one of the largest networks there, offering a universal banking model and playing a vital role in facilitating international trade. Our priority markets in the region are Saudi Arabia, Egypt and the United Arab Emirates (‘UAE’). Strong performance reflecting robust cost management and lower LICs – Reported profit before tax was $1.5bn, and was broadly unchanged from 2015. – On an adjusted basis, profit before tax increased by $178m (13%), primarily reflecting a reduction in costs of $142m, and a decrease in LICs of $135m, partly offset by lower share of profit in associates and joint ventures. – Reported revenue fell by $210m, primarily due to the adverse effects of currency translation differences ($182m). Adjusted revenue decreased marginally, mainly reflecting reductions in RBWM in Turkey as we restructured our business there, and in CMB in the UAE, mainly within GTRF, in part reflecting customer exits. This was partly offset by GB&M with growth in GLCM, which benefited from interest rate rises across the region, in Global Banking mainly driven by infrastructure and real estate fee income in the UAE and Egypt, and Securities Services due to higher balances and spreads. – Reported LICs fell by $154m with adjusted LICs decreasing by $135m, mainly in CMB in the UAE due to lower charges and the release of provisions taken in 2015, notably relating to exposures in the oil and gas sector. – Costs were $137m lower on a reported basis, and $142m (9%) lower on an adjusted basis, mainly in the UAE and Turkey due to cost-saving initiatives, which more than offset our continued investment in compliance. – Share of profit in associates and joint ventures fell by $70m (14%), mainly due to higher impairment charges in Saudi British Bank and lower revenue in HSBC Saudi Arabia reflecting lower asset management and investment banking revenues. This was partly offset by revenue growth in Saudi British Bank and well- managed costs in both associates. North America The US is a key partner in global trade, and the US dollar remains the primary currency for global trade and payments. We support our North American customers within the NAFTA region and around the world, helping them grow their businesses. Continued run-off of the US CML portfolio led to a fall in revenue, partly offset by cost reductions across all businesses – Reported profit before tax was $185m, and fell by $429m from 2015, partly reflecting the net adverse effects of significant items, notably higher costs to achieve of $298m. – Adjusted profit before tax fell by $208m (14%) from the continued reduction in our US CML run-off portfolio. – Reported revenue fell $592m, and included the adverse effects of significant items ($57m) and currency translation of $59m. Movements in significant items were primarily driven by minimal fair value movements arising from changes in credit spread on our own debt in 2016, compared with favourable movements of $219m in 2015, although these movements were partly offset by a gain of $116m recorded on our sale of Visa US shares in 2016 and lower losses on disposal in our CML run-off portfolio of $77m. Adjusted revenue was $475m lower, primarily from a decrease in income in the US CML run-off portfolio in Corporate Centre. By contrast, adjusted revenue in GB&M increased by 6%, notably as a result of increased income in Rates and Credit driven by higher client flows and collateralised financing activity. – LICs increased by $188m on a reported basis and $191m on an adjusted basis, primarily as a result of a small number of individually assessed charges in the mining sector in GB&M, as well as higher charges in the US CML run-off portfolio. In CMB, there were net collectively assessed releases in 2016, compared with charges in 2015, relating to exposures in the oil and gas sector. – Reported costs fell by $353m, although this included a rise of $298m in costs to achieve in significant items, partly offset by a reduction in fines, penalties and charges in relation to legal matters of $128m. Adjusted costs fell by $460m, reflecting lower staff costs across all businesses. Latin America We are focusing on growing our business in Mexico, where we are among the top five banks by assets and our branch network has a market share of more than 10%. On 1 July 2016, we completed our sale of operations in Brazil, but we will continue to provide access to the region for large multinational companies. Continued progress in strategic initiatives with a strong business performance – Reported loss before tax was $1.6bn. This compared with a profit of $310m in 2015, with the loss driven by a number of significant items, primarily the accounting loss on our sale of Brazil operations which totalled $1.7bn. – On an adjusted basis, profit before tax rose by $0.4bn due to higher revenue, partly offset by higher LICs and costs. – Reported revenue fell by $3.9bn, partly driven by the accounting loss on our sale of Brazil operations ($1.7bn). The reported results also include the revenue earned in our Brazil business of $1.5bn in 2016, compared with $3.3bn in 2015, and the adverse effects of currency translation differences of $0.9m. However, adjusted revenue was $0.7bn (29%) higher than for 2015. We increased revenue in RBWM in Mexico with lending growth and an increase in market share across core retail portfolios, and in Argentina, reflecting wider spreads and growth in deposits, together with higher income from insurance. Revenue also increased in GB&M, partly due to increased client activity, and in CMB from lending and deposit balance growth. – Reported LICs fell by $266m, primarily driven by a reduction in Brazil ($184m) and favourable effects of currency translation ($120m). By contrast, adjusted LICs rose by $38m due to higher LICs in RBWM in Mexico of $124m reflecting growth in unsecured lending and a rise in delinquency rates, partly offset by lower LICs in CMB and GB&M. – Reported costs fell by $1.7bn, and included $1.1bn of costs relating to Brazil in 2016, compared with $2.5bn in 2015. These also included the favourable effects of currency translation differences ($0.6bn). Excluding these factors, adjusted costs increased by $0.3bn (or 16%), although this was below the average rate of inflation in the region as we continued to control our costs. Proﬁt before tax ($bn) 2016 2015 Proﬁt before tax ($bn) 2016 2015 Proﬁt before tax ($bn) 2016 2015 Reported Adjusted 1.5 1.5 1.6 1.4 Reported Adjusted Reported Adjusted 0.2 0.6 1.3 1.5 (1.6) 0.3 0.6 0.2 21 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 How we do business We conduct our business intent on supporting the sustained success of our customers, people and communities. Building lasting business relationships We serve more than 37 million customers around the world, ranging from individuals to the largest companies. We are committed to conducting our business in a way that delivers fair value to customers and supports them in realising their ambitions. Conduct and ensuring fair outcomes Operating with high standards of conduct is central to our long-term success and ability to serve customers. In 2016, we continued to embed good conduct practice across all our businesses, with a range of initiatives to further improve the service and experience we offer to customers. For example, in the UK we have introduced a simplified overdraft charging structure with real time notifications to prompt customers whenever they are at risk of incurring unarranged overdraft charges. In the UAE, we automated pricing for foreign exchange to provide clients with consistent and competitive rates for cross-currency payments. We also enhanced our investment advice processes and introduced tools and guidelines to make all our customer communication clear and easy to understand. These and related initiatives are guided by our Conduct Framework, which focuses on delivering fair customer outcomes and improved market integrity through our behaviours. The Conduct Framework guides activities to strengthen our business, and increases our understanding and awareness of how the decisions we make affect customers and other stakeholders. Additional detail on the Conduct Framework is available online at www.hsbc.com/conduct. For further details on regulatory compliance risk and on conduct-related costs included in significant items, see pages 81 and 62, respectively. Complaint types (RBWM) 34% 24% 11% Key 31% Product – features and policy Product – fees and charges Other product-related complaints Service complaints 22 Strategic ReportHSBC Holdings plc Annual Report and Accounts 2016How we do business t r o p e R c g e t a r t S i Our values define who we are as an organisation and make us distinctive. Open We are open to different ideas and cultures, and value diverse perspectives. Connected We are connected to our customers, communities, regulators and each other, caring about individuals and their progress. Dependable We are dependable, standing firm for what is right and delivering on commitments. Increasing quality of service Innovation and technology We rely on customer feedback to help determine where we can make improvements. In RBWM, we conducted more than 1.6 million customer surveys in 2016 across multiple points of customer interaction, including live online chat. We also improved the speed and quality of complaint resolution with more than two-thirds of retail customer complaints resolved on first contact, an improvement of 9% compared with 2015. Our customers increasingly use digital channels to interact, including mobile banking. We are investing in innovation and technology to serve customers better and enhance security around financial transactions and customer data. In 2016, we introduced voice biometric identification technology for retail customers globally. HSBC is one of the first large-scale global users of this technology. Customer feedback helps us to identify and address root causes of complaints. For example, we increased capacity in our call centres in response to concerns about long waiting times in the UK. We also addressed the most common complaints related to fees and charges through increased staff training and customer communication. As a result, complaints of this type reduced significantly in a number of our markets, including a 35% reduction in Hong Kong and a 27% reduction in France. In the UK, we also launched a mobile application for commercial banking customers that allows them to digitally verify their identity. Since its launch, nearly 80% of the customers able to use this digital channel have chosen to do so. We have also adjusted our branch network to reflect changing customer needs and concluded our retail branch review in the UK, with a further reduction of 117 branches in 2016. In Hong Kong, we launched a research and development lab in partnership with the government to promote technology development for the financial sector. Areas of focus include biometrics, data analytics, cybersecurity and internet finance. Separately, we are developing a mobile application to help retail customers manage all of their finances more effectively through a single interface. Sustainable finance We recognise that reducing global carbon dioxide emissions is a critical challenge for society. We seek to be a leader in managing climate change risk while developing opportunities with our customers. We continue to facilitate investment in areas such as infrastructure and renewable energy that help lower carbon dioxide emissions. In 2016, for example, we helped issue the largest-ever renewable energy bond in Canada to support a solar power farm. In the UK, we provided financing and asset management expertise to support deployment of energy smart meters throughout the country. In December, we established a team dedicated to sustainable finance within the business in order to engage clients more effectively in assessing and responding to potential impacts from climate change. 23 Our valuesFinancial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Strategic Report | How we do business 255,000 workday hours volunteered $137m charitable giving in 2016 Empowering people Valuing diversity Building a more diverse and inclusive workforce is critical to developing a sustainable and successful business. Our approach aims to increase and leverage diversity of thought to improve workforce agility, enhance our risk management capability, drive innovation and grow markets. Our diversity and inclusion ambitions focus on attracting, developing and retaining talent that reflects our customers and the communities where we do business, and deploying that talent effectively to anticipate and address expectations. Our seven global employee networks support this strategy and focus on gender, age, ethnicity, LGBT+, faith, working parents and carers, and ability. We have continued our focus on improving gender balance within senior leadership. Supporting our employees We believe that if someone is worth talking to, they are worth listening to. Exchange meetings are our way of doing that: meetings with no agendas and where managers are participants rather than leaders. These meetings bring people together to listen to each other, and allow people to express themselves without interruption or rebuttal. Our employee surveys indicate that Exchange participants respond positively by 11% more than others when asked if there is honest, two-way communication. Similarly, our At Our Best programme reinforces the habits required for a strong culture, including asking for feedback, being mindful of one’s own emotions and deploying tools for making better decisions. In 2016, nearly 100,000 employees attended an At Our Best training course, and a further 18,000 managers attended similar training centred on managing teams. 24 The programme is supported through a behaviour recognition scheme and the launch of Our Charter, a framework for good decision-making. To further strengthen our culture and promote positive behaviours, we have developed culture change plans that are regularly discussed in global and local management forums. The plans emphasise enabling a speak-up culture, principles-based judgement and other behaviours that are key to supporting the Group’s strategic objectives such as managing financial crime risk. In 2016, our employees completed more than eight million courses in person or through online learning in order to build skills and reinforce behaviours more broadly. We have a wellbeing programme that provides benefits and services to support employees’ wellness. For example, we offer free, confidential counselling to address personal issues at home or work. We also allow employees who have been at HSBC for five years or more to apply to take a sabbatical. Above all, we aim to provide a working environment where colleagues can talk openly about wellbeing issues, including anxiety and stress. Such measures are particularly valuable amid the demands of multiple change programmes and financial crime remediation initiatives. Whistleblowing We operate a global whistleblowing platform, HSBC Confidential, which allows staff to report matters of concern confidentially. During 2016, employees have raised more than 1,100 cases. Common themes among the cases raised included concerns regarding staff behaviour and recruitment practices, allegations of fraud perpetrated by staff, and weaknesses in incentive arrangements and information security. Employees (FTEs) by region 7% 9% 5% 26% 53% Key Asia Europe Middle East and North Africa North America Latin America Exchange meeting insights (% of employees who believe Exchange allows them to talk freely about issues important to them) 84% Employee retention 81.7% Gender diversity statistics Female Male Holdings Board Group Management Board Senior employees All employees (30%) 14 6 11 1 (8%) 6,551 2,230 (25%) 116,077 125,230 (48%) (52%) (70%) (92%) (75%) HSBC Holdings plc Annual Report and Accounts 2016How we do business Ensuring sustainable outcomes Our Global Sustainability function works with our global businesses, global functions and our regions to manage environmental and social issues that affect the Group and on which we can have an impact. Key issues are reviewed below and further details are available online at www.hsbc.com/sustainability. Sustainability performance data for 2016 will be available in spring 2017. Climate change We have committed to supporting the global shift to a low-carbon economy. Our award-winning Global Research team published 60 reports on sustainability topics in 2016. These included the implications of the Paris Agreement on climate change. In light of the Paris Agreement, we reviewed our mining and metals policy, and included restrictions on lending to new thermal coal mines, in addition to our existing policies on coal-fired power plants and deforestation. We also added more specific guidance on human rights impacts that could arise in the mining sector. For more information about our sustainability risk policies see page 84. We completed a number of GB&M and CMB client transactions that help lower carbon dioxide emissions in areas including infrastructure and renewable energy. In 2016, HSBC was the third- ranked bookrunner for green, social and sustainability bonds that exceeded $250m excluding self-led transactions by Dealogic. We also published a report on our own green bond, issued in 2015. We scored the highest grade in a global index run by CDP, a not-for-profit organisation that rates companies and governments on how they are tackling the climate change challenge. We also published an HSBC Statement on Climate Change, providing a summary of our approach and initiatives. We are reducing the amount of energy we consume, and increasing the proportion from renewable sources. By the end of 2016, more than 17% of our electricity was from wind or solar farms, compared with 9% in 2015. We signed additional agreements in 2016 to increase the percentage of the electricity we use from new wind and solar sources. In total, we have agreements in place to meet 23% of our global electricity needs from these sources by 2018. We report our carbon dioxide emissions on page 62. Sustainable investment Our Global Research team has expanded its environmental, social and governance research offering, hiring analysts to specifically cover social and governance drivers, and to cover the fast-growing green bond market. Our Global Asset Management business published a new climate change policy to encourage the transition to a low-carbon economy and increase the climate resilience of clients’ investments. Human rights We have issued our first statement as required by the UK’s Modern Slavery Act, which can be found at www.hsbc.com. We updated our supplier code of conduct to take account of revised legislation on modern slavery and human rights. More than 240 of our largest suppliers have already accepted this code. Community investment In 2016, we contributed $137m to charitable programmes, and our employees volunteered 255,000 hours in community activities during the working day. Our flagship environmental partnership, the HSBC Water Programme, exceeded its five-year targets at the end of 2016. Building on this success, we are extending the programme for a further three years. In 2016, we renewed our commitments to our two flagship global education programmes, the HSBC Youth Opportunities Programme and Junior Achievement More than Money, for another three years. These programmes help young people access education and realise their potential. Tax Taxes paid by region $0.9bn $0.3bn $0.2bn $7.4bn $2.8bn Key UK Rest of Europe Asia Middle East and North Africa North America Latin America t r o p e R c g e t a r t S i $2.4bn $0.8bn Taxes paid by HSBC relate to HSBC's own tax liabilities including tax on proﬁts earned, employer taxes, bank levy and other duties/levies such as stamp duty. Our approach to tax We apply the spirit and the letter of the law in all territories where we operate. We have adopted the UK Code of Practice for the Taxation of Banks. As a consequence, we pay our fair share of tax in the countries in which we operate. We continue to strengthen our processes to help ensure our banking services are not associated with any arrangements known or suspected to facilitate tax evasion. HSBC continues to apply global initiatives to improve tax transparency such as: – the US Foreign Account Tax Compliance Act (‘FATCA’); – the OECD Standard for Automatic Exchange of Financial Account Information (also known as the Common Reporting Standard); – the Capital Requirements Directive IV (‘CRD IV’) Country by Country Reporting; and – the OECD Base Erosion and Profit Shifting (‘BEPS’) initiative. We do not expect BEPS or similar initiatives adopted by national governments to adversely impact HSBC’s results. Further financial and tax information for the countries in which we operate will be published in 2017 in a CRD IV Country by Country report at www.hsbc.com/tax. 25 Financial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Risk overview We actively manage risk to protect and enable the business. Managing risk HSBC has maintained a conservative and consistent approach to risk throughout its history, helping to ensure we protect customers’ funds, lend responsibly and support economies. By carefully aligning our risk appetite to our strategy, we aim to deliver long-term shareholder returns. All employees are responsible for the management of risk, with the ultimate accountability residing with the Board. We have a strong risk culture, which is embedded through clear and consistent communication and appropriate training for all employees. A comprehensive risk management framework is applied throughout the Group, with effective governance and corresponding risk management tools. This framework is underpinned by our risk culture and reinforced by the HSBC Values and our Global Standards programme. Our Global Risk function oversees the framework, and is led by the Group Chief Risk Officer, an executive Director. It is independent from the global businesses, including our sales and trading functions, to provide challenge, appropriate oversight, and balance in risk/reward decisions. HSBC’s risk appetite defines its desired forward-looking risk profile, and informs the strategic and financial planning process. Top and emerging risks It is articulated in our Risk Appetite Statement, which is approved by the Board. Key elements include: – risks that we accept as part of doing business, such as credit risk and market risk; – risks that we incur as part of doing business, such as operational risk, which are actively managed to remain below an acceptable tolerance; and – risks for which we have zero tolerance, such as knowingly engaging in activities where foreseeable reputational risk has not been considered. We operate a comprehensive stress testing programme to help ensure the strength and resilience of HSBC, taking part in regulators’ as well as our own internal stress tests. In 2016, we participated in the annual stress test by the Bank of England, our lead regulator, and again exceeded its requirements comfortably. This reflected our conservative risk appetite, and our diversified geographical and business mix. It also reflected our ongoing strategic actions, including the sale of our operations in Brazil, RWA reductions in GB&M and continued sales from our US CML run-off portfolio. Our internal stress test scenarios include potential macroeconomic, geopolitical and operational risk events, and events that are applicable to HSBC. The results help management understand material risks and consider potential mitigants. Our risk management framework and risks associated with our banking and insurance manufacturing operations are described on pages 68 and 82 respectively. Key risk appetite metrics Component Measure Risk appetite 2016 Returns Return on average ordinary shareholders’ equity ≥10.0% 0.8% Capital Common equity tier 1 ratio – CRD IV end point basis ≥11.0% 13.6% Liquidity HSBC consolidated balance sheet advances-to-deposits ratio ≤90% 67.7% Loan impairment charges Loan impairment charges as % of advances: RBWM ≤0.50% 0.37% Loan impairment charges as % of advances: wholesale (CMB, GB&M and GPB) ≤0.45% 0.27% Our top and emerging risks framework helps enable us to identify current and forward-looking risks so that we may take action to either prevent them materialising or limit their effect. Top risks are those that may have a material impact on the financial results, reputation or business model of the Group in the year ahead. Emerging risks are those that have large unknown components and may form beyond a one-year horizon. If these risks were to occur, they could have a material effect on HSBC. During 2016, we made two changes to our top and emerging risks to reflect our assessment of their effect on HSBC. Firstly, ‘IT systems infrastructure and resilience’ was added as a new risk due to the need to ensure core banking systems remain robust as digital and mobile banking services continue to evolve. Secondly, ‘Dispute risk’ was removed as the key drivers of this thematic issue have already materialised and are therefore reported through other reporting channels. In addition, three thematic risks were renamed to better reflect the challenges facing HSBC. We use the new names in the table that follows. Our current top and emerging risks are summarised on the next page and discussed in more detail on page 64. Our approach to identifying and monitoring top and emerging risks is described on page 70. 26 Strategic ReportHSBC Holdings plc Annual Report and Accounts 2016Risk overview t r o p e R c g e t a r t S i Risk Trend Mitigants Externally driven Economic outlook and capital flows Geopolitical risk Turning of the credit cycle Cyber threat and unauthorised access to systems Regulatory and technological developments with adverse impact on business model and profitability Regulatory focus on conduct of business and financial crime US deferred prosecution agreement and related agreements and consent orders Internally driven IT systems infrastructure and resilience Impact of organisational change and regulatory demands on employees Execution risk Third-party risk management Enhanced model risk management expectations Data management Risk heightened during 2016 Risk remained at the same level as 2015 Thematic risk renamed during 2016 We are actively monitoring our wholesale credit and trading portfolios to identify areas of stress following the UK electorate’s vote to leave the European Union. We have also undertaken stress tests on our businesses and portfolios to assess potential impacts under a range of possible exit scenarios. We have increased physical security at our premises where the risk of terrorism is heightened and have enhanced our major incident response capabilities. A number of sectors remain under enhanced monitoring with risk appetite and new lending significantly curtailed, including our oil and gas and commodities lending portfolios. We have brought all cybersecurity initiatives together under one programme in order to strengthen our resilience and defence capabilities. We have revised our cybersecurity risk appetite to reflect our evolving defence approach. We are actively engaged with regulators and policy makers to help ensure that new regulatory requirements are considered fully and can be implemented in an effective manner. We have established a specialist digital solutions team to lead our response to new technologies. We created a new function, Financial Crime Risk, which brings together all areas of financial crime risk management at HSBC and continued to enhance our management of conduct in areas including the treatment of potentially vulnerable customers, market surveillance, employee training and performance management. We are continuing to take concerted action to remediate anti-money laundering and sanctions compliance deficiencies and to implement Global Standards. We have invested in specialist teams and are upgrading our systems capability to enhance data and digital capabilities and help ensure strong delivery quality and resilience to customers. We have increased our focus on resource planning and employee retention and well-being, and are developing initiatives to equip line managers with skills to both manage change and support their employees. The Group Change Committee monitored the progress of the high priority programmes across the Group that support the strategic actions, reviewing progress on deliverables and addressing resource prioritisation issues as they arose. To help enable a consistent risk assessment of the third-party services that the Group utilises, we are implementing a framework to provide a holistic view of third-party risks, which assesses third parties against key criteria, combined with associated control monitoring, testing and assurance throughout the third-party lifecycle. We have implemented a new global policy on model risk management and updated the model governance framework to address key internal and regulatory requirements. Additional resources have also been recruited to support the independent model review function. We continued to enhance our data governance, quality and architecture to help enable consistent data aggregation, reporting and management. 27 Strategic ReportFinancial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Strategic Report Remuneration Our remuneration policy supports the achievement of our strategic objectives by balancing reward for short- and long-term sustainable performance. Remuneration principles The remuneration strategy for our employees is based on a series of key principles. What we do What we don’t do – Focus on total compensation with a strong link between pay and performance – Judge not only what is achieved, but also how it is achieved, in line with the HSBC Values – Operate a thorough performance management and HSBC Values assessment process – Reward inappropriate or excessive risk taking or short-term performance at the expense of long-term company sustainability – Use only a formulaic approach to determine bonuses for our executives – Award discretionary bonuses to employees rated unacceptable against the HSBC Values and behaviours – Recognise and reward our employees – Allow our employees to hedge against for outstanding positive behaviour – Design our policy to align compensation with long-term stakeholder interests – Apply consequence management to strengthen the alignment between risk and reward their unvested or retained awards – Offer employment contracts with a notice period of more than 12 months – Have pre-arranged individual severance agreements Embedding our values in our remuneration framework Instilling the right behaviours, and driving and encouraging actions that are aligned to organisational values and expectations, are essential. We therefore have a number of programmes to reinforce our values. Pay Outcomes Positive adjustments – Individuals who exhibit exceptional conduct and behaviours are awarded positive variable pay adjustments during the year. Global consequence management policy – Ensures clear messaging to employees on the impact of any inappropriate conduct as part of reward communications, with consistency in approach and actions taken depending on the severity of the misconduct. Global recognition programme – Our global recognition programme is now available in more than 50 countries. – In 2016, approximately 600,000 recognitions were made with a total value of $8.1m. Performance management – Employees set objectives, which connect business, team and individual goals and are guided by expected behaviours aligned to our core values. – All employees receive a behaviour rating based on their adherence to HSBC Values to ensure performance is judged not only on what is achieved, but also on how it is achieved. – Employees and managers are encouraged to hold frequent conversations throughout the year, exploring alternative ways to stay connected outside the regular performance management cycle using a mix of informal and formal check-ins on a range of topics, including performance, development and wellbeing. 28 HSBC Holdings plc Annual Report and Accounts 2016Remuneration t r o p e R c g e t a r t S i How we set our variable pay pool When deciding on the variable pay pool, the Remuneration Committee considers a number of factors, which are set out in the following table: Performance and risk appetite statement Countercyclical funding methodology Distribution of profits Commerciality and affordability – Our variable pay pool takes into account our performance in the context of our risk appetite. – To dampen effects of economic cycles, the variable pay pool’s size has a floor and a ceiling, and we also limit the payout ratio as performance increases to prevent the risk of inappropriate behaviour. – Our funding methodology ensures that the distribution of post-tax profit between capital, shareholders and variable pay is appropriate, and that the majority of post-tax profit is allocated to capital and shareholders. – We face challenges arising from being headquartered in the UK, which has more stringent reward practices. We take into account these challenges in determining the size of the variable pay pool to ensure we can continue to attract and retain talent in key markets. Our variable pay pool for 2016 Our variable pay pool is $3,035m, a decrease of 12.3% compared with 2015. Variable pay pool ($m) 2015 2016 Group Of which Global Banking and Markets 3,035 3,462 954 1,086 Remuneration for our executive Directors Our remuneration policy for executive Directors was approved at our 2016 Annual General Meeting and implemented for the first time in 2016. Full details of our remuneration policy can be found online in our Directors’ Remuneration Policy Supplement 2016. The table below shows the amount our executive Directors earned in 2016. For details of Directors’ pay and performance for 2016, see the Directors’ Remuneration Report on page 153. (Audited) (in £000) Base salary Fixed pay allowance Pension Annual incentive GPSP/LTI 1 Sub-total Taxable benefits Non- taxable benefits Notional returns Total Douglas Flint 2016 1,500 2015 1,500 — — 450 750 — — Stuart Gulliver Iain Mackay Marc Moses 2016 1,250 1,700 375 1,695 2015 1,250 1,700 2016 2015 2016 2015 700 700 700 700 950 950 950 950 625 210 350 210 350 1,072 987 1,068 — — — 1,950 2,250 5,020 1,969 6,616 — 2,847 1,101 4,169 100 151 557 662 52 54 15 6 86 95 71 53 37 28 38 29 — — 27 9 17 5 18 5 2,136 2,496 5,675 7,340 2,953 4,256 2,936 3,968 1,005 — 2,865 827 1,101 3,928 1 Executive Directors received Group Performance Share Plan (‘GPSP’) awards for 2015. For 2016, executive Directors will receive a long-term incentive (‘LTI’) award, with a performance period ending in 2019, which will be included in the single figure table for the financial year ending on 31 December 2019. If target performance is achieved for this award, LTI payout would be 50% of grant value. In this case, the 2016 total single figure for year-on-year comparison would be (in £000) £7,670 for Stuart Gulliver, £4,069 for Iain Mackay and £4,052 for Marc Moses. 29 Strategic ReportFinancial Review Corporate Governance Financial Statements Shareholder Information HSBC Holdings plc Annual Report and Accounts 2016 Report of the Directors | Financial summary Financial summary Use of non-GAAP financial measures Critical accounting estimates and judgements Consolidated income statement Group performance by income and expense item Net interest income Net fee income Net trading income Net income/(expense) from financial instruments designated at fair value Gains less losses from financial investments Net insurance premium income Other operating income Net insurance claims and benefits paid and movement in liabilities to policyholders Loan impairment charges and other credit risk provisions Operating expenses Share of profit in associates and joint ventures Tax expense Consolidated balance sheet Movement in 2016 Page 30 30 31 32 32 34 34 35 36 36 36 37 38 38 40 40 41 42 The management commentary included in the Strategic Report, the Report of the Directors: ‘Financial Review’, together with the ‘Employees’ and ‘Corporate sustainability’ sections of ‘Corporate Governance’ and the ‘Directors’ Remuneration Report’ is presented in compliance with the IFRSs Practice Statement ‘Management Commentary’ issued by the IASB. Use of non-GAAP financial measures Our reported results are prepared in accordance with IFRSs as detailed in the Financial Statements starting on page 183. In measuring our performance, the financial measures that we use include those derived from our reported results in order to eliminate factors that distort period-on-period comparisons. These are considered non-GAAP financial measures. Non-GAAP financial measures that we use throughout the Annual Report and Accounts 2016 are described below. Non- GAAP financial measures are described and reconciled to the closest reported financial measure when used. The global business segmental results on pages 45 to 60 are presented on an adjusted basis in accordance with IFRS 8 ‘Operating Segments’ as detailed in ‘Basis of preparation’ on page 44. Adjusted performance Adjusted performance is computed by adjusting reported results for the year-on-year effects of foreign currency translation differences and significant items, which distort year- on-year comparisons. We use ‘significant items’ to describe collectively the group of individual adjustments excluded from reported results when arriving at adjusted performance. These items, which are detailed below, are ones that management and investors would ordinarily identify and consider separately when assessing performance to understand better the underlying trends in the business. These items include the operating results for our Brazil operations sold to Banco Bradesco S.A. on 1 July 2016, as well as the loss recognised on disposal. We consider adjusted performance provides useful information for investors by aligning internal and external reporting, identifying and quantifying items management believes to be significant and providing insight into how management assesses year-on-year performance. 30 HSBC Holdings plc Annual Report and Accounts 2016 Foreign currency translation differences Foreign currency translation differences reflect the movements of the US dollar against most major currencies during 2016. We exclude our reporting currency translation differences when deriving constant currency data because using these data allows us to assess balance sheet and income statement performance on a like-for-like basis to understand better the underlying trends in the business. Foreign currency translation differences Foreign currency translation differences for 2016 are computed by retranslating into US dollars for non-US dollar branches, subsidiaries, joint ventures and associates: • the income statements for 2015 and 2014 at the average rates of exchange for 2016; and • the balance sheets at 31 December 2015 and 31 December 2014 at the prevailing rates of exchange on 31 December 2016. No adjustment has been made to the exchange rates used to translate foreign currency denominated assets and liabilities into the functional currencies of any HSBC branches, subsidiaries, joint ventures or associates. When reference is made to foreign currency translation differences in tables or commentaries, comparative data reported in the functional currencies of HSBC’s operations have been translated at the appropriate exchange rates applied in the current period on the basis described above. Significant items The tables on pages 54 to 60 detail the effects of significant items on each of our global business segments and geographical regions in 2016, 2015 and 2014. Critical accounting estimates and judgements The results of HSBC reflect the choice of accounting policies, assumptions and estimates that underlie the preparation of HSBC’s consolidated financial statements. The significant accounting policies, including the policies which include critical accounting estimates and judgements, are described in Note 1.2 on the Financial Statements. The accounting policies listed below are highlighted as they involve a high degree of uncertainty and have a material impact on the financial statements: • Impairment of loans and advances: For collective impairment allowances, estimation methods include the use of historical information supplemented by significant management judgement about whether current economic and credit conditions are such that actual incurred losses are likely to be greater or less than experienced in the past. For individually assessed loans, judgements are made about the financial condition of individual borrowers, which can involve a wide range of factors relating to their business and the value of any security. The exercise of judgement requires the use of assumptions that are highly subjective and sensitive, in particular to changes in economic and credit conditions across a large number of geographical areas. See Note 1.2(d) on page 198. • Deferred tax assets: The most significant judgements relate to those made in respect of expected future profitability. See Note 1.2(h) on page 202. • Valuation of financial instruments: In determining the fair value of financial instruments a variety of valuation techniques are used, some of which feature significant unobservable inputs and are subject to substantial uncertainty. See Note 1.2(c) on page 197. • 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, based on a number of management assumptions. See Note 1.2(a) on page 196. • Goodwill impairment: A high degree of uncertainty is involved in estimating the future cash flows of the cash generating units (‘CGUs’) and the rates used to discount these cash flows. See Note 1.2(a) on page 196. • Provisions: A high degree of judgement may be required due to the high degree of uncertainty associated with determining whether a present obligation exists, and estimating the probability and amount of any outflows that may arise. See Note 1.2(i) on page 202. Consolidated income statement Summary consolidated income statement Net interest income Net fee income Net trading income Net income/(expense) from financial instruments designated at fair value Gains less losses from financial investments Dividend income Net insurance premium income Gains on disposal of US branch network, US cards business and Ping An Insurance (Group) Company of China, Ltd Other operating income/(expense) Total operating income Net insurance claims and benefits paid and movement in liabilities to policyholders Net operating income before loan impairment charges and other credit risk provisions Loan impairment charges and other credit risk provisions Net operating income Total operating expenses Operating profit Share of profit in associates and joint ventures Profit before tax Tax expense Profit for the year Attributable to: – ordinary shareholders of the parent company – preference shareholders of the parent company – other equity holders – non-controlling interests Profit for the year Five-year financial information Basic earnings per share Diluted earnings per share Dividends per ordinary share Dividend payout ratio Post-tax return on average total assets Return on risk-weighted assets Return on average ordinary shareholders’ equity Average foreign exchange translation rates to $: $1: £ $1: € Footnotes 1 2 3 Given the inherent uncertainties and the high level of subjectivity involved in the recognition or measurement of the items above, it is possible that the outcomes in the next financial year could differ from the expectations on which management’s estimates are based, resulting in the recognition and measurement of materially different amounts from those estimated by management in these Financial Statements. 2016 $m 29,813 12,777 9,452 (2,666) 1,385 95 9,951 — (971) 59,836 (11,870) 47,966 (3,400) 44,566 (39,808) 4,758 2,354 7,112 (3,666) 3,446 1,299 90 1,090 967 3,446 2016 $ 0.07 0.07 0.51 % 728.6 0.1 0.7 0.8 0.741 0.904 2015 $m 32,531 14,705 8,723 1,532 2,068 123 2014 $m 34,705 15,957 6,760 2,473 1,335 311 2013 $m 35,539 16,434 8,690 768 2,012 322 10,355 11,921 11,940 — 1,055 71,092 — 1,131 74,593 — 2,632 78,337 (11,292) (13,345) (13,692) 59,800 (3,721) 56,079 (39,768) 16,311 2,556 18,867 (3,771) 15,096 61,248 (3,851) 57,397 (41,249) 16,148 2,532 18,680 (3,975) 14,705 64,645 (5,849) 58,796 (38,556) 20,240 2,325 22,565 (4,765) 17,800 2012 $m 37,672 16,430 7,091 (2,226) 1,189 221 13,044 7,024 2,100 82,545 (14,215) 68,330 (8,311) 60,019 (42,927) 17,092 3,557 20,649 (5,315) 15,334 12,572 13,115 15,631 13,454 90 860 1,574 15,096 90 483 1,017 14,705 90 483 1,596 17,800 90 483 1,307 15,334 2015 2014 2013 2012 $ 0.65 0.64 0.50 % 76.5 0.6 1.6 7.2 $ 0.69 0.69 0.49 % 71.0 0.5 1.5 7.3 $ 0.84 0.84 0.48 % 57.1 0.7 2.0 9.2 $ 0.74 0.74 0.41 % 55.4 0.6 1.8 8.4 0.654 0.902 0.607 0.754 0.639 0.753 0.631 0.778 For footnotes, see page 63. Unless stated otherwise, all tables in the Annual Report and Accounts 2016 are presented on a reported basis. For a summary of our financial performance in 2016, see page 14. For further financial performance data for each global business and geographical region, see pages 45 to 51 and 54 to 60, respectively. HSBC Holdings plc Annual Report and Accounts 2016 31 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Financial summary Group performance by income and expense item Net interest income Interest income Interest expense Net interest income Average interest-earning assets Gross interest yield Less: cost of funds Net interest spread Net interest margin For footnotes, see page 63. Footnotes 4 5 6 7 2016 $m 42,414 (12,601) 29,813 2015 $m 47,189 (14,658) 32,531 2014 $m 50,955 (16,250) 34,705 1,723,702 1,726,949 1,786,536 % 2.46 (0.87) 1.59 1.73 % 2.73 (1.00) 1.73 1.88 % 2.85 (1.05) 1.80 1.94 In 2016, we earned net interest income of $0.9bn in Brazil (2015: $2.1bn) from average interest earning assets in Brazil of $25.8bn (2015: $40.0bn). Our net interest margin excluding Brazil was 1.70% (2015: 1.79%). Summary of interest income by type of asset 2016 2015 2014 Average balance Interest income Footnotes $m $m 203,799 1,510 865,356 29,272 168,207 430,775 55,565 1,227 7,248 3,157 1,723,702 42,414 Yield % 0.74 3.38 0.73 1.68 5.68 2.46 Average balance Interest income $m $m 221,924 2,277 909,707 33,104 162,308 396,113 36,897 1,301 7,508 2,999 1,726,949 47,189 Yield % 1.03 3.64 0.80 1.90 8.13 2.73 Average balance Interest income $m $m 237,148 3,068 931,311 37,429 198,273 399,816 19,988 1,800 8,323 335 1,786,536 50,955 Yield % 1.29 4.02 0.91 2.08 1.68 2.85 8, 9 179,780 3,897 2.17 195,285 4,626 2.37 238,958 5,596 2.34 (9,127) 653,115 (10,606) 682,143 (14,015) 668,564 2,547,470 46,311 1.82 2,593,771 51,815 2.00 2,680,043 56,551 2.11 Short-term funds and loans and advances to banks Loans and advances to customers Reverse repurchase agreements – non-trading Financial investments Other interest-earning assets Total interest-earning assets Trading assets and financial assets designated at fair value Impairment allowances Non-interest-earning assets Year ended 31 Dec For footnotes, see page 63. Summary of interest expense by type of liability and equity Deposits by banks Financial liabilities designated at fair value – own debt issued Customer accounts Repurchase agreements – non-trading Debt securities in issue Other interest-bearing liabilities Footnotes 10 11 12 2016 Average balance Interest expense $m 49,782 62,042 1,074,661 118,789 114,343 22,387 $m 342 942 5,492 626 2,807 2,392 Cost % Average balance $m 0.69 55,863 1.52 58,489 0.51 1,075,901 0.53 2.45 117,947 129,039 10.68 28,396 2015 Interest expense $m 378 717 7,401 355 3,521 2,286 Cost % 0.68 Average balance $m 61,217 1.23 66,374 0.69 1,088,493 0.30 2.73 8.05 190,705 129,724 10,120 2014 Interest expense $m 481 837 9,131 652 4,554 595 Total interest-bearing liabilities 1,442,004 12,601 0.87 1,465,635 14,658 1.00 1,546,633 16,250 Cost % 0.79 1.26 0.84 0.34 3.51 5.88 1.05 Trading liabilities and financial liabilities designated at fair value (excluding own debt issued) Non-interest bearing current accounts Total equity and other non-interest bearing liabilities Year ended 31 Dec For footnotes, see page 63. 138,486 1,986 1.43 151,294 2,071 1.37 178,518 2,856 1.60 184,016 782,964 190,914 785,928 185,990 768,902 2,547,470 14,587 0.57 2,593,771 16,729 0.64 2,680,043 19,106 0.71 32 HSBC Holdings plc Annual Report and Accounts 2016 Significant items and currency translation Significant items – releases/(provisions) arising from the ongoing review of compliance with the UK Consumer Credit Act – acquisitions, disposals and dilutions Currency translation Year ended 31 Dec 2016 $m 951 2 949 951 2015 $m 2,104 (10) 2,114 1,808 3,912 Net interest income of $29.8bn decreased by $2.7bn or 8% compared with 2015. This was partly the impact of the disposal of our operations in Brazil on 1 July 2016, which reduced net interest income by ($1.2bn), and adverse effects of currency translation differences. These decreases were partly offset by growth in net interest income in Asia, notably in Hong Kong, and in Mexico, partly offset by a decrease in the UK and the US. Net interest margin in 2016 of 1.73% was 15 basis points (‘bps’) lower than 2015. This reflected the effects of the disposal and currency translation noted above, which had an adverse effect of 8bps. The remainder of the decrease was primarily as a result of lower yields on customer lending, which had an adverse effect of 9bps on our net interest margin, partly reflecting the continuing run-off of our US CML portfolio. In addition, we recorded an increase in the cost of debt, partly offset by a lower cost of funds on customer accounts, notably in Hong Kong. Interest income Interest income decreased by $4.8bn compared with 2015, notably driven by our sale of Brazil operations ($3.1bn) and currency translation. Excluding these factors, total interest income increased marginally. Interest income on loans and advances to customers decreased by $3.8bn, driven by a reduction of $1.9bn relating to our operations in Brazil, and the adverse effects of currency translation. Excluding these factors, interest income on customer lending was broadly unchanged. The effects of growth in balances in Europe and Mexico, together with central bank rate rises in Mexico and Argentina, were broadly offset by the run-off of our US CML portfolio and the effect of lower average balances in Asia. Income growth in Mexico was driven by growth in average balances, reflecting gains in market share and higher yields, notably on term lending due to central bank rate increases. Income increased in Europe as the effect of growth in average balances, primarily an increase in term lending volumes, more than offset the effect of lower yields on both term lending and mortgages, reflecting competitive pricing in the market and lower interest rates in the eurozone. By contrast, interest income decreased in Asia, as a result of lower average balances in term lending, despite increased mortgage balances, notably in Hong Kong. Yields in Asia also decreased marginally as a result of central bank rate cuts in China during 2015, although these were partly offset by rate rises in Hong Kong. Interest income on short-term funds and financial investments decreased by $1.0bn in 2016, including a decrease of $0.7bn relating to Brazil. Excluding the effect of currency translation and Brazil, interest income on short-term funds and financial investments increased by $0.2bn. The movement predominantly reflected increases in available-for-sale debt securities in Asia, reflecting growth in our surplus liquidity. In North America income increased, driven by higher balances primarily due to net purchase of US Treasury securities, and a higher yield, following the US rate rise at the end of 2015. Interest income on reverse repurchase agreements – non- trading was $0.1bn lower, including a decrease relating to Brazil ($0.4bn). Excluding currency translation and Brazil, income increased primarily in North America, reflecting higher balances and improved market rates. Interest expense Reported interest expense decreased by $2.1bn, driven by the reductions relating to Brazil ($1.8bn) and currency translation. Excluding these factors, interest expense rose by $0.4bn, as increases in the cost of debt and repurchase agreements were partly offset by decreases in interest expense on customer accounts. Interest expense on customer accounts decreased by $1.9bn, including amounts relating to Brazil ($0.8bn) and currency translation. Excluding these factors, interest expense on customer accounts decreased by $0.5bn, driven by Asia and Europe, partly offset by Mexico, Argentina and North America. In Asia, the effect of an increase in balances was more than offset by a lower cost of funds, partly a change in portfolio mix towards lower-cost accounts in Hong Kong, which more than offset the effect of central bank rate rises. In addition to these factors, the central bank rate cuts in a number of markets, including mainland China, Australia and India, further lowered our cost of funds. In Europe, interest expense decreased as a result of a reduction in the cost of funds, partly due to a negative rate environment, although the average balances increased, notably in the UK. These decreases were partly offset by higher interest expense on customer accounts in the US, Mexico and Argentina, reflecting promotional deposit offerings and the central bank rate rises. Interest expense on debt securities in issue and own debt designated at fair value decreased by $0.5bn, including the impact of Brazil ($0.8bn). Excluding currency translation and the effect of Brazil, interest expense increased by $0.4bn. This was driven by an increase in the cost of funds and an increase in average balances, as redemptions across the Group were more than offset by issuances of senior debt from HSBC Holdings plc (‘HSBC Holdings’). The increase in the cost of debt designated at fair value was as a result of longer maturities and the structural subordination of our new issuances from HSBC Holdings. Interest expense increased on repurchase agreements by $0.3bn, notably in North America, reflecting higher balances and market rates. HSBC Holdings plc Annual Report and Accounts 2016 33 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Financial summary Net fee income Account services Funds under management Cards Credit facilities Broking income Unit trusts Imports/exports Remittances Underwriting Global custody Insurance agency commission Other Fee income Less: fee expense Year ended 31 Dec Significant items and currency translation Significant items – acquisitions, disposals and dilutions Currency translation Year ended 31 Dec Net fee income fell by $1.9bn compared with 2015, partly as a result of the adverse effects of currency translation of $0.6bn, primarily in the UK, Argentina and Mexico, which notably affected account services, cards and fee expense. The sale of our operations in Brazil to Banco Bradesco S.A. reduced net fee income by a further $0.3bn. In addition, the decrease was driven by RBWM in Hong Kong, reflecting risk-averse retail investor sentiment in Asia. Fee income from broking and unit trusts decreased by $525m, largely due to a strong performance in Hong Kong in the first half of 2015. The decrease was mainly in RBWM in Hong Kong, from lower securities broking income resulting from a reduction in stock market turnover. In addition, fee income from cards decreased by $311m, primarily reflecting lower interchange fees in the UK, following regulatory change in late 2015. Net trading income Trading activities Net interest income on trading activities Gain/(loss) on termination of hedges Other trading income – hedge ineffectiveness – on cash flow hedges – on fair value hedges 2016 $m 2,417 2,076 1,970 1,795 1,060 863 820 766 705 662 419 2,116 15,669 (2,892) 12,777 2015 $m 2,745 2,570 2,281 1,919 1,441 1,007 971 772 762 721 519 2,308 18,016 (3,311) 14,705 2016 $m 233 233 2014 $m 3,407 2,658 2,460 1,890 1,371 1,005 1,115 833 872 726 516 2,692 19,545 (3,588) 15,957 2015 $m 533 574 1,107 Fee income from funds under management decreased by $0.5bn, partly driven by a reclassification between fee income from funds under management and fee expense in Germany ($0.2bn). In addition, fee income from funds under management decreased in RBWM’s Global Asset Management business, driven by a change in the product mix towards lower margin fixed income products, as well as in GPB in Switzerland. The reduction in fee income from funds under management was partly offset by a fall in fee expense of $419m, primarily reflecting lower brokerage fees, and the reclassification noted above. Footnote 2016 $m 8,702 1,386 1 (5) 23 (655) 9,452 2015 $m 7,285 1,775 (11) 15 (11) (330) 8,723 2014 $m 5,419 1,907 1 34 19 (620) 6,760 Fair value movement on non-qualifying hedges 13 Year ended 31 Dec For footnote, see page 63. 34 HSBC Holdings plc Annual Report and Accounts 2016 Significant items and currency translation Significant items Included within trading activities – favourable debit valuation adjustment on derivative contracts Included in other net trading income – fair value movement on non-qualifying hedges – acquisitions, disposals and dilutions Total significant items Currency translation Year ended 31 Dec For footnote, see page 63. Footnote 13 2016 $m 26 26 (508) (687) 179 (482) (482) 2015 $m 230 230 (42) (327) 285 188 596 784 Net trading income of $9.5bn was $0.7bn higher than in 2015, despite the net adverse effects of $1.3bn of significant items and currency translation summarised in the table above. The increase (excluding the movements tabulated above) was driven by: • favourable movements on assets held as economic hedges of foreign currency debt designated at fair value of $1.7bn in 2016 compared to minimal movements in 2015. These movements were offset by adverse movements in foreign currency debt designated at fair value in ‘Net income/ (expense) from financial instruments designated at fair value’; and • increases in GB&M ($0.2bn), notably in Rates and in Credit, as we gained market share in Europe, partly offset by a decrease in Equities, reflecting lower trading volumes in Europe and Asia. In addition, we recorded adverse movements of $70m in credit and funding valuation adjustments compared with favourable movements of $227m in the prior year, primarily relating to movements in our own credit spread on structured liabilities. Net income/(expense) from financial instruments designated at fair value Net income/(expense) arising from: Financial assets held to meet liabilities under insurance and investment contracts Liabilities to customers under investment contracts HSBC’s long-term debt issued and related derivatives – change in own credit spread on long-term debt (significant item) – other changes in fair value Other instruments designated at fair value and related derivatives Year ended 31 Dec The majority of our financial liabilities designated at fair value are fixed-rate, long-term debt issuances, and are managed in conjunction with interest rate swaps as part of our interest rate management strategy. Significant items and currency translation Significant items – own credit spread – acquisitions, disposals and dilutions Currency translation Year ended 31 Dec We recorded a net expense from financial instruments designated at fair value of $2.7bn in 2016, compared with net income of $1.5bn in 2015. In 2016, there were unfavourable movements of $1.8bn in the fair value of our own long-term debt reflecting changes in credit spread, compared with favourable movements of $1.0bn in 2015. The decrease was also as a result of ‘Other changes in fair value’ on our long-term debt and related derivatives, which reflected: • higher adverse movements of $1.7bn in 2016 compared with minimal movements in 2015 on foreign currency debt designated at fair value and issued as part of our overall funding strategy (offset by assets held as economic hedges in ‘Net trading income’); and 2016 $m 1,480 (218) (3,975) (1,792) (2,183) 47 (2,666) 2015 $m 531 34 863 1,002 (139) 104 1,532 These liabilities are discussed further on page 242. 2016 $m (1,488) (1,792) 304 (1,488) 2014 $m 2,300 (435) 508 417 91 100 2,473 2015 $m 1,426 1,002 424 24 1,450 • higher adverse movements of $0.2bn relating to the economic hedging of interest and exchange rate risk on our long-term debt. By contrast, net income from financial assets held to meet liabilities under insurance and investment contracts of $1.5bn was $0.9bn higher than in 2015. This was primarily driven by improved equity market performance in Asia and Europe in 2016, partly offset by the disposal of our operations in Brazil in July 2016. Net income arising from financial assets held to meet liabilities under insurance and investment contracts results in a corresponding movement in liabilities to customers, reflecting the extent to which they participate in the investment performance of the associated asset portfolio. These offsetting movements are recorded in ‘Net income/(expense) arising from liabilities to customers under investment contracts’ and ‘Net HSBC Holdings plc Annual Report and Accounts 2016 35 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Financial summary insurance claims and benefits paid and movement in liabilities to policyholders’. In 2016, the majority of the variance arose in unit-linked contracts where the policyholder bears the investment risk, and was therefore offset by movements in liabilities to customers. Gains less losses from financial investments Net gains from disposal – debt securities – equity securities – other financial investments Impairment of available-for-sale equity securities Year ended 31 Dec Significant items and currency translation Significant items – gain on disposal of our membership interest in Visa – Europe – gain on disposal of our membership interest in Visa – US – gain on the partial sale of shareholding in Industrial Bank – acquisitions, disposals and dilutions Currency translation Year ended 31 Dec 2016 $m 1,421 357 1,058 6 (36) 1,385 2015 $m 2,179 345 1,829 5 (111) 2,068 2016 $m 701 584 116 — 1 701 2014 $m 1,708 665 1,037 6 (373) 1,335 2015 $m 1,385 — — 1,372 13 34 1,419 In 2016, gains less losses from financial investments decreased by $0.7bn compared with 2015. This was largely due to the significant items and currency translation tabulated above, notably the non-recurrence of the gain on the partial sale of our shareholding in Industrial Bank of $1.4bn in 2015, partly offset by gains on disposal of our membership interests in Visa Europe of $0.6bn and in Visa US of $0.1bn in 2016. Net insurance premium income Gross insurance premium income Reinsurance premiums Year ended 31 Dec Significant items and currency translation Significant items – acquisitions, disposals and dilutions Currency translation Year ended 31 Dec 2016 $m 10,588 (637) 9,951 2015 $m 11,012 (657) 10,355 2016 $m 362 362 2014 $m 12,370 (449) 11,921 2015 $m 764 169 933 Net insurance premium income was $0.4bn lower than in 2015, and included reductions due to the disposal of our operations in Brazil ($0.4bn) and currency translation movements of $0.2bn. Net insurance premium income increased in Hong Kong, partly offset by reductions in France in response to low interest rates Other operating income and market volatility, and in the UK, following the disposal of our pension business in 2015. Rent received Gains/(losses) recognised on assets held for sale Gains on investment properties Gain on disposal of property, plant and equipment, intangible assets and non-financial investments Losses arising from dilution of interest in Industrial Bank and other associates and joint ventures Change in present value of in-force long-term insurance business Other Year ended 31 Dec 2016 $m 157 (1,949) 4 35 — 902 (120) (971) 2015 $m 171 (244) 61 53 — 799 215 2014 $m 162 220 120 32 (32) 261 368 1,055 1,131 36 HSBC Holdings plc Annual Report and Accounts 2016 Change in present value of in-force long-term insurance business Value of new business Expected return Assumption changes and experience variances Other adjustments Year ended 31 Dec Significant items and currency translation Significant items Included within gains/(losses) recognised on assets held for sale: – portfolio disposals Included within the remaining line items: – acquisitions, disposals and dilutions Total significant items Currency translation Year ended 31 Dec 2016 $m 900 (532) 513 21 902 2015 $m 809 (552) 504 38 799 2016 $m (163) (163) (1,763) (1,763) (1,926) (1,926) 2014 $m 870 (545) (116) 52 261 2015 $m (214) (214) 157 157 (57) 71 14 Other operating income decreased by $2.0bn from 2015. This was as a result of the loss on the sale of our operations in Brazil of $1.7bn and the effects of the other significant items recorded in the table above. In addition, we recorded lower revaluation gains on investment properties. These decreases were partly offset by higher favourable movements of $0.1bn in present value of in-force (‘PVIF’) long- term insurance business, which was primarily driven by an increase in the value of new business written in Hong Kong, partly offset by a reduction in France and the impact of the disposal of our operations in Brazil. In 2016, we recognised $513m of income in ‘Assumption changes and experience variances’, which was broadly unchanged from the $504m recognised in 2015. For further details, please see Note 20. Net insurance claims and benefits paid and movement in liabilities to policyholders Net insurance claims and benefits paid and movement in liabilities to policyholders: – gross – less reinsurers’ share Year ended 31 Dec For footnote, see page 63. Significant items and currency translation Significant items – acquisitions, disposals and dilutions Currency translation Year ended 31 Dec Footnote 14 2016 $m 12,508 (638) 11,870 2015 $m 11,872 (580) 11,292 2016 $m 538 538 2014 $m 13,723 (378) 13,345 2015 $m 962 246 1,208 Net insurance claims and benefits paid and movement in liabilities to policyholders were $0.6bn higher compared with 2015, and included reductions due to the disposal of our operations in Brazil ($0.4bn) and currency translation movements of $0.2bn. This increase was primarily due to improved returns on financial assets supporting unit-linked contracts, where the policyholder bears the investment risk, reflecting improved equity market performance in Hong Kong compared to 2015. In addition, movements in liabilities to policyholders were higher due to increased premium income, and interest rate-driven changes to liability valuations in Hong Kong. These increases were partly offset by decreased premiums and reducing investment returns in France. The gains or losses recognised on the financial assets designated at fair value that are held to support these insurance contract liabilities are reported in ‘Net income/(expense) from financial instruments designated at fair value’ on page 203. HSBC Holdings plc Annual Report and Accounts 2016 37 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Financial summary Loan impairment charges and other credit risk provisions New allowances net of allowance releases Recoveries of amounts previously written off Loan impairment charges: – individually assessed allowances – collectively assessed allowances Releases of impairment on available-for-sale debt securities Other credit risk provisions Year ended 31 Dec Impairment charges on loans and advances to customers as a percentage of average gross loans and advances to customers Significant items and currency translation Significant items – acquisitions, disposals and dilutions Currency translation Year ended 31 Dec Loan impairment charges and other credit risk provisions (‘LICs’) of $3.4bn were $0.3bn lower than in 2015. This was partly as a result of favourable currency translation differences of $0.2bn, notably in Mexico and the UK. In addition, our sale of operations in Brazil resulted in a $0.2bn reduction. Collectively assessed LICs of $1.5bn were down $568m compared with 2015. This reduction included the net favourable effect of $230m as a result of our sale of operations in Brazil and favourable currency translation of $95m. The remaining variance reflected the following: • In CMB (down $226m), a net release of collectively assessed LICs compared with a net charge in 2015. The net release of allowances in 2016 was primarily on exposures related to the oil and gas sector, notably in the US and Canada, the UAE and Asia. This reflected a more positive outlook for this sector. By contrast, in 2015 we increased our collective allowances on exposures related to the oil and gas sector. The reduction in collectively assessed LICs was partly offset by an increase in the UK, primarily reflecting new allowances against exposures in the oil and gas sector. • In GB&M, a net release of collectively assessed LICs, notably in the UK and US, compared with a net charge in 2015. This was partly offset: • In RBWM, where collectively assessed LICs rose by $75m. The increase was mainly in Mexico reflecting our strategic focus on growing unsecured lending, as well as an increase in delinquency rates. By contrast, collectively assessed LICs decreased in a small number of markets in the Middle East and North Africa and Asia. • In Corporate Centre, LICs increased in our US CML run-off portfolio by $67m. Operating expenses 2016 $m 3,977 (627) 3,350 1,831 1,519 (63) 113 3,400 2015 $m 4,400 (808) 3,592 1,505 2,087 (17) 146 3,721 2014 $m 5,010 (955) 4,055 1,780 2,275 (319) 115 3,851 0.39% 0.39% 0.43% 2016 $m 748 748 748 2015 $m 933 933 184 1,117 Individually assessed LICs of $1.8bn increased by $326m compared with 2015. Higher charges in GB&M were partly offset by a reduction in CMB and favourable currency translation of $79m. This primarily reflected the following: • In GB&M (up $0.6bn), the increase was primarily in the US related to a significant specific charge against a mining- related corporate exposure, as well as charges relating to exposures in the oil and gas sector. Additionally, in Hong Kong, individually assessed LICs in 2016 largely related to a single corporate exposure. This compared with a net release of LICs in 2015. This was partly offset: • In CMB, lower individually assessed LICs (down $261m), included favourable currency translation of $70m and a net favourable effect of $45m attributable to our sale of operations in Brazil. The decrease also reflected lower individually assessed LICs in Indonesia, where charges in 2015 related to a small number of exposures across multiple sectors. Lower charges in both the UK and the UAE also contributed to the reduction. These decreases were partly offset by higher LICs in Hong Kong, related to various sectors, including manufacturing, and in Canada due to a rise in the number of exposures in the oil and gas sector migrating to default. Notably, the increase in individually assessed LICs in Canada was more than offset by the movement in collective allowances related to the oil and gas sector, discussed above. In 2016, we recorded higher net releases of impairment allowances against available for sale debt securities. These were primarily related to asset-backed securities (‘ABSs’) in our Legacy Credit business in Corporate Centre. In addition to detailing operating expense items by category, as set out in the table below, we also categorise adjusted expenses as follows: • • ‘Run-the-bank’ costs comprise business-as-usual running costs that keep operations functioning at the required quality and standard year on year, maintain IT infrastructure and support revenue growth. Run- the-bank costs are split between front office and back office, reflecting the way the Group is organised into four global businesses (‘front office’) supported by global functions (‘back office’). ‘Change-the-bank’ costs comprise expenses relating to the implementation of mandatory regulatory changes and other investment costs incurred relating to projects to change business- activity to enhance future operating capabilities. • ‘Costs to achieve’ comprise those specific costs relating to the achievement of the strategic actions set out in the Investor Update in June 2015. They comprise costs incurred between 1 July 2015 and 31 December 2017, and do not include ongoing initiatives such as Global Standards. Any costs arising within this category have been incurred as part of a significant transformation programme. Costs to achieve are included within significant items and incorporate restructuring costs that were identified as a separate significant item prior to 1 July 2015. • The UK bank levy is reported as a separate category. 38 HSBC Holdings plc Annual Report and Accounts 2016 Operating expenses By expense category Employee compensation and benefits Premises and equipment (excluding depreciation and impairment) General and administrative expenses Administrative expenses Depreciation and impairment of property, plant and equipment Amortisation and impairment of intangible assets Goodwill impairment Year ended 31 Dec By expense group Run-the-bank – front office Run-the-bank – back office Change-the-bank Bank levy Significant items Currency translation Year ended 31 Dec Staff numbers (full-time equivalents) Global businesses Retail Banking and Wealth Management Commercial Banking Global Banking and Markets Global Private Banking Corporate Centre At 31 Dec 2016 $m 18,089 3,758 12,715 34,562 1,229 777 3,240 39,808 2015 $m 19,900 3,830 13,832 37,562 1,269 937 — 39,768 2016 $m 13,612 13,275 2,746 922 9,253 39,808 2014 $m 20,366 4,204 14,361 38,931 1,382 936 — 41,249 2015 $m 13,711 13,437 3,161 1,421 5,947 2,091 39,768 2016 2015 2014 124,810 44,712 46,659 8,054 10,940 235,175 145,868 48,651 47,894 8,513 4,277 255,203 151,802 48,650 46,605 8,775 1,771 257,603 Reported operating expenses of $39.8bn were $40m higher than in 2015. This reflected an increase in significant items of $3.3bn which included: • the operating expenses incurred in our Brazil business of $1.1bn in 2016, compared with $2.5bn in 2015; and • a reduction of $1.0bn in settlements and provisions in • a $3.2bn write-off of the goodwill in our GPB business in connection with legal matters. Europe (please see Note 20 for further details); • costs to achieve of $3.1bn, compared with $0.9bn in 2015; partly offset by The increase in significant items was partly offset by the favourable effects of currency translation of $2.1bn. Significant items and currency translation Significant items – costs associated with portfolio disposals – costs to achieve – cost to establish UK ring-fenced bank – impairment of GPB – Europe goodwill – regulatory provisions in GPB – restructuring and other related costs – settlements and provisions in connection with legal matters – UK customer redress programmes – acquisitions, disposals and dilutions Currency translation Year ended 31 Dec Excluding the significant items and currency translation tabulated above, operating expenses of $30.6bn were $1.2bn lower than in 2015. This primarily reflected cost savings of $2.2bn achieved in 2016 and a reduction in the UK bank levy of $0.5bn. This was partly offset by the impact of inflation and continued investment in regulatory programmes and compliance. 2016 $m 9,252 28 3,118 223 3,240 344 — 681 559 1,059 — 9,252 2015 $m 5,947 — 908 89 — 172 117 1,649 541 2,471 2,091 8,038 Run-the-bank costs of $26.9bn were $0.3bn lower than in 2015 and change-the-bank costs of $2.7bn were $0.4bn lower than in 2015. Our total investment in regulatory programmes and compliance, comprising both was $3.0bn, up $0.4bn or 14% from 2015. This reflected the ongoing implementation of our Global Standards programme to enhance our financial crime risk controls and capabilities, and to meet our external commitments. and change-the-bank elements, HSBC Holdings plc Annual Report and Accounts 2016 39 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Financial summary We have maintained our transformational efforts and continue to realise the benefit of our cost-saving programme. Taking the 2016 savings into account, our run rate savings are now $3.7bn since the start of our initiatives. • Within RBWM, savings of $0.4bn reflected the impact of our branch optimisation programme enabled by our digital initiatives. • Within Operations and Technology, savings of $1.2bn reflected migrations to lower cost locations, the simplification of our IT structure and the implementation of target operating models. • Within our back office functions, savings of $0.4bn were realised as a result of the re-engineering and simplification of processes and the implementation of global operating models. Share of profit in associates and joint ventures Share of profit in associates – Bank of Communications Co., Limited – The Saudi British Bank – other Share of profit in joint ventures Year ended 31 Dec The number of employees expressed in FTEs at 31 December 2016 was 235,175, a decrease of 20,028 since 31 December 2015. This included a 19,145 reduction following our disposal of operations in Brazil. Excluding Brazil, the decrease in FTE was 883 as a reduction of 17,855 FTEs realised across global businesses and global functions was partly offset by investment in our Global Standards Programme of 5,694 FTEs, costs to achieve FTEs of 8,073 and investment for growth. 2016 $m 2,326 1,892 415 19 28 2,354 2015 $m 2,518 2,011 462 45 38 2,556 2014 $m 2,493 1,974 455 64 39 2,532 Our share of profit in associates and joint ventures was $2.4bn, a decrease of $0.2bn or 8%, which included the adverse effects of currency translation of $0.1bn, notably affecting our share of profit in BoCom. Excluding the impact of currency translation, our share of profit in associates and joint ventures fell by $0.1bn or 4%, relating to higher impairment charges in the Saudi British Bank and lower revenue in HSBC Saudi Arabia, reflecting lower asset management and investment banking revenue. This was partly offset by revenue growth in Saudi British Bank and well- managed costs in both associates. Our share of profit in BoCom for the year was $1.9bn. At 31 December 2016, we performed an impairment review of our investment in BoCom and concluded that it was not impaired, based on our value in use calculation (see Note 20 on the Financial Statements for further details). In future periods, the value in use may increase or decrease depending on the effect of changes to model inputs. It is expected that the carrying amount will increase in 2017 due to retained profits earned by BoCom. At the point where the carrying amount exceeds the value in use, HSBC would continue to recognise its share of BoCom’s profit or loss, but the carrying amount would be reduced to equal the value in use, with a corresponding reduction in income, unless the market value has increased to a level above the carrying amount. Tax expense Profit before tax Tax expense Profit after tax for the year ended 31 Dec Effective tax rate 2016 $m 7,112 (3,666) 3,446 51.55% 2015 $m 18,867 (3,771) 15,096 19.99% 2014 $m 18,680 (3,975) 14,705 21.28% The effective tax rate for 2016 of 51.6% was higher than the 20.0% in 2015, reflecting events that occurred in 2016 that reduced the reported profit before tax but not taxable profits. These included the non-deductible goodwill impairment and the non-deductible loss on our disposal of operations in Brazil. The 2016 tax charge includes tax losses not recognised, prior year adjustments and the impact of the 8% bank corporation tax surcharge applicable in the UK from 1 January 2016. Further detail is provided in Note 7 of the Financial Statements. 40 HSBC Holdings plc Annual Report and Accounts 2016 Consolidated balance sheet Five-year summary consolidated balance sheet Assets Cash and balances at central banks Trading assets Financial assets designated at fair value Derivatives Loans and advances to banks Loans and advances to customers Reverse repurchase agreements – non-trading Financial investments Assets held for sale Other assets Total assets at 31 Dec Liabilities and equity Liabilities Deposits by banks Customer accounts Repurchase agreements – non-trading Trading liabilities Financial liabilities designated at fair value Derivatives Debt securities in issue Liabilities of disposal groups held for sale Liabilities under insurance contracts Other liabilities Total liabilities at 31 Dec Equity Total shareholders’ equity Non-controlling interests Total equity at 31 Dec Total liabilities and equity at 31 Dec For footnote, see page 63. Five-year selected financial information Footnote 2016 $m 2015 $m 2014 $m 2013 $m 2012 $m 15 128,009 235,125 24,756 290,872 88,126 861,504 160,974 436,797 4,389 144,434 98,934 224,837 23,852 288,476 90,401 924,454 146,255 428,955 43,900 139,592 129,957 304,193 29,037 345,008 112,149 974,660 161,713 415,467 7,647 166,599 303,192 38,430 282,265 120,046 992,089 179,690 425,925 4,050 154,308 159,032 141,532 408,811 33,582 357,450 117,085 962,972 70,112 421,101 19,269 160,624 2,374,986 2,409,656 2,634,139 2,671,318 2,692,538 59,939 54,371 77,426 86,507 95,480 1,272,386 1,289,586 1,350,642 1,361,297 1,311,396 88,958 153,691 86,832 279,819 65,915 2,790 75,273 80,400 141,614 66,408 281,071 88,949 36,840 69,938 107,432 190,572 76,153 340,669 95,947 6,934 73,861 164,220 207,025 89,084 274,284 104,080 2,804 74,181 40,567 304,563 87,720 358,886 119,461 5,018 68,195 106,805 102,961 114,525 117,377 118,123 2,192,408 2,212,138 2,434,161 2,480,859 2,509,409 175,386 188,460 190,447 181,871 175,242 7,192 9,058 9,531 8,588 7,887 182,578 197,518 199,978 190,459 183,129 2,374,986 2,409,656 2,634,139 2,671,318 2,692,538 Called up share capital Capital resources Undated subordinated loan capital Preferred securities and dated subordinated loan capital Risk-weighted assets Financial statistics Loans and advances to customers as a percentage of customer accounts Average total shareholders’ equity to average total assets Net asset value per ordinary share at year-end ($) Number of $0.50 ordinary shares in issue (millions) Closing foreign exchange translation rates to $: $1: £ $1: € For footnotes, see page 63. Footnotes 16, 17 18 16 19 2016 $m 10,096 172,358 1,967 42,600 2015 $m 9,842 2014 $m 9,609 2013 $m 9,415 2012 $m 9,238 189,833 190,730 194,009 180,806 2,368 42,844 2,773 47,208 2,777 48,114 2,778 48,260 857,181 1,102,995 1,219,765 1,092,653 1,123,943 67.7 7.37 7.91 71.7 7.31 8.73 72.2 7.01 9.28 72.9 6.55 9.27 73.4 6.16 9.09 20,192 19,685 19,218 18,830 18,476 0.811 0.949 0.675 0.919 0.642 0.823 0.605 0.726 0.619 0.758 A more detailed consolidated balance sheet is contained in the Financial Statements on page 186. HSBC Holdings plc Annual Report and Accounts 2016 41 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Financial summary Combined view of customer lending and customer deposits Footnote 2016 $m 2015 $m Combined customer lending Loans and advances to customers 861,504 924,454 Loans and advances to customers reported in ‘Assets held for sale’ – Brazil – other At 31 Dec Combined customer deposits Customer accounts Customer accounts reported in ‘Liabilities of disposal groups held for sale’ – Brazil – other At 31 Dec For footnote, see page 63. Movement in 2016 20 20 3,623 — 3,623 19,021 17,001 2,020 865,127 943,475 1,272,386 1,289,586 2,713 — 2,713 16,682 15,094 1,588 1,275,099 1,306,268 Total reported assets of $2.4tn were 1% lower than at 31 December 2015 on a reported basis, and 5% higher on a constant currency basis. We have maintained the strength of our balance sheet, as targeted asset growth was partly offset by reductions in our legacy portfolios and the completion of our sale of operations in Brazil to Banco Bradesco S.A. We also issued more than $30bn of senior debt during the year from HSBC Holdings to build up the Group’s total loss-absorbing capacity in line with anticipated regulatory requirements. Our ratio of customer advances to customer accounts was 68%. Loans and advances to customers fell on a reported basis by $63bn and customer accounts fell on a reported basis by $17bn. These changes included: • adverse currency translation movements of $62bn on loans and advances to customers and $81bn on customer accounts; • a $9bn reduction in corporate overdraft and current account balances relating to a small number of clients in our Global Liquidity and Cash Management business in the UK that settled their overdraft and deposit balances on a net basis; and • an $11bn transfer to ‘Assets held for sale’ of US first lien mortgage balances in Corporate Centre. Excluding these movements, customer lending increased by $19bn, as a result of strong fourth-quarter growth in Asia and increases in Europe throughout the year. Assets Cash and balances at central banks increased by $29bn or 29%, primarily from higher euro denominated balances in continental Europe, and in the US. Trading assets increased by $10bn, mainly in Hong Kong and the US. This included higher balances in settlement accounts and an increase in debt and equity securities. Reverse repurchase agreements – non-trading increased by $15bn, primarily in the US, as we managed our surplus liquidity to maximise returns. Assets held for sale reduced by $40bn, of which $42bn related to our disposal of operations in Brazil. Loans and advances to customers decreased by $63bn on a reported basis, primarily in Europe (down $48bn) and North America (down $17bn), partly offset by Asia (up $9bn). This included: • adverse currency translation movements of $62bn; 42 HSBC Holdings plc Annual Report and Accounts 2016 • a $9bn reduction in corporate overdraft balances in Europe, with a corresponding fall in corporate customer accounts; and • an $11bn transfer to ‘Assets held for sale’ of US first lien mortgage balances in Corporate Centre, reflecting our strategic focus on reducing our legacy portfolios. (We sold most of these loans during 2016). Excluding these factors, customer lending balances increased by $19bn or 2%. We grew balances in Asia by $13bn, notably in Hong Kong in both GB&M ($8bn) and CMB ($4bn) in term lending, although trade lending remained broadly unchanged. We also grew RBWM balances ($4bn), particularly in mortgages in Hong Kong. We recorded particularly strong growth in the fourth quarter ($20bn) in the region. In addition, we increased balances in Europe by $15bn as a result of higher term lending in CMB and mortgages in RBWM, both mainly in the UK. By contrast, US GB&M balances fell, reflecting our active management of overall client returns. Liabilities Customer accounts at 31 December 2016 were $17bn lower than at 31 December 2015 and included: • adverse currency translation movements of $81bn; and • a $9bn reduction in corporate current account balances, in line with a fall in corporate overdraft positions. Excluding these factors, customer accounts grew by $73bn, primarily in RBWM and in GLCM in Hong Kong and the UK, with the latter driven by targeted customer mandate acquisition. Trading liabilities increased by $12bn, mainly in the US, reflecting an increase in settlement accounts and net short positions from increased trading activity at the end of 2016, compared with the same period in 2015. Financial liabilities designated at fair value increased by $20bn, reflecting new issuances of senior debt by HSBC Holdings. Debt securities in issue fell by $23bn, mainly in HSBC Bank plc., following reductions in commercial paper issuances. These have been replaced by intra-group funding from HSBC Holdings from total loss-absorbing capacity resources. In the US, balances also fell, reflecting a lower funding requirement as we continued to run off legacy portfolios. Liabilities of disposal groups held for sale decreased by $34bn, reflecting the completion of our sale of operations in Brazil. Equity Total shareholders’ equity fell by $13.1bn or 7%. The effects of profits generated in the year were more than offset by dividends paid and an increase in accumulated foreign exchange losses, reflecting the significant appreciation of the US dollar against the British pound and the euro. The net increase in treasury shares, principally reflecting our share buy-back initiative, also reduced shareholders’ equity by $2.5bn. Risk-weighted assets Risk-weighted assets (‘RWAs’) were $857.2bn at 31 December 2016, a decrease of $245.8bn compared with 31 December 2015. After foreign currency translation differences, RWAs reduced by $207.7bn in 2016. This reflected targeted RWA- reduction initiatives of $143.2bn and the change of regulatory treatment of our investment in BoCom reducing RWAs by $120.9bn. This was partly offset by book size increases of $38.7bn. The RWA initiatives included: • exposure reductions, process improvements and refined calculations, which reduced RWAs by $69.8bn, 55% of which were in GB&M; • the disposal of our activities in Brazil, which reduced RWAs by $41.8bn; and • an accelerated sell-down of our consumer mortgage portfolio in the US and our Legacy Credit book, together contributing $31.6bn to the reduction The book size increase of $38.7bn primarily came from higher term lending to corporate customers in CMB and higher general lending to customers in GB&M, both mainly in Europe and Asia. Customer accounts by country Europe – UK – France – Germany – Switzerland – other Asia – Hong Kong – Mainland China – Singapore – Australia – Malaysia – Taiwan – India – Indonesia – other Middle East and North Africa (excluding Saudi Arabia) – United Arab Emirates – Turkey – Egypt – other North America – US – Canada – other Latin America – Mexico – other At 31 Dec 2016 $m 446,615 361,278 35,996 13,925 9,474 25,942 631,723 461,626 46,576 39,062 18,030 12,904 11,731 11,289 5,092 25,413 34,766 16,532 4,122 3,790 10,322 138,790 88,751 42,096 7,943 20,492 14,423 6,069 2015 $m 491,520 404,084 35,635 13,873 10,448 27,480 598,620 421,538 46,177 41,307 17,703 14,114 11,812 11,795 5,366 28,808 42,824 18,281 6,356 6,602 11,585 135,152 86,322 39,727 9,103 21,470 15,798 5,672 1,272,386 1,289,586 HSBC Holdings plc Annual Report and Accounts 2016 43 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Financial summary / Global businesses Global businesses and geographical regions Change in reportable segments Analysis of adjusted results by global business Reconciliation of reported and adjusted items Reconciliation of reported and adjusted items - global businesses Retail Banking and Wealth Management Commercial Banking Global Banking and Markets Global Private Banking Corporate Centre Analysis of reported results by geographical regions Reconciliation of reported and adjusted items - geographical regions Analysis of reported results by country Page 44 45 47 48 51 52 52 53 53 54 56 59 Change in reportable segments (Audited) The Group Chief Executive as supported by the GMB is considered to be the CODM for the purposes of identifying the Group’s reportable segments. They review operating activity on a number of bases, including by global business and geographical region. While in 2015 we considered the reportable segments to be the geographical regions, over time the focus of internal management reporting provided to the GMB and CODM has moved towards global business. The shift in internal reporting was further augmented in 2016 to include financial information and metrics on the consumption of, and returns on, capital by global business to support the GMB assessment of business performance and the allocation of capital resources. As a result global business is now the most prominent view used by management to allocate resources and assess performance, and is considered to be the Group’s reportable segment. In addition, we made the following realignments within our internal reporting to the GMB and CODM: • Creation of a Corporate Centre: Certain functions were combined to create a Corporate Centre. These include Balance Sheet Management, legacy businesses and interests in associates and joint ventures. The Corporate Centre also includes the results of our financing operations, central support costs with associated recoveries and the UK bank levy, previously reported within Other. • Reallocation of Head Office costs: We have reviewed central costs previously reported in Other and reallocated them to the global businesses where appropriate. Residual costs are reported within the Corporate Centre. • Customer realignment: We conducted a number of internal reviews aligning customer requirements to those global businesses best suited to service their respective needs, resulting in the transfer of a portfolio of customers from CMB to GB&M and the transfer of certain policyholders in Asia from CMB to RBWM during the year. Comparative data have been represented accordingly. In addition, geographical comparative data for Europe and Middle East and North Africa have been re-presented to reflect the management oversight provided by our Middle East and North Africa region following the management services agreement entered between HSBC Bank plc and HSBC Bank Middle East Limited in 2016 in respect of HSBC Bank A.S. (Turkey). Basis of preparation Following the changes in internal reporting to the CODM, analysis by global business is considered more prominent than the geographical region view in the way the CODM assesses performance and allocates resources. The global businesses are therefore considered our reportable segments under IFRS 8. Global business results are assessed by the CODM on the basis of adjusted performance that removes the effects of significant items and currency translation from reported results. We therefore present these results on an adjusted basis as required by IFRSs. The 2015 and 2014 adjusted performance comparative information is presented on a constant currency basis as described on page 45. As required by IFRS 8, reconciliations of the total adjusted global business results of the Group reported results are presented on page 46. Supplementary reconciliations from reported to adjusted results by global business are presented on pages 47 to 51 for information purposes. Our operations are closely integrated and, accordingly, the presentation of data includes internal allocations of certain items of income and expense. These allocations include the costs of certain support services and global functions to the extent that they can be meaningfully attributed to operational business lines and geographical regions. While such allocations have been made on a systematic and consistent basis, they necessarily involve a degree of subjectivity. Costs which are not allocated to global businesses are included in the Corporate Centre. Where relevant, income and expense amounts presented include the results of inter-segment funding along with inter-company and inter- business line transactions. All such transactions are undertaken on arm’s length terms. The intra-Group elimination items for the global businesses are presented in the Corporate Centre. The expense of the UK bank levy is included in the Europe geographical region as HSBC regards the levy as a cost of being headquartered in the UK. For the purposes of the presentation by global business, the cost of the levy is included in the Corporate Centre. The results of geographical regions are presented on a reported basis. A description of the global businesses is provided in the Strategic Report, pages 3, 18 and 19. 44 HSBC Holdings plc Annual Report and Accounts 2016 Analysis of adjusted results by global business (Audited) HSBC adjusted profit before tax and balance sheet data Retail Banking and Wealth Management Commercial Banking 2016 Global Banking and Markets Global Private Banking Footnotes $m $m $m 21 34 22 37 21 34 22 Profit before tax Net interest income Net fee income/(expense) Net trading income Other income/(expenses) Net operating income before loan impairment charges and other credit risk provisions – external – inter-segment Loan impairment (charges)/recoveries and other credit risk provisions Net operating income Total operating expenses Operating profit/(loss) Share of profit in associates and joint ventures Adjusted profit before tax Share of HSBC’s adjusted profit before tax Adjusted cost efficiency ratio Adjusted balance sheet data Loans and advances to customers (net) Interests in associates and joint ventures Total external assets Customer accounts Adjusted risk-weighted assets (unaudited) Profit before tax Net interest income Net fee income/(expense) Net trading income Other income Net operating income before loan impairment charges and other credit risk provisions – external – inter-segment Loan impairment charges and other credit risk provisions Net operating income Total operating expenses Operating profit Share of profit in associates and joint ventures Adjusted profit before tax Share of HSBC’s adjusted profit before tax Adjusted cost efficiency ratio Adjusted balance sheet data Loans and advances to customers (net) Interests in associates and joint ventures Total external assets Customer accounts Adjusted risk-weighted assets (unaudited) 37 13,198 4,839 435 453 18,925 16,319 2,606 (1,171) 17,754 (12,441) 5,313 20 5,333 % 27.6 65.7 $m 8,689 3,627 447 124 4,923 3,392 6,327 277 12,887 12,953 14,919 17,798 (66) (2,879) (1,000) (457) 11,887 14,462 (5,835) 6,052 — 6,052 % 31.4 45.3 $m (8,865) 5,597 — 5,597 % 29.0 59.4 $m $m 809 749 183 16 1,757 1,498 259 1 1,758 (1,469) 289 — 289 % 1.5 83.6 $m 306,056 281,930 225,855 35,456 395 413,287 590,502 111,899 — 306,256 341,729 274,893 — 925,187 256,095 299,629 — 41,459 69,850 15,213 12,579 5,545 443 675 19,242 16,763 2,479 (1,060) 18,182 (12,514) 5,668 22 5,690 % 29.1 65.0 $m 8,461 3,739 462 91 12,753 12,863 (110) (1,434) 11,319 (5,896) 5,423 — 5,423 % 27.8 46.2 $m 201535 4,514 3,500 6,175 377 14,566 17,055 (2,489) (74) 14,492 (8,958) 5,534 — 5,534 % 28.3 61.5 $m 296,607 269,758 231,215 393 399,866 548,835 113,268 — 296,380 327,285 270,915 — 842,437 240,971 308,189 824 933 204 4 1,965 1,690 275 (11) 1,954 (1,567) 387 — 387 % 2.0 79.7 $m 41,161 — 49,241 78,318 17,121 Corporate Centre $m 1,243 (63) 2,542 (2,057) 1,665 1,585 80 Total $m 28,862 12,544 9,934 (1,187) 50,153 50,153 — (25) (2,652) 1,640 (1,946) (306) 2,335 2,029 % 10.5 116.9 $m 12,207 19,634 47,501 (30,556) 16,945 2,355 19,300 % 100.0 60.9 $m 861,504 20,029 688,797 2,374,986 14,210 1,272,386 150,327 851,961 2,241 (119) 655 116 2,893 3,048 (155) (25) 2,868 (2,795) 73 2,421 2,494 % 12.8 96.6 $m 28,619 13,598 7,939 1,263 51,419 51,419 — (2,604) 48,815 (31,730) 17,085 2,443 19,528 % 100.0 61.7 $m 23,451 18,080 625,813 13,337 305,691 862,192 18,473 2,213,737 1,208,746 1,015,184 HSBC Holdings plc Annual Report and Accounts 2016 45 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Global businesses HSBC adjusted profit before tax and balance sheet data (continued) 201435 Retail Banking and Wealth Management Commercial Banking Global Banking and Markets Global Private Banking Footnotes $m $m $m Profit before tax Net interest income Net fee income/(expense) Net trading income/(expense) Other income Net operating income before loan impairment charges and other credit risk provisions – external – inter-segment Loan impairment (charges)/recoveries and other credit risk provisions Net operating income Total operating expenses Operating profit Share of profit in associates and joint ventures Adjusted profit before tax 21 34 22 Share of HSBC’s adjusted profit before tax Adjusted cost efficiency ratio Adjusted balance sheet data Loans and advances to customers (net) Interests in associates and joint ventures Total external assets Customer accounts Adjusted risk-weighted assets (unaudited) 37 For footnotes, see page 63. 12,400 5,572 380 623 18,975 17,050 1,925 (901) 18,074 (11,964) 6,110 40 6,150 % 28.6 63.1 $m 8,094 3,809 479 216 12,598 13,103 (505) (894) 11,704 (5,576) 6,128 — 6,128 % 28.4 44.3 $m 4,148 3,412 5,261 757 13,578 15,406 (1,828) (408) 13,170 (8,246) 4,924 — 4,924 % 22.8 60.7 $m Corporate Centre $m 3,103 (115) (18) 929 3,899 3,771 128 291 4,190 (2,723) 1,467 2,342 3,809 % 17.7 69.8 $m Total $m 28,606 13,649 6,345 2,529 51,129 51,129 — (1,901) 49,228 (30,060) 19,168 2,382 21,550 % 100.0 58.8 $m $m 861 971 243 4 2,079 1,799 280 11 2,090 (1,551) 539 — 539 % 2.5 74.6 $m 287,496 259,053 228,323 40,928 383 385,926 514,074 109,526 — 288,755 309,152 262,634 — 928,215 261,110 349,661 — 51,283 78,592 17,660 28,844 16,801 844,644 17,184 640,404 2,294,583 23,681 1,186,609 343,882 1,083,363 46 HSBC Holdings plc Annual Report and Accounts 2016 Reconciliation of reported and adjusted items (Audited) Adjusted results reconciliation 2016 Significant items Adjusted Reported Adjusted Currency translation Significant items Reported Adjusted Currency translation Significant items Reported 2015 2014 Footnote $m $m $m $m 22 50,153 (2,187) 47,966 51,419 $m 3,001 $m $m $m 5,380 59,800 51,129 $m 7,612 $m $m 2,507 61,248 (2,652) (748) (3,400) (2,604) (184) (933) (3,721) (1,901) (918) (1,032) (3,851) (30,556) (9,252) (39,808) (31,730) (2,091) (5,947) (39,768) (30,060) (5,433) (5,756) (41,249) 2,355 (1) 2,354 2,443 114 (1) 2,556 2,382 150 — 2,532 19,300 (12,188) 7,112 19,528 840 (1,501) 18,867 21,550 1,411 (4,281) 18,680 Revenue LICs Operating expenses Share of profit in associates and joint ventures Profit/(loss) before tax Adjusted balance sheet reconciliation 2016 Brazil operations Adjusted Reported Adjusted Currency translation Brazil operations Reported Adjusted Currency translation Brazil operations Reported 2015 2014 $m $m $m $m $m $m $m $m $m $m $m Loans and advances to customers (net) Interests in associates and joint ventures Total external assets Customer accounts 861,504 20,029 2,374,986 1,272,386 Adjusted profit reconciliation — — 861,504 862,192 62,262 — 924,454 844,644 110,001 20,015 974,660 20,029 18,473 666 — 19,139 17,184 990 7 18,181 — 2,374,986 2,213,737 145,747 50,172 2,409,656 2,294,583 289,936 49,620 2,634,139 — 1,272,386 1,208,746 80,840 — 1,289,586 1,186,609 145,084 18,949 1,350,642 For the year ended 31 Dec Adjusted profit before tax DVA on derivative contracts Fair value movements on non-qualifying hedges Gain on disposal of our membership interest in Visa – Europe Gain on disposal of our membership interest in Visa – US Gain on sale of shareholding in Bank of Shanghai Gain on the partial sale of shareholding in Industrial Bank (Loss)/gain and trading results from disposals and changes in ownership levels Impairment of our investment in Industrial Bank Own credit spread Portfolio disposals Releases/(provisions) arising from the ongoing review of compliance with the UK Consumer Credit Act Charge in relation to the settlement agreement with the Federal Housing Finance Authority Footnotes 23 24 Costs associated with portfolio disposals Costs to achieve Costs to establish UK ring-fenced bank Impairment of GPB – Europe goodwill Regulatory provisions in GPB Restructuring and other related costs Settlements and provisions in connection with legal matters UK customer redress programmes Currency translation Reported profit before tax For footnotes, see page 63. 2016 $m 19,300 26 (687) 584 116 — — (2,081) — (1,792) (163) 2 — (28) (3,118) (223) (3,240) (344) — (681) (559) 7,112 2015 $m 19,528 230 (327) — — — 1,372 — (78) — 1,002 (214) (10) — — (908) (89) — (172) (117) (1,649) (541) 840 18,867 2014 $m 21,550 (332) (541) — — 428 (163) (271) 417 168 (632) (550) — — — — (65) (278) (1,187) (1,275) 1,411 18,680 HSBC Holdings plc Annual Report and Accounts 2016 47 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Global businesses Reconciliation of reported and adjusted items – global businesses Supplementary unaudited analysis of significant items by global business is presented below. 2016 compared with 2015 and 2014 Revenue Reported Significant items – DVA on derivative contracts – fair value movements on non-qualifying hedges 23 – gain on disposal of our membership interest in Visa – Europe – gain on disposal of our membership interest in Visa – 24 US – own credit spread – portfolio disposals – releases arising from the ongoing review of compliance with the UK Consumer Credit Act – loss and trading results from disposed-of operations in Brazil Adjusted Loan impairment charge and other credit risk provisions (‘LICs’) Reported Significant items – trading results from disposed-of operations in Brazil Adjusted Operating expenses Reported Significant items – costs associated with portfolio disposals – costs to achieve – costs to establish UK ring-fenced bank – impairment of GPB – Europe goodwill – regulatory provisions in GPB – settlements and provisions in connection with legal matters – UK customer redress programmes – trading results from disposed-of operations in Brazil Adjusted Share of profit in associates and joint ventures Reported Significant items – trading results from disposed-of operations in Brazil Adjusted Profit/(loss) before tax Reported Significant items – revenue – LICs – operating expenses – share of profit in associates and joint ventures Adjusted Retail Banking and Wealth Management Commercial Banking 2016 Global Banking and Markets Global Private Banking Corporate Centre $m $m $m $m $m Total $m Footnotes 22 15,213 1,745 (2,735) 47,966 20,338 (1,413) — — 13,405 (518) — — (354) (230) (72) — — — — — — — (294) (26) — — — — — — (987) (288) (268) 18,925 12,887 14,919 1,757 12 — — — — — 26 (2) (12) 4,400 2,187 — 687 (26) 687 — (584) (44) (116) 1,792 137 1,792 163 — (2) 1,828 1,665 273 50,153 (1,633) (1,272) 462 462 272 272 (1,171) (1,000) (14,138) 1,697 (6,087) 252 — 393 2 — — — 497 805 (12,441) 20 — — 20 4,587 746 (1,413) 462 1,697 — 5,333 — 62 1 — — — 34 155 (5,835) — — — — 6,046 6 (518) 272 252 — (471) 14 14 (457) (9,302) 437 — 233 — — — 94 28 82 1 — — 1 (25) (3,400) — — 748 748 (25) (2,652) (5,074) 3,605 (5,207) (39,808) 3,261 9,252 10 6 — 3,240 341 — — 8 18 2,424 220 — 3 587 — 9 28 3,118 223 3,240 344 681 559 1,059 (8,865) (1,469) (1,946) (30,556) — — — — 5,440 157 (294) 14 437 — — — — — (3,328) 3,617 12 — 3,605 — 289 2,334 2,354 1 1 1 1 2,335 2,355 (5,633) 7,662 4,400 — 3,261 1 7,112 12,188 2,187 748 9,252 1 2,029 19,300 6,052 5,597 48 HSBC Holdings plc Annual Report and Accounts 2016 Reconciliation of reported and adjusted items (continued) Revenue Reported Currency translation Significant items – DVA on derivative contracts – fair value movements on non-qualifying hedges – gain on the partial sale of shareholding in Industrial – own credit spread – portfolio disposals – provisions/(releases) arising from the ongoing review of compliance with the UK Consumer Credit Act – trading results from disposed-of operations in Brazil Footnotes 22 23 24 Adjusted LICs Reported Currency translation Significant items – trading results from disposed-of operations in Brazil Adjusted Operating expenses Reported Currency translation Significant items – costs to achieve – costs to establish UK ring-fenced bank – regulatory provisions in GPB – restructuring and other related costs – settlements and provisions in connection with legal matters – UK customer redress programmes – trading results from disposed-of operations in Brazil Adjusted Share of profit in associates and joint ventures Reported Currency translation Significant items – trading results from disposed-of operations in Brazil Adjusted Profit/(loss) before tax Reported Currency translation Significant items – revenue – LICs – operating expenses – share of profit in associates and joint ventures Adjusted Retail Banking and Wealth Management Commercial Banking 201535 Global Banking and Markets Global Private Banking Corporate Centre $m $m $m $m $m 14,198 15,972 2,076 22,624 (1,288) (2,094) — — — — — 22 (2,116) 19,242 (790) (655) — — — — — 18 (673) 12,753 (1,878) (1,761) 105 713 713 76 251 251 (1,060) (1,434) (724) (682) (230) — — — — — (452) 14,566 (47) 4 (31) (31) (74) (54) (57) — — — — — (30) (27) 4,930 (145) (1,892) — 327 (1,372) (1,002) 214 — (59) 1,965 2,893 (13) 2 — — (11) (22) (3) — — (25) Total $m 59,800 (3,001) (5,380) (230) 327 (1,372) (1,002) 214 10 (3,327) 51,419 (3,721) 184 933 933 (2,604) (15,970) (6,852) (10,767) (1,840) (4,339) (39,768) 1,015 2,441 153 — — 9 — 541 1,738 (12,514) 23 (1) — — 22 4,799 (169) 1,060 (2,094) 713 2,441 — 5,690 352 604 163 — — 5 — 18 418 (5,896) — — — — — 5,585 (362) 200 (655) 251 604 — 5,423 573 1,236 69 — — 22 949 (19) 215 46 227 16 — 171 18 — — 22 105 1,439 507 89 1 63 700 1 78 2,091 5,947 908 89 172 117 1,649 541 2,471 (8,958) (1,567) (2,795) (31,730) — — — — — 5,158 (147) 523 (682) (31) 1,236 — 5,534 — — — — — 223 (6) 170 (57) — 227 — 387 2,533 (113) 1 1 2,556 (114) 1 1 2,421 2,443 3,102 18,867 (156) (452) (1,892) — 1,439 1 (840) 1,501 (5,380) 933 5,947 1 2,494 19,528 HSBC Holdings plc Annual Report and Accounts 2016 49 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Global businesses Reconciliation of reported and adjusted items (continued) Footnotes 22 23 24 Revenue Reported Currency translation Significant items – DVA on derivative contracts – fair value movements on non-qualifying hedges – gain on sale of shareholding in Bank of Shanghai – impairment of our investment in Industrial Bank – own credit spread – portfolio disposals – provisions arising from the ongoing review of compliance with the UK Consumer Credit Act – (gain)/loss and trading results from disposals and changes in ownership levels Adjusted LICs Reported Currency translation Significant items – trading results from disposals and changes in ownership levels Adjusted Operating expenses Reported Currency translation Significant items – charge in relation to the settlement agreement with the Federal Housing Finance Authority – regulatory provisions in GPB – restructuring and other related costs – settlements and provisions in connection with legal matters – UK customer redress programmes – trading results from disposals and changes in ownership levels Adjusted Share of profit in associates and joint ventures Reported Currency translation Significant items – trading results from disposals and changes in ownership levels Adjusted Profit/(loss) before tax Reported Currency translation Significant items – revenue – LICs – operating expenses – share of profit in associates and joint ventures Adjusted For footnotes, see page 63. Retail Banking and Wealth Management Commercial Banking 201435 Global Banking and Markets Global Private Banking Corporate Centre $m $m $m $m $m Total $m 61,248 (7,612) (2,507) 332 541 (428) 271 (417) (168) 632 24,056 (3,490) (1,591) 15,197 (1,967) (632) 15,392 (1,725) (89) 332 — — — — — — 2,248 (185) 16 — — — — — — 40 4,355 (245) (211) — 541 (428) 271 (417) (168) — — — — — — — 24 — — — — — — 568 (2,159) 18,975 (656) 12,598 (421) 13,578 (24) 2,079 (10) (3,270) 3,899 51,129 (1,905) (1,551) 488 516 516 (901) 318 339 339 (894) (721) 139 174 174 (408) 8 — 3 3 11 318 (27) — — 291 (3,851) 918 1,032 1,032 (1,901) (17,670) (7,115) (11,257) (1,780) (3,427) (41,249) 2,869 2,837 — — 86 — 992 1,759 (11,964) 41 (1) — — 40 4,522 (134) 1,762 (1,591) 516 2,837 — 6,150 976 563 — — 37 — 138 388 1,455 1,556 — — 27 1,187 145 197 136 93 — 65 6 — — 22 (3) 707 550 — 122 — — 35 5,433 5,756 550 65 278 1,187 1,275 2,401 (5,576) (8,246) (1,551) (2,723) (30,060) — — — — — 6,531 (673) 270 (632) 339 563 — 6,128 — — — — — 3,414 (131) 1,641 (89) 174 1,556 — 4,924 — — — — — 476 (49) 112 16 3 93 — 2,491 (149) 2,532 (150) — — — — 2,342 2,382 3,737 18,680 (424) 496 (211) — 707 — (1,411) 4,281 (2,507) 1,032 5,756 — 539 3,809 21,550 50 HSBC Holdings plc Annual Report and Accounts 2016 Reconciliation of reported and adjusted risk-weighted assets 2016 Retail Banking and Wealth Management Commercial Banking Global Banking and Markets $bn $bn $bn 115.1 (3.2) 111.9 275.9 (1.0) 274.9 300.4 (0.8) 299.6 Global Private Banking $bn 15.3 — 15.3 Corporate Centre $bn 150.5 (0.2) 150.3 130.7 (3.8) (13.6) 113.3 133.7 (12.0) (12.2) 109.5 302.2 (14.9) (16.4) 270.9 312.1 (32.6) (16.9) 262.6 201535 330.3 (9.0) (13.1) 308.2 201435 385.8 (23.2) (12.9) 349.7 18.0 (0.7) (0.2) 17.1 18.9 (1.1) (0.1) 17.7 321.8 (13.0) (3.1) 305.7 369.3 (24.2) (1.2) 343.9 Total $bn 857.2 (5.2) 852.0 1,103.0 (41.4) (46.4) 1,015.2 1,219.8 (93.1) (43.3) 1,083.4 Risk-weighted assets Reported Brazil operations Adjusted Risk-weighted assets Reported Currency translation Brazil operations Adjusted Risk-weighted assets Reported Currency translation Brazil operations Adjusted For footnote, see page 63. Management view of adjusted revenue The tables below provide a breakdown of revenue by major products for RBWM, CMB, GB&M and Corporate Centre. These reflect the basis on which revenue performance of the businesses is assessed and managed. For GPB, the key measure of business performance is client assets, which is presented below. Adjusted return on risk-weighted assets (‘RoRWA’) is used to measure performance of RBWM, CMB, GB&M and GPB and is presented below. Further information on the global businesses can be found in the Strategic Report on pages 18 to 19. A reconciliation of changes in the global businesses is available in the re-segmentation data pack which can be found online at www.hsbc.com/investor-relations. Retail Banking and Wealth Management Management view of adjusted revenue Footnotes 22 2016 $m 2015 $m 2014 $m 12,979 12,806 13,041 5,359 7,620 2,590 3,111 1,919 5,288 2,926 4,941 7,865 2,694 3,312 1,859 5,799 3,262 4,881 8,160 2,758 3,438 1,964 5,331 3,030 1,404 1,553 1,384 958 658 984 637 917 603 18,925 19,242 18,975 % 4.6 % 4.9 % 5.4 26 25 27 38 Net operating income Retail Banking Current accounts, savings and deposits Personal lending – mortgages – credit cards – other personal lending Wealth Management – investment distribution – life insurance manufacturing – asset management Other Year ended 31 Dec RoRWA For footnotes, see page 63. HSBC Holdings plc Annual Report and Accounts 2016 51 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Global businesses RBWM – summary Year ended 31 Dec 2016 Net operating income before loan impairment charges and other credit risk provisions 22 Footnote – net interest income – net fee income/(expense) – other income/(loss) LICs Net operating income Total operating expenses Operating profit/(loss) Income from associates Profit/(loss) before tax Year ended 31 Dec 2015 Net operating income before loan impairment charges and other credit risk provisions 22 – net interest income – net fee income/(expense) – other income LICs Net operating income Total operating expenses Operating profit/(loss) Income from associates Profit/(loss) before tax For footnote, see page 63. Total RBWM $m 18,925 13,198 4,839 888 (1,171) 17,754 (12,441) 5,313 20 5,333 19,242 12,579 5,545 1,118 (1,060) 18,182 (12,514) 5,668 22 5,690 Consists of Banking operations Insurance manufacturing Asset management $m $m $m 16,437 11,292 4,474 671 (1,171) 15,266 (11,415) 3,851 — 3,851 16,548 10,807 5,081 660 (1,060) 15,488 (11,484) 4,004 — 4,004 1,531 1,898 (539) 172 — 1,531 (380) 1,151 20 1,171 1,709 1,763 (493) 439 — 1,709 (364) 1,345 22 1,367 957 8 904 45 — 957 (646) 311 — 311 985 9 957 19 — 985 (666) 319 — 319 Insurance manufacturing for RBWM excluded other global businesses which contributed net operating income of $167m (2015: $171m) and profit before tax of $117m (2015: $108m) to overall insurance manufacturing. In 2016 insurance manufacturing net operating income for RBWM included $1,404m within Wealth Management (2015: $1,553m) and $127m within other products (2015: $156m). In total insurance manufacturing generated $2,634m of annualised new business premiums (2015: $2,349m) of which $2,519m (2015: $2,230m) related to RBWM. Distribution of insurance products by HSBC channels contributed $1,048m of net fee income (2015: $994m) of which RBWM channels earned $922m (2015: $896m). Of this total income, $615m was in respect of HSBC manufactured products (2015: $568m) and a corresponding fee expense is therefore recognised within the Insurance manufacturing. Commercial Banking Global Banking and Markets Management view of adjusted revenue Management view of adjusted revenue Net operating income Global Trade and Receivables Finance Credit and Lending Global Liquidity and Cash Management Markets products, Insurance and Investments and Other Year ended 31 Dec RoRWA Footnotes 22 2016 $m 1,879 5,102 2015 $m 2,077 5,019 2014 $m 2,125 4,688 4,345 4,164 4,014 30 38 1,561 12,887 % 2.1 1,493 1,771 12,753 12,598 % 1.9 % 2.4 Net operating income Global Markets – Credit – Rates – Foreign Exchange – Equities Global Banking Global Liquidity and Cash Management Securities Services Global Trade and Receivables Finance Principal Investments Credit and funding valuation adjustments Other Year ended 31 Dec RoRWA Footnotes 22 28 29 38 2016 $m 6,775 803 2,149 2,813 1,010 3,820 1,951 1,585 702 218 (70) (62) 2015 $m 6,140 631 1,391 2,714 1,404 3,801 1,798 1,620 691 226 227 63 2014 $m 5,488 669 1,172 2,519 1,128 3,521 1,699 1,508 693 467 127 75 14,919 14,566 13,578 % 1.8 % 1.6 % 1.5 The table above has been re-presented. In 2016, ‘Credit and funding valuation adjustments’ of $(70)m is a separate line previously included within ‘Markets’ (2015: $227m). 52 HSBC Holdings plc Annual Report and Accounts 2016 Global Private Banking Corporate Centre Management view of adjusted revenue Management view of adjusted revenue Net operating income Investment Revenue Lending Deposit Other 2016 $m 725 414 343 275 2015 $m 2014 $m 899 416 355 295 954 425 381 319 Net operating income Central Treasury Legacy portfolios – US run-off portfolio – Legacy credit Year ended 31 Dec 1,757 1,965 2,079 Other Year ended 31 Dec Footnotes 22 42 43 2016 $m 1,504 715 692 23 (554) 1,665 2015 $m 1,905 1,234 1,164 70 (246) 2,893 2014 $m 1,938 1,571 1,548 23 390 3,899 Reported client assets31 Footnote At 1 Jan Net new money – of which: areas targeted Value change Disposals Exchange and other At 31 Dec RoRWA 38 Reported client assets by geography 2016 $bn 349 (17) 2 1 (24) (11) 298 % 1.7 2015 $bn 365 1 14 1 — (18) 349 % 2.1 2014 $bn 382 (3) 14 8 (11) (11) 365 % 2.9 Footnote 40 2016 2015 2014 $bn 147 108 40 3 — 298 $bn 167 112 61 8 1 349 $bn 177 112 63 11 2 365 Europe Asia North America Latin America Middle East At 31 Dec For footnotes, see page 63. HSBC Holdings plc Annual Report and Accounts 2016 53 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Geographical regions Analysis of reported results by geographical regions HSBC reported profit/(loss) before tax and balance sheet data Europe35 Footnotes $m Asia $m Loans and advances to customers (net) 336,670 365,430 30,740 111,710 16,954 – reported in held for sale Total external assets Customer accounts – reported in held for sale 1,057 1,068,446 446,615 2,012 — 965,730 631,723 — 474 60,472 34,766 701 2,092 409,021 138,790 — — 43,137 20,492 — Risk-weighted assets (unaudited) 33 298,384 333,987 59,065 150,714 34,341 Profit/(loss) before tax Net interest income Net fee income/(expense) Net trading income/(expense) Other income/(expense) Net operating income before loan impairment charges and other credit risk provisions Loan impairment charges and other credit risk provisions Net operating income Total operating expenses Operating profit/(loss) Share of profit/(loss) in associates and joint ventures Profit/(loss) before tax Share of HSBC’s profit before tax Cost efficiency ratio Balance sheet data 21 34 22 20 Profit/(loss) before tax Net interest income Net fee income/(expense) Net trading income/(expense) Other income/(expense) Net operating income before loan impairment charges and other credit risk provisions Loan impairment charges and other credit risk provisions Net operating income Total operating expenses Operating profit/(loss) Share of profit/(loss) in associates and joint ventures Profit/(loss) before tax Share of HSBC’s profit before tax Cost efficiency ratio Balance sheet data 21 34 22 20 2016 North America MENA35 Latin America Intra-HSBC items $m $m $m 8,346 4,247 4,949 (2,026) 12,490 1,831 5,200 3,127 2,503 709 385 44 4,220 1,898 462 485 3,006 723 449 (1,492) (3,590) 15,516 23,320 2,969 7,065 2,686 (3,590) 47,966 (446) (677) 15,070 22,643 (21,845) (10,785) (6,775) 11,858 1 1,921 (6,774) 13,779 % (95.2) 140.8 $m % 193.7 46.2 $m (316) 2,653 (1,584) 1,069 434 1,503 % 21.1 53.4 $m (732) 6,333 (6,147) 186 (1) 185 % 2.6 87.0 $m (1,229) 1,457 (3,037) (1,580) (1) (1,581) % (22.2) 113.1 $m $m (80) — 80 Total $m 29,813 12,777 9,452 (4,076) — (3,590) 3,590 — — — $m — — (3,400) 44,566 (39,808) 4,758 2,354 7,112 % 100.0 83.0 $m 861,504 3,623 (171,820) 2,374,986 — — — 1,272,386 2,713 857,181 9,686 4,702 3,968 2,116 12,184 6,032 3,090 3,997 1,849 822 418 90 2015 4,532 2,018 545 562 4,318 1,131 664 479 (38) — 38 (3,403) 32,531 14,705 8,723 3,841 20,472 25,303 3,179 7,657 6,592 (3,403) 59,800 (519) 19,953 (19,274) 679 9 688 % 3.6 94.1 $m (693) 24,610 (10,889) 13,721 2,042 15,763 % 83.5 43.0 $m (470) 2,709 (1,721) 988 504 1,492 % 7.9 54.1 $m (544) 7,113 (6,501) 612 2 614 % 3.3 84.9 $m (1,495) 5,097 (4,786) 311 (1) 310 % 1.7 72.6 $m 17,293 17,001 86,262 21,470 15,094 73,425 — (3,403) 3,403 — — — $m — — (151,871) — — — (3,721) 56,079 (39,768) 16,311 2,556 18,867 % 100.0 66.5 $m 924,454 19,021 2,409,656 1,289,586 16,682 1,102,995 Loans and advances to customers (net) 385,037 356,375 36,898 128,851 – reported in held for sale Total external assets Customer accounts – reported in held for sale — 1,121,401 491,520 — — 889,747 598,620 — — 70,157 42,824 — 2,020 393,960 135,152 1,588 Risk-weighted assets (unaudited) 33 327,219 459,680 70,585 191,611 54 HSBC Holdings plc Annual Report and Accounts 2016 Footnotes Net interest income Net fee income Net trading income/(expense) Other income/(expense) Net operating income before loan impairment charges and other credit risk provisions Loan impairment charges and other credit risk provisions Net operating income Total operating expenses Operating profit/(loss) Share of profit in associates and joint ventures Profit/(loss) before tax Share of HSBC’s profit before tax Cost efficiency ratio Balance sheet data 21 34 22 20 Europe $m 10,115 5,738 2,557 2,394 Asia $m 12,273 5,910 2,622 2,872 MENA $m 2,014 954 292 79 2014 North America $m 5,015 1,940 411 786 Latin America Intra-HSBC items $m 5,310 1,415 856 691 $m (22) — 22 (2,996) Total $m 34,705 15,957 6,760 3,826 20,804 23,677 3,339 8,152 8,272 (2,996) 61,248 (518) 20,286 (19,633) 653 6 659 % 3.6 94.4 $m (647) 23,030 (10,427) 12,603 2,022 14,625 % 78.3 44.0 $m (240) 3,099 (1,824) 1,275 488 1,763 % 9.4 54.6 $m (322) 7,830 (6,429) 1,401 16 1,417 % 7.6 78.9 $m (2,124) 6,148 (5,932) 216 — 216 % 1.1 71.7 $m — (2,996) 2,996 — — — $m — — (3,851) 57,397 (41,249) 16,148 2,532 18,680 % 100.0 67.3 $m 974,660 577 (153,223) 2,634,139 — — — 1,350,642 145 1,219,765 Loans and advances to customers (net) 401,642 362,955 37,154 129,787 43,122 – reported in held for sale Total external assets Customer accounts – reported in held for sale 91 1,279,817 538,104 145 — 878,723 577,491 — — 76,609 47,575 — 486 436,859 138,884 — — 115,354 48,588 — Risk-weighted assets (unaudited) 33 363,473 499,846 74,785 221,378 88,781 For footnotes, see page 63. HSBC Holdings plc Annual Report and Accounts 2016 55 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Geographical regions Reconciliation of reported and adjusted items – geographical regions 2016 compared with 2015 and 2014 Revenue Reported Significant items – DVA on derivative contracts – fair value movements on non-qualifying hedges – gain on disposal of our membership interest in Visa – Europe – gain on disposal of our membership interest in Visa – US – own credit spread – portfolio disposals – releases arising from the ongoing review of compliance with the UK Consumer Credit Act – loss and trading results from disposed-of operations in Brazil Adjusted LICs Reported Significant items – trading results from disposed-of operations in Brazil Adjusted Operating expenses Reported Significant items – costs associated with portfolio disposals – costs to achieve – costs to establish UK ring-fenced bank – impairment of GPB – Europe goodwill – regulatory provisions in GPB – settlements and provisions in connection with legal matters – UK customer redress programmes – trading results from disposed-of operations in Brazil Adjusted Share of profit in associates and joint ventures Reported Significant items – trading results from disposed-of operations in Brazil Adjusted Profit/(loss) before tax Reported Significant items – revenue – LICs – operating expenses – share of profit in associates and joint ventures Adjusted Footnotes Europe $m Asia $m MENA $m 2016 North America Latin America $m $m Total $m UK $m Hong Kong $m 22 32 23 24 15,516 23,320 2,969 7,065 2,686 47,966 10,893 14,014 1,740 (56) 563 (573) — 1,782 26 (2) — (6) (15) 17 — — (8) — — — (11) — — (11) — — — — — 155 9 107 — (116) 18 137 — — 309 36 2,187 1,795 (26) (63) — — — — — — 687 532 (584) (441) (116) 1,792 163 (2) — 1,769 — (2) — 273 273 (1) (22) 26 — — (5) — — — 32 17,256 23,314 2,958 7,220 2,995 50,153 12,688 14,013 (446) (677) (316) (732) (1,229) (3,400) (245) (321) — — — — — — — — 748 748 748 748 — — — — (446) (677) (316) (732) (481) (2,652) (245) (321) 32 (21,845) (10,785) (1,584) (6,147) (3,037) (39,808) (14,562) (5,646) 6,632 28 2,098 223 3,240 390 94 559 — 430 — 476 — — (46) — — — 103 — 103 — — — — — — 989 — 402 — — — 587 — — 1,098 9,252 2,670 — 39 — — — — — 28 3,118 223 3,240 344 681 559 1,059 1,059 — 1,838 223 — — 50 559 — 183 — 229 — — (46) — — — 32 (15,213) (10,355) (1,481) (5,158) (1,939) (30,556) (11,892) (5,463) 1 — — 1 1,921 434 — — — — 1,921 434 (6,774) 13,779 1,503 8,372 1,740 — 6,632 424 (6) — 430 92 (11) — 103 — — — (1) — — (1) 185 1,144 155 — 989 — (1) 1 1 — 2,354 1 1 2,355 1 — — 1 (1,581) 7,112 (3,913) 2,156 12,188 309 748 1,098 2,187 748 9,252 1 1 4,465 1,795 — 2,670 — 552 22 — — 22 8,069 182 (1) — 183 — 8,251 1,598 14,203 1,595 1,329 575 19,300 56 HSBC Holdings plc Annual Report and Accounts 2016 Reconciliation of reported and adjusted items (continued) Footnotes 22 32 32 23 24 Revenue Reported Currency translation Significant items – DVA on derivative contracts – fair value movements on non-qualifying hedges – gain on the partial sale of shareholding in Industrial Bank – own credit spread – portfolio disposals – provisions arising from the ongoing review of compliance with the UK Consumer Credit Act – trading results from disposed-of operations in Brazil Adjusted LICs Reported Currency translation Significant items – trading results from disposed-of operations in Brazil Adjusted Operating expenses Reported Currency translation Significant items – costs to achieve – costs to establish UK ring-fenced bank – regulatory provisions in GPB – restructuring and other related costs – settlements and provisions in connection with legal matters – UK customer redress programmes – trading results from disposed-of operations in Brazil Adjusted Share of profit in associates and joint ventures Reported Currency translation Significant items – trading results from disposed-of operations in Brazil Adjusted Profit/(loss) before tax Reported Currency translation Significant items – revenue – LICs – operating expenses – share of profit in associates and joint ventures Adjusted Asia $m MENA $m 2015 North America Latin America $m $m 25,303 (305) (1,431) (58) 2 (1,372) (3) — — — 3,179 (182) (10) (1) — — (9) — — — 7,657 (60) 98 (21) 124 — (219) 214 — — 6,592 (896) (3,381) (55) 1 — — — — Europe $m 20,472 (1,613) (656) (95) 200 — (771) — 10 — Total $m 59,800 (3,001) (5,380) (230) UK $m 15,493 (1,577) (595) (78) Hong Kong $m 15,616 (20) (1,383) (13) 327 204 6 (1,372) (1,002) 214 10 — (731) — 10 — (1,372) (4) — — — (3,327) (3,327) 32 18,203 23,567 2,987 7,695 2,315 51,419 13,321 14,213 (519) (693) (470) (544) (1,495) (3,721) (248) (155) 36 — — 6 — — 19 — — 3 — — (483) (687) (451) (541) 120 933 933 (442) 184 933 933 39 — — — — — (2,604) (209) (155) 32 32 (19,274) (10,889) (1,721) (6,501) (4,786) (39,768) (15,555) (5,686) 1,287 2,405 600 89 172 68 935 541 — 177 130 122 — — 8 — — — 83 15 14 — — 1 — — — 32 851 103 — — 34 714 — — 567 2,546 69 — — 6 — — 2,091 5,947 908 89 172 117 1,649 541 2,471 2,471 1,253 2,151 536 89 — 50 935 541 — 7 49 43 — — 6 — — — 32 (15,582) (10,582) (1,623) (5,618) (1,673) (31,730) (12,151) (5,630) 9 — — — 9 688 (290) 1,749 (656) — 2,405 — 2,042 (113) — — 504 — — — 1,929 504 15,763 (235) (1,301) (1,431) — 130 — 1,492 (80) 5 (10) — 15 — 2 (1) — — 1 614 (26) 949 98 — 851 — 2,147 14,227 1,417 1,537 (1) — 1 1 — 310 (209) 99 (3,381) 933 2,546 1 200 2,556 (114) 1 1 2,443 18,867 (840) 1,501 (5,380) 933 5,947 1 19,528 10 (1) — — 9 (300) (286) 1,556 (595) — 2,151 — 970 31 — — — 31 9,806 (13) (1,334) (1,383) — 49 — 8,459 HSBC Holdings plc Annual Report and Accounts 2016 57 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Geographical regions Reconciliation of reported and adjusted items (continued) Footnotes 22 32 32 23 24 Asia $m MENA $m 2014 North America Latin America $m $m Total $m UK $m 23,677 (964) (48) 69 4 (428) 271 4 — — 32 3,339 (367) (3) 5 — — — 6 — — (14) 8,152 (311) 116 16 302 — — (34) (168) — — 8,272 (2,703) (3,280) 61,248 (7,612) (2,507) 8 — — — — — — 332 541 (428) 271 (417) (168) 632 (3,288) (3,270) 15,727 (2,574) 353 203 (8) — — (474) — 632 — Hong Kong $m 13,844 (17) (119) 26 11 (428) 271 1 — — — Europe $m 20,804 (3,404) 708 234 235 — — (393) — 632 — 32 18,108 22,665 2,969 7,957 2,289 51,129 13,506 13,708 (518) 137 — — (381) (647) (240) (322) (2,124) (3,851) (214) (320) 38 — — 71 (2) (2) 16 — — 656 1,034 918 1,032 1,034 1,032 81 — — 1 — — (609) (171) (306) (434) (1,901) (133) (319) 32 32 (19,633) (10,427) (1,824) (6,429) (5,932) (41,249) (15,576) (5,424) 2,797 2,600 — 16 122 1,187 1,275 — 509 58 212 34 — 49 9 — — — — — 3 — — 31 158 578 550 — 28 — — — 1,894 2,486 — — 116 — — 5,433 5,756 550 65 278 1,187 1,275 2,165 2,553 — — 91 1,187 1,275 2,370 2,401 — 6 56 — 49 7 — — — 32 (14,236) (9,860) (1,578) (5,693) (1,552) (30,060) (10,858) (5,362) 6 (1) — — 5 659 (471) 3,308 708 — 2,600 — 2,022 (147) — — 488 — — — 1,875 488 14,625 1,763 (564) 10 (48) — 58 — (84) 29 (3) (2) 34 — 16 (2) — — 14 1,417 (139) 694 116 — 578 — 3,496 14,071 1,708 1,972 — — — — — 216 (153) 240 (3,280) 1,034 2,486 — 303 2,532 (150) — — 2,382 18,680 (1,411) 4,281 (2,507) 1,032 5,756 7 (1) — — 6 (56) (329) 2,906 353 — 2,553 — — 42 1 — — 43 8,142 (9) (63) (119) — 56 — 21,550 2,521 8,070 Revenue Reported Currency translation Significant items – DVA on derivative contracts – fair value movements on non-qualifying hedges – gain on sale of shareholding in Bank of Shanghai – impairment of our investment in Industrial Bank – own credit spread – portfolio disposals – provisions arising from the ongoing review of compliance with the UK Consumer Credit Act – (gain)/loss and trading results from disposals and changes in ownership levels Adjusted LICs Reported Currency translation Significant items – trading results from disposals and changes in ownership levels Adjusted Operating expenses Reported Currency translation Significant items – charge in relation to the settlement agreement with the Federal Housing Finance Authority – regulatory provisions in GPB – restructuring and other related costs – settlements and provisions in connection with legal matters – UK customer redress programmes – trading results from disposals and changes in ownership levels Adjusted Share of profit in associates and joint ventures Reported Currency translation Significant items – trading results from disposals and changes in ownership levels Adjusted Profit/(loss) before tax Reported Currency translation Significant items – revenue – LICs – operating expenses – share of profit in associates and joint ventures Adjusted For footnotes, see page 63. 58 HSBC Holdings plc Annual Report and Accounts 2016 Analysis of reported results by country Profit/(loss) before tax by priority markets within global businesses Retail Banking and Wealth Management Commercial Banking Global Banking and Markets Europe – UK – of which: HSBC Holdings 36, 41 Footnotes – France – Germany – Switzerland – other Asia – Hong Kong – Australia – India – Indonesia – Mainland China – Malaysia – Singapore – Taiwan – other Middle East and North Africa – Egypt – UAE – Saudi Arabia – other North America – US – Canada – other Latin America – Mexico – other – of which: Brazil Year ended 31 Dec 2016 $m 524 338 (676) 147 23 — 16 4,115 3,796 108 15 (9) (72) 65 107 24 81 20 58 83 1 (122) 64 (28) 46 46 (136) 94 (230) (281) 4,587 $m 2,129 1,834 (379) 198 68 9 20 2,920 2,191 74 123 66 68 65 43 10 280 290 104 94 — 92 648 336 292 20 59 84 (25) (139) 6,046 $m 1,009 385 (425) 289 142 — 193 3,211 1,298 156 355 110 456 172 170 102 392 652 213 298 — 141 259 86 155 18 309 79 230 176 Global Private Banking $m (3,695) 86 (63) 9 7 (493) (3,304) 268 221 — 10 — (3) — 42 (1) (1) — — — — — 90 67 — 23 9 5 4 4 Corporate Centre $m (6,741) (6,556) (3,748) (53) 13 (7) (138) 3,265 563 31 240 11 2,158 53 77 13 119 541 79 5 434 23 (876) (932) 47 9 (1,822) (15) (1,807) (1,836) (5,633) Total $m (6,774) (3,913) (5,291) 590 253 (491) (3,213) 13,779 8,069 369 743 178 2,607 355 439 148 871 1,503 454 480 435 134 185 (471) 540 116 (1,581) 247 (1,828) (2,076) 7,112 5,440 (3,328) HSBC Holdings plc Annual Report and Accounts 2016 59 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Geographical regions / Other information Profit/(loss) before tax by priority markets within global businesses (continued) Retail Banking and Wealth Management Commercial Banking Global Banking and Markets Global Private Banking Corporate Centre Europe – UK – of which: HSBC Holdings 36, 41 – France – Germany – Switzerland – other Asia – Hong Kong – Australia – India – Indonesia – Mainland China – Malaysia – Singapore – Taiwan – other Middle East and North Africa – Egypt – UAE – Saudi Arabia – other North America – US – Canada – other Latin America – Mexico – other – of which: Brazil Year ended 31 Dec 2015 Europe – UK – of which: HSBC Holdings 36, 41 – France – Germany – Switzerland – other Asia – Hong Kong – Australia – India – Indonesia – Mainland China – Malaysia – Singapore – Taiwan – other Middle East and North Africa – Egypt – UAE – Saudi Arabia – other North America – US – Canada – other Latin America – Mexico – other – of which: Brazil Year ended 31 Dec 2014 For footnotes, see page 63. $m 914 560 (530) 357 23 — (26) 4,154 3,811 60 (25) (6) 32 118 105 10 49 50 85 2 (138) (23) (112) 57 32 (245) 70 (315) (344) $m 1,953 1,722 (399) 130 66 8 27 2,843 2,317 51 79 (128) 97 78 81 17 251 92 (24) — 120 445 194 240 11 156 (8) 164 13 4,799 5,585 352 283 (335) 6 28 — 35 4,239 3,727 78 4 10 31 155 162 18 54 84 64 162 1 (143) 19 (99) 95 23 (172) 4 (176) (230) 2,238 1,917 (321) 215 70 5 31 3,123 2,217 99 101 42 86 108 120 29 321 379 84 158 — 137 799 323 479 (3) (8) (27) 19 (97) $m 122 (361) (274) 84 137 — 262 3,653 1,629 232 321 76 574 196 193 113 319 179 270 — 161 444 319 101 24 329 (70) 399 341 5,158 (1,010) (1,655) (206) 319 139 2 185 3,102 1,163 222 378 101 449 165 181 130 313 695 136 363 — 196 388 215 140 33 239 11 228 79 $m (93) 126 (91) 14 20 (267) 14 252 177 — 14 — (3) — 65 — (1) — — — 2 59 64 — (5) 3 (2) 5 6 223 181 154 (22) — 26 (46) 47 212 145 — 11 — (3) — 57 — 2 — — — — — 87 84 — 3 (4) (2) (2) (2) $m (2,208) (2,347) (2,892) 54 (7) 43 49 4,861 1,872 30 217 51 2,360 50 63 15 203 89 36 498 70 (311) (424) 87 26 67 42 25 (11) 3,102 (1,102) (755) (1,965) (326) 15 81 (117) 3,949 890 33 206 45 2,388 68 69 44 206 605 51 (21) 485 90 124 9 115 — 161 65 96 3 4,522 6,531 3,414 476 3,737 60 HSBC Holdings plc Annual Report and Accounts 2016 Total $m 688 (300) (4,186) 639 239 (216) 326 15,763 9,806 373 606 (7) 3,060 442 507 155 821 410 367 500 215 614 41 485 88 310 32 278 5 18,867 659 (56) (2,849) 214 278 42 181 14,625 8,142 432 700 198 2,951 496 589 221 896 1,763 335 662 486 280 1,417 532 829 56 216 51 165 (247) 18,680 Other information Funds under management and assets held in custody Taxes paid by region and country Conduct-related matters Carbon dioxide emissions Page 61 61 62 62 Funds under management and assets held in custody Funds under management Funds under management Footnote 44 2016 $bn 2015 $bn At 1 Jan Net new money Value change Exchange and other Disposals At 31 Dec Funds under management by business Global Asset Management Global Private Banking Affiliates Other At 31 Dec For footnote, see page 63. 896 (8) 25 (40) (42) 831 410 222 2 197 831 954 (3) 2 (57) – 896 419 261 4 212 896 Funds under management (‘FuM’) represents assets managed, either actively or passively, on behalf of our customers. At 31 December 2016, FuM amounted to $831bn, a decrease of 7% as a result of adverse foreign exchange movements and disposals, which included our sale of operations in Brazil, partly offset by favourable market performance. Global Asset Management FuM decreased by 2% to $410bn compared with 31 December 2015. Excluding currency translation, FuM increased by 3% primarily as a result of positive market performance, with net new money from our retail and institutional customers in Asia into fixed income products being offset by outflows from our customers in Europe and the Americas. GPB FuM decreased by 15% to $222bn compared with 31 December 2015. Excluding currency translation, FuM decreased by 13%, reflecting the ongoing repositioning of our client base. This was partly offset by positive net new money in areas targeted for growth, notably in the UK, the Channel Islands and Hong Kong. Other FuM, of which the main element is a corporate trust business in Asia, decreased by 7% to $197bn. Assets held in custody44 and under administration Custody is the safekeeping and servicing of securities and other financial assets on behalf of clients. At 31 December 2016, we held assets as custodian of $6.3tn, 1% higher than the $6.2tn held at 31 December 2015. The increase was driven by favourable foreign exchange movements in Asia, together with the onboarding of new clients in Europe and Asia. This was partly offset by adverse foreign exchange movements in the UK. Our Assets Under Administration business, which includes the provision of bond and loan administration services and the valuation of portfolios of securities and other financial assets on behalf of clients, complements the Custody business. At 31 December 2016, the value of assets held under administration by the Group amounted to $2.9tn. This was 7% lower than the $3.1tn held at 31 December 2015. The decrease primarily reflected net asset outflows in the Corporate Trust and Loan Agency business in North America, together with adverse foreign exchange movements in the UK. Taxes paid by region and country The following tables reflect a geographical view of HSBC’s operations. Taxes paid by HSBC relate to HSBC’s own tax liabilities including tax on profits earned, employer taxes, bank levy and other duties/levies such as stamp duty. Numbers are reported on a cash flow basis. Taxes paid by country Europe Home and priority markets Footnote 45 – UK – France – Germany – Switzerland Other markets Asia Home and priority markets – Hong Kong – Mainland China – India – Australia – Malaysia – Indonesia – Singapore – Taiwan – Japan Other markets Middle East and North Priority markets – Saudi Arabia – UAE – Egypt – Turkey Other markets North America Priority markets – US – Canada Other markets Latin America Priority markets – Argentina – Mexico Brazil Other markets Total For footnote, see page 63. 2016 $m 3,151 3,096 2,385 553 124 34 55 2,755 2,470 1,488 241 315 147 99 46 85 35 14 285 293 267 60 89 97 21 26 276 276 135 141 — 965 303 224 79 658 4 2015 $m 3,644 3,346 2,526 620 108 92 298 2,780 2,458 1,415 277 285 173 92 70 80 53 13 322 449 407 151 120 136 16 26 353 353 127 226 — 2014 $m 3,550 3,391 2,363 790 131 107 159 2,687 2,418 1,273 278 290 204 133 76 101 44 19 269 369 246 84 102 60 75 48 (108) (108) (377) 269 — 1,184 1,384 431 340 91 735 18 534 333 201 804 46 7,440 8,410 7,882 HSBC Holdings plc Annual Report and Accounts 2016 61 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Other information Conduct-related matters Carbon dioxide emissions Conduct-related costs included in significant items Income statement Net interest income/(expense) provisions arising from the ongoing review of compliance with the UK Consumer Credit Act Operating expenses Comprising: Legal proceedings and regulatory matters – charge in relation to the settlement agreement with the Federal Housing Finance Authority – regulatory provisions in GPB – settlements and provisions in connection with legal matters Customer remediation – of which: total provisions charge for the year total provisions utilised during the year Balance sheet at 31 Dec Total provisions – legal proceedings and regulatory matters – customer remediation Accruals, deferred income and other liabilities 2016 $m 2015 $m 2014 $m 2 2 (10) (632) (10) (632) 1,025 1,821 1,802 — 344 681 559 — 172 1,649 541 2,362 550 65 1,187 1,275 3,077 To report carbon emissions, we use the revised edition of the Greenhouse Gas Protocol’s A Corporate Accounting and Reporting Standard guideline for disclosure that incorporates the Scope 2 market-based methodology. We report carbon dioxide emissions resulting from energy use in our buildings and employees’ business travel. For 29 countries where we operated in 2016, which accounted for approximately 92% of our full-time employees (‘FTEs’), we collect data on energy use and business travel. For the other countries where we have financial control and a small presence, we estimate emissions by scaling up from 92% to 100% of FTEs. We then apply emission uplift rates to reflect uncertainty concerning the quality and coverage of emission measurement and estimation. The rates are 4% for electricity, 10% for other energy and 6% for business travel. This is consistent both with the Intergovernmental Panel on Climate Change’s Good Practice Guidance and Uncertainty Management in National Greenhouse Gas Inventories and our internal analysis of data coverage and quality. Figures for 2016 and the previous year are in the following tables. 1,584 2,362 2,500 Carbon dioxide emissions in tonnes 2,265 1,021 2,503 3,056 3,926 2,545 2,060 996 2,729 1,197 1,154 1,391 106 168 379 Total From energy From travel Footnote 46 2016 2015 617,000 529,000 88,000 771,000 662,000 109,000 Carbon dioxide emissions in tonnes per FTE Total operating expenses 1,584 Total charge for the year relating to significant items 1,582 2,372 3,709 The table above provides a summary of conduct-related costs incurred and included within significant items (see pages 33 and 39). Total From energy From travel Footnote 46 2016 2.63 2.25 0.38 2015 2.97 2.54 0.42 For footnote, see page 63. Our greenhouse gas reporting year runs from October to September. For the year from 1 October 2015 to 30 September 2016, carbon dioxide emissions from our global operations were 617,000 tonnes. Independent assurance of our carbon dioxide emissions will be available in the first half of 2017 on our website. The HSBC approach to conduct is designed to ensure that through our actions and behaviours we deliver fair outcomes for our customers and do not disrupt the orderly and transparent operation of financial markets. The Board places a strong emphasis on conduct, requiring adherence to high behavioural standards and adhering to the HSBC Values. Board oversight of conduct matters is provided by the Conduct & Values Committee, which oversees the embedding of HSBC Values and our required global conduct outcomes, and the Remuneration Committee, which considers conduct and compliance-related matters relevant to remuneration. These committees’ reports may be found on pages 143 to 145. The management of business conduct and the steps taken to raise standards are described on page 81. ‘Regulatory focus on conduct of business and financial crime’ is one of the Group’s top and emerging risks and is discussed on page 66. Provisions relating to significant items raised for conduct costs in 2016 resulted from the ongoing consequences of a small number of historical events. Operating expenses included significant items related to conduct matters in respect of legal proceedings and regulatory matters of $1.0bn and customer remediation costs in respect of the mis-selling of payment protection insurance of $0.5bn. These are discussed in Note 27 and Note 35 of the Financial Statements. 62 HSBC Holdings plc Annual Report and Accounts 2016 Footnotes to financial summary and other information Consolidated income statement/ Group performance by income and expense item 1 Dividends recorded in the financial statements are dividends per ordinary share declared in a year and are not dividends in respect of, or for, that year. 2 Dividends per ordinary share expressed as a percentage of basic earnings per share. 3 Return on risk-weighted assets (‘RoRWA’) is calculated using pre-tax return and reported average RWAs. 4 Net interest income includes the cost of internally funding trading assets, while the related external revenues are reported in ‘Trading income’. In our global business results, the cost of funding trading assets is included with Global Banking and Market’s net trading income as interest expense. 5 Gross interest yield is the average annualised interest rate earned on average interest-earning assets (‘AIEA’). 6 Net interest spread is the difference between the average annualised interest rate earned on AIEA, net of amortised premiums and loan fees, and the average annualised interest rate paid on average interest-bearing funds. 7 Net interest margin is net interest income expressed as an annualised percentage of AIEA. 8 Interest income on trading assets is reported as ‘Net trading income’ in the consolidated income statement. 9 Interest income on financial assets designated at fair value is reported as ‘Net income/(expense) from financial instruments designated at fair value’ in the consolidated income statement. 10 Including interest-bearing bank deposits only. 11 Interest expense on financial liabilities designated at fair value is reported as ‘Net income on financial instruments designated at fair value’ in the consolidated income statement, other than interest on own debt, which is reported in ‘Interest expense’. 12 Including interest-bearing customer accounts only. 13 Trading income also includes movements on non-qualifying hedges. These hedges are derivatives entered into as part of a documented interest rate management strategy for which hedge accounting was not, nor could be, applied. They are principally cross-currency and interest rate swaps used to economically hedge fixed rate debt issued by HSBC Holdings and floating rate debt issued by HSBC Finance. The size and direction of the changes in the fair value of non-qualifying hedges that are recognised in the income statement can be volatile from year-to-year, but do not alter the cash flows expected as part of the documented interest rate management strategy for both the instruments and the underlying economically hedged assets and liabilities if the derivative is held to maturity. 14 Net insurance claims and benefits paid and movement in liabilities to policyholders arise from both life and non-life insurance business. For non-life business, amounts reported represent the cost of claims paid during the year and the estimated cost of incurred claims. For life business, the main element of claims is the liability to policyholders created on the initial underwriting of the policy and any subsequent movement in the liability that arises, primarily from the attribution of investment performance to savings-related policies. Consequently, claims rise in line with increases in sales of savings-related business and with investment market growth. Consolidated balance sheet 15 Net of impairment allowances. 24 ‘Own credit spread’ includes the fair value movements on our long-term debt attributable to credit spread where the net result of such movements will be zero upon maturity of the debt. This does not include fair value changes due to own credit risk in respect of trading liabilities or derivative liabilities. 25 ‘Investment distribution’ includes Investments, which comprises mutual funds (HSBC manufactured and third party), structured products and securities trading, and Wealth Insurance distribution, consisting of HSBC manufactured and third-party life, pension and investment insurance products. 26 ‘Other personal lending’ includes personal non-residential closed-end loans and personal overdrafts. 27 ‘Other’ mainly includes the distribution and manufacturing (where applicable) of retail and credit protection insurance. 28 In 2016, credit and funding valuation adjustments included an adverse fair value movement of $110m on the widening of own credit spreads on structured liabilities (2015: favourable fair value movement of $179m; 2014: favourable fair value movement of $12m). 29 ‘Other’ in GB&M includes net interest earned on free capital held in the global business not assigned to products, allocated funding costs and gains resulting from business disposals. Within the management view of total operating income, notional tax credits are allocated to the businesses to reflect the economic benefit generated by certain activities which is not reflected within operating income; for example, notional credits on income earned from tax- exempt investments where the economic benefit of the activity is reflected in tax expense. In order to reflect the total operating income on an IFRS basis, the offset to these tax credits are included within ‘Other’. 30 ‘Markets products, Insurance and Investments and Other’ includes revenue from Foreign Exchange, insurance manufacturing and distribution, interest rate management and GCF products. 31 ‘Client assets’ are translated at the rates of exchange applicable for their respective period-ends, with the effects of currency translation reported separately. The main components of client assets were funds under management ($222bn at 31 December 2016) which were not reported on the Group’s balance sheet, and customer deposits ($76bn at 31 December 2016), of which $70bn was reported on the Group’s balance sheet and $6bn were off- balance sheet deposits. 32 Amounts are non-additive across geographical regions due to inter-company transactions within the Group. 33 Risk-weighted assets are non-additive across geographical regions due to market risk diversification effects within the Group. 34 Other income in this context comprises where applicable net income/expense from other financial instruments designated at fair value, gains less losses from financial investments, dividend income, net insurance premium income and other operating income less net insurance claims and benefits paid and movement in liabilities to policyholders. 35 2015 and 2014 figures are restated for the changes explained on page 44. 36 For the purposes of the analysis of reported results by country table, HSBC Holdings profit/(loss) is presented excluding the effect of the early adoption of the requirements of IFRS 9 ‘Financial Instruments’ relating to the presentation of gains and losses on financial liabilities designated at fair value’, which was early adopted in the separate financial statements of HSBC Holdings but not in the consolidated financial statements of HSBC. 37 Adjusted RWAs are calculated using reported RWAs adjusted for the effects of currency translation differences and significant items. 38 Adjusted RoRWA is calculated using adjusted profit before tax and adjusted average risk-weighted assets. 39 Includes Head Office costs attributable to Global Business operations. 40 Client assets related to our Middle East clients are booked across to various other regions, primarily in Europe. 16 On 1 January 2014, CRD IV came into force and the calculation of capital 41 Excludes intra-Group dividend income. resources and RWAs for 2014 to 2016 are calculated and presented on this basis. 2012 and 2013 comparatives are on a Basel 2.5 basis. 17 Capital resources are regulatory capital, the calculation of which is set out on page 127. 18 Including perpetual preferred securities, details of which can be found in Note 28 on the Financial Statements. 19 The definition of net asset value per ordinary share is total shareholders’ equity, less non-cumulative preference shares and capital securities, divided by the number of ordinary shares in issue excluding shares the company has purchased and are held in treasury. 20 In the first half of 2015 our operations in Brazil were classified as held for sale. As a result, balance sheet accounts were classified as ‘Assets held for sale’ and ‘Liabilities of disposal groups held for sale’. There was no separate income statement classification. The sale completed on 1 July 2016. Global businesses and geographical regions 21 Net interest income includes the cost of internally funding trading assets, while the related revenues are reported in net trading income. In our global business results, the total cost of funding trading assets is included within Corporate Centre net trading income as an interest expense. In the statutory presentation, internal interest income and expense are eliminated. 22 Net operating income before loan impairment charges and other credit risk provisions, also referred to as revenue. 23 Excludes items where there are substantial offsets in the income statement for the same year. 42 Central Treasury includes revenue relating to BSM of $3,060m (2015: $2,885m; 2014:$2,794m ), interest expense of $948m (2015: $710m; 2014: $484m) and adverse valuation differences on issued long-term debt and associated swaps of $278m (2015: loss of $64m; 2014: gain of $33m). Revenue relating to BSM includes other internal allocations, including notional tax credits to reflect the economic benefit generated by certain activities which is not reflected within operating income, for example notional credits on income earned from tax-exempt investments where the economic benefit of the activity is reflected in tax expense. In order to reflect the total operating income on an IFRS basis, the offset to these tax credits are included in other Central Treasury. 43 Other miscellaneous items in Corporate Centre includes internal allocations relating to Legacy Credit. Other information 44 Funds under management and assets held in custody are not reported on the Group’s balance sheet, except where it is deemed that we are acting as principal rather than agent in our role as investment manager, and these assets are consolidated as Structured entities (see Note 19 on the Financial Statements). 45 Taxes paid by HSBC relate to HSBC’s own tax liabilities, including tax on profits earned, employer taxes, bank levy and other duties/levies such as stamp duty. Numbers are reported on a cash flow basis. 46 In the Annual Report and Accounts 2015, we applied our own internal methodology which did not contain the Greenhouse Gas Protocol’s Scope 2 quality criteria verification and the residual mix factors which are recommended in the Scope 2 market-based methodology. HSBC Holdings plc Annual Report and Accounts 2016 63 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Risk Our conservative risk appetite Top and emerging risks Externally driven Internally driven Areas of special interest Process of UK withdrawal from the European Union Oil and gas prices Risk management Our risk management framework Our material banking and insurance risks Credit risk management Liquidity and funding risk management Market risk management Operational risk management Regulatory compliance risk management Financial crime risk management Insurance manufacturing operations risk management Other material risks – Reputational risk management – Sustainability risk management – Pension risk management Key developments and risk profile in 2016 Key developments in 2016 Credit risk profile Liquidity and funding risk profile Market risk profile Operational risk profile Insurance manufacturing operations risk profile Page 64 64 64 66 67 67 68 68 68 71 73 75 77 80 81 81 82 83 84 84 85 85 85 106 114 121 121 Our conservative risk appetite Throughout its history, HSBC has maintained a conservative risk profile. This is central to our business and strategy. The following principles guide the Group’s overarching risk appetite and determine how its businesses and risks are managed. Financial position • Strong capital position, defined by regulatory and internal capital ratios. • Liquidity and funding management for each operating entity, on a stand-alone basis. Operating model • Returns generated in line with risk taken. • Sustainable and diversified earnings mix, delivering consistent returns for shareholders. Business practice • Zero tolerance for knowingly engaging in any business, activity or association where foreseeable reputational risk or damage has not been considered and/or mitigated. • No appetite for deliberately or knowingly causing detriment to consumers arising from our products and services or incurring a breach of the letter or spirit of regulatory requirements. • No appetite for inappropriate market conduct by a member of staff or by any Group business. 64 HSBC Holdings plc Annual Report and Accounts 2016 Top and emerging risks Our approach to identifying and monitoring top and emerging risks is described on page 70. During 2016, we made a number of changes to our top and emerging risks to reflect our assessment of the issues facing HSBC and their effect on the Group, which are described on page 27. Our current top and emerging risks are as follows. Externally driven Economic outlook and capital flows Global economic growth remained muted in 2016, with headwinds adversely affecting both developed and emerging markets. The UK electorate’s vote to leave the European Union (‘EU’) caused significant market volatility in its immediate aftermath, and since then sterling has depreciated against major currencies. Uncertainty regarding the terms of the UK’s exit agreement, its future relationship with the EU and its trading relationship with the rest of the world may lead to economic uncertainty and market volatility, which could affect both the Group and its customers. Following robust policy action during the course of 2016, market concerns have eased over the extent of the slowdown of the mainland Chinese economy, and the potential for further renminbi depreciation. However, a prolonged or severe slowdown cannot be ruled out, which would have wider ramifications for regional and global economic growth, and global trade and capital flows, as a consequence. While oil and gas prices have partly recovered from the lows of 2015, global supply and demand imbalances continue to place considerable financial strain on some producers and exporters. A continuation of low oil prices, particularly in conjunction with a low inflation environment and/or low or negative interest rates, would adversely affect global growth prospects and, as a consequence, our results. Mitigating actions • We actively assess the impact of economic developments in key markets on specific customers, customer segments or portfolios and take appropriate mitigating action – that may include revising risk appetite or limits – as circumstances evolve. • We use internal stress testing and scenario analysis, as well as regulatory stress test programmes, to evaluate the potential impact of macroeconomic shocks on our businesses and portfolios. Analysis undertaken on our oil and gas lending portfolios are described on page 68, and our wider approach to stress testing is described on page 70. • We have carried out detailed reviews of our wholesale credit portfolios, particularly across those sectors most affected by the UK referendum result. We have also run a number of stress tests on our wholesale and trading portfolios to examine potential impacts under a range of possible exit scenarios and develop a suite of possible mitigating actions. Geopolitical risk Our operations and portfolios are exposed to risks arising from political instability, civil unrest and military conflict in many parts of the world. These may include physical risk to our staff and/or physical damage to our assets, disruption to our operations and a curtailment in global trade flows. The outcome of the US election has added to concerns about a rise in protectionism. This has been accentuated in many parts of the world by rapid technological change and income inequality. Any amplification of this trend could cause a curtailment in global trade, and thus impact HSBC’s traditional lines of business. European states are experiencing heightened political tension, reflecting concerns over migration, fears of terrorism, increased tension with Russia, and uncertainty about the future relationship between the UK and the EU. Elections in France, Germany, the Netherlands and possibly Italy in 2017 are adding to the uncertainty. In the Middle East, the terrorist group Daesh has come under increasing pressure as an international coalition recaptured territory across Syria and Iraq. Despite this, Daesh has proved capable of carrying out terrorist attacks both in neighbouring countries and further afield. In Asia, ongoing territorial disputes in the South China Sea and a region-wide build-up in military capability have strained diplomatic relations, and are testing the resolve of the US to defend freedom of navigation. Mitigating actions • We continually monitor the geopolitical outlook, in particular in countries where we have material exposures and/or a physical presence. We established a new dedicated forum to monitor and advise senior management on global developments, including analysis on how the Group’s strategy could be affected by geopolitical events. • We have taken steps to increase the physical security of our premises and have enhanced our major incident response capabilities, particularly in those geographical areas deemed to be at a higher risk from terrorism and military conflicts. • Our internal credit risk ratings of sovereign counterparties take geopolitical factors into account and drive our appetite for conducting business in those countries. Where necessary, we adjust our country limits and exposures to reflect our risk appetite and mitigate risks as appropriate. • We incorporate geopolitical scenarios, such as conflicts in countries where we have a significant presence or political developments that could disrupt our operations, into our internal stress tests to assess their potential effect on our portfolios and businesses. Turning of the credit cycle Although the credit environment has stabilised in the latter part of the year, due in part to further monetary loosening, there is a risk that the credit cycle could turn sharply in 2017 if economic and/or geopolitical shocks unfold. Stress could appear across a wide array of credit segments, particularly given the substantial amounts of external refinancing due in emerging markets in 2017 and 2018. Sentiment towards mainland China could also deteriorate amid concerns over its increasing debt burden, or political events in the US, UK and EU could deliver negative economic outcomes. Impairment allowances could increase if the credit quality of our customers is affected by less favourable global economic conditions in some markets. Should oil prices remain low or fall, our oil and gas portfolios would come under further pressure. Mitigating actions • We closely monitor economic developments in key markets and sectors, taking portfolio actions where necessary, including enhanced monitoring, amending our risk appetite and/or reducing limits and exposures. • We stress test portfolios of particular concern to identify sensitivity to loss under a range of scenarios, with management actions being taken to manage risk appetite where necessary. • Reviews of key portfolios are undertaken regularly to ensure that individual customer or portfolio risks are understood and that the level of facilities offered and our ability to manage these through any downturn are appropriate. Cyber threat and unauthorised access to systems HSBC and other public and private organisations continue to be the targets of increasing and more sophisticated cyber attacks that may disrupt customer services. Mitigating actions • We continue to strengthen and significantly invest in our ability to prevent, detect and respond to the ever-increasing and sophisticated threat of cyber attacks. Specifically, we continue to enhance our capabilities to protect against increasingly sophisticated malware, denial of service attacks and data leakage prevention, as well as enhancing our security event detection and incident response processes. • Cyber risk is a priority area for the Board and is regularly reported at Board level to ensure appropriate visibility, governance and executive support for our ongoing cybersecurity programme. • We participate in intelligence sharing with both law enforcement and industry schemes to help improve our understanding of, and ability to respond to, the evolving threats faced by us and our peers within our industry. Regulatory and technological developments with adverse impact on business model and profitability Financial service providers continue to face stringent regulatory and supervisory requirements, particularly in the areas of capital and liquidity management, conduct of business, financial crime, operational structures, the use of models and the integrity of financial services delivery. The competitive landscape in which the Group operates may be significantly altered by future regulatory changes and government intervention, which could be introduced with different, potentially conflicting requirements and to differing timetables by different regulatory regimes. Regulatory changes may affect the activities of the Group as a whole, or of some or all of its principal subsidiaries. While the rise of financial technology (‘fintech’) presents a number of opportunities that we are actively engaging in, there is also a risk that it could disrupt financial institutions’ traditional business model. Mitigating actions • We are engaged closely with governments and regulators in the countries in which we operate to help ensure that new requirements are considered properly by regulatory authorities and the financial sector and can be implemented effectively. • We have strengthened governance and resourcing around regulatory change management. Significant regulatory programmes, such as the implementation of International Financial Reporting Standard 9, are overseen by the Group Change Committee (see ‘Execution risk’ on page 67). • We are actively pursuing opportunities in the fintech space, and have established HSBC Digital Solutions, a specialist team to design, build and run digital services. We have also established a technology advisory board to help ensure we are fully aware of, and respond to, industry developments as they arise. Regulatory focus on conduct of business and financial crime Financial institutions remain under considerable scrutiny regarding conduct of business, particularly in relation to fair outcomes for customers and orderly and transparent operations in financial markets, as well as financial crime. Regulators, prosecutors, the media and the public all have heightened expectations as to the behaviour and conduct of financial institutions, and any shortcomings or failure to demonstrate adequate controls are in place to mitigate such risks could result in regulatory sanctions or fines. This could also lead to HSBC Holdings plc Annual Report and Accounts 2016 65 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk an increase in civil litigation arising from or relating to issues which are subject to regulatory investigation, sanction or fine. Mitigating actions • We have created a new function, Financial Crime Risk, which brings together all areas of financial crime risk management at HSBC. For further details, see ‘Financial crime risk management’ on page 81. • We have also continued to enhance our management of conduct in areas including the treatment of potentially vulnerable customers, market surveillance, employee training and performance management (see ‘Regulatory compliance risk management’ on page 81). US deferred prosecution agreement and related agreements and consent orders HSBC is subject to a five-year deferred prosecution agreement (‘US DPA’) with the US DoJ and related agreements and consent orders with the FRB, the OCC and the FCA. Under the agreements entered into with the DoJ and the FCA in 2012, an independent compliance monitor (the ‘Monitor’) was appointed in July 2013 for an expected five-year period to produce annual assessments of the effectiveness of the Group’s anti-money laundering (‘AML’) and sanctions compliance programme. The design and execution of the AML and sanctions remediation plans to address the findings of the US DPA and the Monitor are complex and require major investments in people, systems and other infrastructure. This complexity creates significant execution risk that could affect our ability to effectively identify and manage financial crime risk and remedy AML and sanctions compliance deficiencies in a timely manner. This, in turn, could impact our ability to satisfy the Monitor or comply with the terms of the US DPA and related agreements and consent orders, and may require us to take additional remedial measures in the future. These risks could be further heightened if the Monitor’s reports were to become public. In February 2017, the Monitor delivered his third annual follow- up review report as required by the US DPA. In his report, which is discussed on page 82, the Monitor concluded that, in 2016, HSBC continued to make progress in enhancing its financial crime compliance controls, including improvements to our global AML policies and procedures. However, the Monitor also expressed significant concerns about the pace of that progress, instances of potential financial crime that the DoJ and HSBC are reviewing further and on-going systems and control deficiencies that in his view raised questions as to whether HSBC is adhering to all its obligations under the US DPA. The Monitor also found that there remain substantial challenges for HSBC to meet its goal of developing a reasonably effective and sustainable AML and sanctions compliance programme. In addition, the Monitor did not certify as to HSBC’s implementation of and adherence to remedial measures specified in the US DPA. Potential consequences of breaching the US DPA could include the imposition of additional terms and conditions on HSBC, an extension of the agreement, including its monitorship, or the criminal prosecution of HSBC that could, in turn, entail further financial penalties and collateral consequences. Moreover, HSBC Bank USA, as the primary US dollar correspondent bank for the Group, is subject to heightened financial crime risk arising from business conducted on behalf of clients as well as its non-US HSBC affiliates. If HSBC Bank USA fails to conduct adequate due diligence on clients, including its affiliates, or otherwise inappropriately processes US dollar payments on behalf of non-US HSBC affiliates, it could be in breach of applicable US AML and sanctions laws and regulations, become subject to legal or regulatory enforcement actions by OFAC or other US agencies and be required to pay substantial fines or penalties. In addition, any such breaches of US legislation could constitute a breach of the US DPA. 66 HSBC Holdings plc Annual Report and Accounts 2016 Under the terms of the US DPA, upon notice and an opportunity to be heard, the DoJ has sole discretion to determine whether HSBC has breached the US DPA. Mitigating actions • We continued to make progress during 2016 toward putting in place an effective and sustainable AML and sanctions compliance programme, including through the creation of a new Financial Crime Risk function and improvements in technology and systems to manage financial crime risk. • We are working to implement the agreed recommendations flowing from the Monitor’s previous reviews, and to implement the agreed recommendations from the 2016 review. Internally driven IT systems infrastructure and resilience HSBC continues to invest in the reliability and resilience of our IT Systems, to help ensure that disruption to customer services resulting in reputational and regulatory damage does not occur. Mitigating actions • We are part-way through a multi-year investment programme that is transforming how technology is developed, delivered and maintained, with a particular focus on providing high-quality, stable and secure services. As part of this, we are simplifying our service provision and replacing older IT infrastructure and applications. These investments are designed to improve IT systems resilience. • During 2016, we continued to upgrade our IT Systems, improve disruption free change, and materially reduce the number of incidents relating to our critical business services. These enhancements led to a material improvement in service availability during the year and helped reduce impact to our customers and colleagues by 45% (when compared with the same period in 2015). Impact of organisational change and regulatory demands on employees The cumulative workload arising from our regulatory reform and remediation programmes, together with those related to the delivery of our strategy, continues to place increasingly complex and conflicting demands on a workforce that operates in an employment market where expertise in key markets is often in short supply and mobile. The scale of organisational change, including the establishment of the ring-fenced bank in the UK, has increased pressure on employees and requires us to ensure that key skills and experience are retained. Furthermore, the outcome of the UK referendum on EU membership has led to some uncertainties regarding movement of labour. Mitigating actions • We have enhanced our wellbeing programme to support our employees, particularly those affected by the Group’s considerable change agenda. • Risks related to organisational change are subject to close management oversight. A range of actions are being developed to address the risks associated with the Group’s major change initiatives, including recruitment and extensive relocation support to existing employees in the UK ring- fenced bank. • We continue to increase the level of specialist resource in key areas, and to engage with our regulators as they finalise new regulations. We use a broad array of talent-sourcing channels, succession planning for key management roles, and heightened promotion of opportunities internally, with particular attention in our more challenging markets. Execution risk Execution risk remained heightened during 2016 as we continued to work towards delivering the strategic actions announced at the Investor Update in June 2015 (see page 12). These, along with the regulatory reform agenda and our commitments under the US DPA, require the management of significant projects that are resource intensive and time sensitive. Risks arising from the volume, magnitude and complexity of the projects underway to meet these demands may include regulatory censure, reputational damage or financial losses. Mitigating actions • We have strengthened our prioritisation and governance processes for significant projects. The Group Change Committee (‘GCC’), chaired by the Group Chief Operating Officer, oversees the most significant programmes and provides regular updates to the Risk Management Meeting of the GMB. • The GCC monitors the concentration of deliverables to ensure that potential resource constraints over the medium term are understood and addressed. the creation of centralised global analytical functions with necessary subject matter expertise. • We have hired additional subject matter experts within our Independent Model Review sub-function and empowered the team to ensure appropriate challenge and feedback are given to models prior to and as part of their ongoing use. • We have strengthened the model risk policy and introduced a Group-wide single model inventory system detailing key metrics on all models, and an assessment of their relative importance to the organisation. Data management The Group currently uses a large number of systems and applications to support business processes and operations. Multiple data sources, including customer data sources, introduce the need for reconciliation to reduce the risk of error. Strong data governance and enhanced data quality are required to meet our regulatory obligations relating to risk data aggregation and risk reporting as set out by the Basel Committee and our obligations under the US DPA, as well as to service our customers more effectively and improve our product offering. Third-party risk management Mitigating actions We utilise third parties for the provision of a range of goods and services, in common with other financial services providers. Global regulators have increased their scrutiny of these arrangements and expect firms to be able to demonstrate adequate control over the selection, governance and oversight of their third parties, including affiliates. Any deficiency in our management of third-party risk could affect our ability to meet strategic, regulatory or client expectations. This may, in turn, lead to a range of consequences, including regulatory censure or reputational damage. Mitigating actions • We are part-way through a multi-year strategic programme to enhance our third-party risk management capability. This is designed to enable the consistent risk assessment of any third-party service against key criteria, along with associated control monitoring, testing and assurance throughout the third-party life cycle. • A new Group policy and supporting framework was published in December 2016. The supporting delivery model and technology will be developed and will start to deploy in the second half of 2017. Enhanced model risk management expectations We use models for a range of purposes in managing our business, including regulatory capital calculations, stress testing, credit approvals, financial crime and fraud risk management, and financial reporting. Regulatory requirements for models are rapidly increasing and often fast-moving. The scale and scope of model development expected by regulators pose significant execution challenges, especially where the breadth and scope are beyond what has previously been expected of the Group. Regulatory scrutiny and supervisory concerns over banks’ use of models is considerable, particularly the internal models and assumptions used by banks in the calculation of regulatory capital. If regulatory approval for key capital models is not achieved in a timely manner, we could be required to hold additional capital. Mitigating actions • We have strengthened our model risk governance framework by establishing additional global model oversight committees and implementing policies and standards in accordance with key regulatory requirements. • We have strengthened our governance over the development, usage and validation of models including • The Chief Information Officer continues to drive the Group’s efforts to enhance data governance, quality and architecture. These services underpin key programmes and initiatives, such as our Global Standards programme. • We are significantly reducing the number of systems and applications that support key business processes, which will streamline the number of data sources across the Group, particularly data used in our customer and transaction screening processes. • We continue to make progress on key initiatives and projects to implement our data strategy and work towards meeting our Basel Committee data obligations. Areas of special interest During 2016, we considered a number of particular areas because of the effect they may have on the Group. While these areas have been identified as part of our top and emerging risks, further details of the actions taken during the year are provided below. Process of UK withdrawal from the European Union The period of uncertainty and market volatility that followed the UK’s decision to leave the EU is likely to continue until the UK’s future relationship with the EU and the rest of the world is clearer. Given the time-frame and the complex negotiations involved, and assuming Article 50 is invoked by the end of March 2017, a clearer picture is not expected to emerge for some time. HSBC is working with clients as they adapt to this new environment and plan for what might follow. Meeting our customers’ needs following the UK’s departure from the EU will likely require adjustments to our cross-border banking model. However, with Article 50 not yet invoked and formal negotiations not yet initiated, it is too early to determine precisely what will be required or what the likely effects on HSBC might be. Despite this uncertainty, use of HSBC’s existing subsidiaries in France, Germany, Malta and Poland should help us more quickly and seamlessly adapt our banking model to this new landscape. Such changes could, among other things, increase our operating costs and require us to relocate staff and businesses outside the UK to other jurisdictions. Through this period of uncertainty, our priorities are to continue to support our clients, take appropriate actions to mitigate risks and maintain stability, and deliver on our strategy. We are actively monitoring our portfolio to identify areas of stress, with HSBC Holdings plc Annual Report and Accounts 2016 67 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk vulnerable sectors subject to management review to determine if any adjustment to our risk policy or appetite is required. As the UK's negotiating priorities and likelihood of achieving them become clearer, we will continue to monitor developments and take actions required to meet these priorities. Oil and gas prices Oil prices improved throughout 2016 and in early 2017, particularly after Opec agreed to cut supply levels. The improved oil prices resulted in a decline in new loan impairments in the second half of the year. The medium- to long-term outlook remains uncertain as technological change impacts the supply side through cheaper methods of extraction and the demand side through the development of renewable energy sources. At 31 December 2016, HSBC’s overall portfolio directly exposed to oil and gas sector had drawn risk exposure of $28bn (2015: $29bn). The portfolio has the following credit quality distribution: ‘strong’ and ‘good’ 53% (2015: 56%), ‘satisfactory’ 28% (2015: 35%), ‘sub-standard’ 15% (2015: 7%) and ‘impaired’ 4% (2015: 2%), with the majority of the exposures located in North America, Asia and Europe. Loan impairment charges in 2016 were approximately $0.3bn. The sector remains under enhanced monitoring with risk appetite and new lending significantly curtailed. Key components of our risk management framework Risk management This section describes the enterprise-wide risk management framework, and the significant policies and practices employed by HSBC in managing its material risks. Our risk management framework We use an enterprise-wide risk management framework across the organisation and across all risk types. It is underpinned by our risk culture and is reinforced by the HSBC Values and our Global Standards programme. The framework fosters continuous monitoring of the risk environment, and an integrated evaluation of risks and their interactions. It also ensures a consistent approach to monitoring, managing and mitigating the risks we accept and incur in our activities. The following diagram and descriptions summarise key aspects of the framework, including governance and structure, our risk management tools and our risk culture, which together help align employee behaviour with our risk appetite. HSBC Values and risk culture The Board and its sub-committees The Board approves the Group’s risk appetite, plans and performance targets. It sets the ‘tone from the top’ and is advised by the Group Risk Committee, the Financial System Vulnerabilities Committee, and the Conduct & Values Committee (see page 132). Governance and structure The Risk Management Meeting of the Group Management Board and its sub-committees Responsible for the enterprise-wide management of all risks, including key policies and frameworks for the management of risk within the Group (see page 69). The Global Standards Steering Meeting is responsible for the management of financial crime risk (see page 81). Risk governance framework Ensures appropriate oversight of and accountability for the management of risk (see page 68). Responsibilities Three lines of defence model Our three lines of defence model defines roles and responsibilities for risk management (see page 69). Global Risk function An independent function to help ensure the necessary balance in risk/return decisions (see page 69). Enterprise-wide risk management tools Processes Risk appetite Top and emerging risks Processes to identify, monitor, mitigate and report risks to ensure we remain within our risk appetite (see pages 70 to 71). Risk map Stress testing Banking and insurance risks Material risks arising from our business activities that are measured, monitored and managed (see pages 71 to 72). Controls Risk Policies and Practices Set by risk stewards for each of our material banking and insurance risks (see pages 68 to 73. Internal Controls The operational risk management framework defines minimum standards and processes for managing operational risks and internal controls (see page 80). Systems and tools Our risk culture Risk culture refers to HSBC’s norms, attitudes and behaviours related to risk awareness, risk taking and risk management. HSBC has long recognised the importance of a strong risk culture, the fostering of which is a key responsibility of senior executives. Our risk culture is reinforced by HSBC Values and our Global Standards programme. It is instrumental in aligning the behaviours of individuals with our attitude to assuming and managing risk, which helps to ensure that our risk profile remains in line with our risk appetite. We use clear and consistent employee communication on risk to convey strategic messages and set the tone from senior management. We also deploy mandatory training on risk and compliance topics to embed skills and understanding in order to strengthen our risk culture and reinforce the attitude to risk in the behaviour expected of employees, as described in our risk policies. Mandatory training materials are updated regularly, 68 HSBC Holdings plc Annual Report and Accounts 2016 describing technical, cultural and ethical aspects of the various risks assumed by the Group and how they should be managed effectively. We operate a global whistleblowing platform, HSBC Confidential, allowing staff to report matters of concern confidentially. We also maintain an external email address for concerns about accounting and internal financial controls or auditing matters (accountingdisclosures@hsbc.com). The Group has a strict policy prohibiting retaliation against those who raise concerns by this route. All allegations of retaliation reported are escalated to senior management. For details on the governance of our whistleblowing policy, see pages 140 and 144. Our risk culture is also reinforced by our approach to remuneration. Individual awards, including those for senior executives, are based on compliance with HSBC Values and the achievement of financial and non-financial objectives, which are aligned to our risk appetite and global strategy. For further information on remuneration, see the Directors’ Remuneration Report on page 153. Governance and structure The Board has ultimate responsibility for the effective management of risk and approves HSBC’s risk appetite. It is advised on risk-related matters by the Group Risk Committee (‘GRC’), the Financial System Vulnerabilities Committee (‘FSVC’), and the Conduct & Values Committee (‘CVC’) (see page 82). Executive accountability for the monitoring, assessment and management of risk resides with the Group Chief Risk Officer. He is supported by the Risk Management Meeting of the Group Management Board (‘RMM’). In the second half of 2016, we established a Financial Crime Risk (‘FCR’) function and appointed a Group Head of FCR, who reports to the Group Chief Executive and chairs the Global Standards Steering Meeting. The FCR function is dedicated to implementing the most effective global standards to combat financial crime, as described under ‘Financial crime risk management’ on page 81. Day-to-day responsibility for risk management is delegated to senior managers with individual accountability for decision making. These managers are supported by global functions as described under ‘Three lines of defence’ below. We use a defined executive risk governance structure to help ensure appropriate oversight and accountability of risk, which facilitates the reporting and escalation to the RMM. This structure is summarised below. Governance structure for the management of risk Authority Membership Responsibilities include: Risk Management Meeting of the Group Management Board Group Chief Risk Officer Chief Legal Officer Group Chief Executive Group Finance Director All other Group Managing Directors • Supporting the Group Chief Risk Officer in exercising Board- delegated risk management authority • Overseeing the implementation of risk appetite and the enterprise- wide risk management framework • Forward-looking assessment of the risk environment, analysing the possible risk impact and taking appropriate action • Monitoring all categories of risk and determining appropriate mitigating action • Promoting a supportive Group culture in relation to risk management and conduct Global Risk Management Board Group Chief Risk Officer • Supporting the Group Chief Risk Officer in providing strategic Global business/regional risk management meetings Chief Risk Officers of HSBC’s global businesses and regions Heads of Global Risk sub-functions Global Business/Regional Chief Risk Officer Global Business/Regional Chief Executive Global Business/Regional Chief Financial Officer Global Business/Regional Heads of global functions direction for the Global Risk function, setting priorities and providing oversight • Overseeing a consistent approach to accountability for, and mitigation of, risk across the Global Risk function • Supporting the Chief Risk Officer in exercising Board-delegated risk management authority • Forward-looking assessment of the risk environment, analysing the • possible risk impact and taking appropriate action Implementation of risk appetite and the enterprise-wide risk management framework • Monitoring all categories of risk and determining appropriate mitigating actions • Embedding a supportive culture in relation to risk management and controls The Board committees with responsibility for oversight of risk-related matters are set out on page 140. Our responsibilities All employees are responsible for identifying and managing risk within the scope of their role as part of the three lines of defence model. Three lines of defence We use an activity-based three lines of defence model to delineate management accountabilities and responsibilities for risk management and the control environment. This creates a robust control environment to manage risks. The model underpins our approach to risk management by clarifying responsibility, encouraging collaboration, and enabling efficient coordination of risk and control activities. The three lines of defence are summarised below: • The first line of defence owns the risks and is responsible for identifying, recording, reporting and managing them, and ensuring that the right controls and assessments are in place to mitigate them. • The second line of defence sets the policy and guidelines for managing specific risk areas, provides advice and guidance in relation to the risk, and challenges the first line of defence on effective risk management. • The third line of defence is our Internal Audit function, which provides independent and objective assurance of the adequacy of the design and operational effectiveness of the Group’s risk management framework and control governance process. Global Risk function We have a Global Risk function, headed by the Group Chief Risk Officer, which is responsible for the Group’s risk management framework. This responsibility includes establishing global policy, monitoring risk profiles, and forward-looking risk HSBC Holdings plc Annual Report and Accounts 2016 69 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk identification and management. Global Risk is made up of sub- functions covering all risks to our operations. Global Risk forms part of the second line of defence. It is independent from the global businesses, including sales and trading functions, to provide challenge, appropriate oversight, and balance in risk/ return decisions. Enterprise-wide risk management tools The Group uses a range of tools to identify, monitor and manage risk. The key enterprise-wide risk tools are summarised below. An ‘emerging risk’ is a thematic issue with large unknown components that may form and crystallise beyond a one-year time horizon. If it were to materialise, it could have a material effect on the Group’s long-term strategy, profitability and/or reputation. Existing mitigation plans are likely to be minimal, reflecting the uncertain nature of these risks at this stage. Some high-level analysis and/or stress testing may have been carried out to assess the potential impact. Our current top and emerging risks are discussed on page 64. Stress testing Risk appetite The Group’s risk appetite defines its desired forward-looking risk profile, and informs the strategic and financial planning process. Furthermore, it is integrated with other key risk management tools, such as stress testing and our top and emerging risk reports, to help ensure consistency in risk management practices. The Group sets out the aggregated level and risk types it accepts in order to achieve its business objectives in a risk appetite statement (‘RAS’). This is reviewed on an ongoing basis, and formally approved by the Board every six months on the recommendation of the GRC. The Group’s actual performance is reported monthly against the approved RAS to the RMM, enabling senior management to monitor the risk profile and guide business activity to balance risk and return. This reporting allows risks to be promptly identified and mitigated, and informs risk-adjusted remuneration to drive a strong risk culture. Global businesses, regions and strategically important countries are required to have their own RASs, which are monitored to ensure they remain aligned with the Group’s. All RASs and business activities are guided and underpinned by qualitative principles (see page 143). Additionally, quantitative metrics are defined along with appetite and tolerance thresholds for key risk areas. Risk map The Group risk map provides a point-in-time view of the risk profiles of countries, regions and global businesses across all risk categories. It assesses the potential for these risks to have a material impact on the Group’s financial results, reputation and the sustainability of its business. Risk stewards assign ‘current’ and ‘projected’ risk ratings, supported by commentary. Risks that have an ‘amber’ or ‘red’ risk rating require monitoring and mitigating action plans to be either in place or initiated to manage the risk down to acceptable levels. Descriptions of our material banking and insurance risks are set out on page 71. Top and emerging risks We use a top and emerging risks process to provide a forward- looking view of issues with the potential to threaten the execution of our strategy or operations over the medium to long term. We proactively assess the internal and external risk environment, as well as review the themes identified across our regions and global businesses, for any risks that may require global escalation, updating our top and emerging risks as necessary. We define a ‘top risk’ as a thematic issue that may form and crystallise in between six months and one year, and that has the potential to materially affect the Group’s financial results, reputation or business model. It may arise across any combination of risk types, regions or global businesses. The impact may be well understood by senior management and some mitigating actions may already be in place. Stress tests of varying granularity may also have been carried out to assess the impact. 70 HSBC Holdings plc Annual Report and Accounts 2016 HSBC operates a comprehensive stress testing programme that supports our risk management and capital planning. It includes execution of stress tests mandated by our regulators. Our stress testing is supported by dedicated teams and infrastructure, and is overseen at the most senior levels of the Group. Our stress testing programme demonstrates our capital strength and enhances our resilience against external shocks. It also helps us understand and mitigate risks, and informs our decisions about capital levels. As well as taking part in regulators’ stress tests, we conduct our own internal stress tests. Many of our regulators – especially the Bank of England (‘BoE’), the Federal Reserve and the HKMA – utilise stress testing as an essential prudential regulatory tool and the Group has focused significant governance attention and resourcing to meet their requirements. We place particular emphasis on the global enterprise-wide stress test run on the Group by the BoE, our lead regulator. In 2016, the results for HSBC as published by the BoE showed that our capital ratios after taking account of CRD IV restrictions and strategic management actions exceeded the BoE’s requirements. The results for HSBC included an assumed dividend payment in the first year of the severe stress projection period. This outcome reflected our conservative risk appetite, and diversified geographical and business mix. It also reflected our ongoing strategic actions, including the sale of operations in Brazil, RWA reductions in GB&M and continued sales from our US CML run-off portfolio. These actions have materially reduced our RWAs, strengthened our capital position and made us even more robust under stress. Bank of England stress test results for 2016 The BoE’s stress test in 2016 specified a global downturn with severe effects in the UK, US, Hong Kong and China, which accounted for approximately two-thirds of HSBC’s RWAs at the end of 2015. The assumed GDP growth rates are detailed in the following table. We estimated that the impact on global GDP in this scenario was about as severe as the global financial crisis of 2007 to 2009, but with a much greater focus on emerging markets. This made it particularly severe for HSBC, given its priority markets in these areas. Assumed GDP growth rates in the 2016 Bank of England stress test scenario UK USA China Hong Kong Source: Bank of England. 2015 2016 2017 2018 % 2.2 1.8 6.7 1.9 % (4.3) (3.0) (0.5) (7.4) % 1.1 0.8 4.2 1.5 % 1.7 1.6 5.6 2.7 PRA assumed GDP growth rates are shown in terms of fourth quarter on fourth quarter annual changes. The following table shows the results of the stress test for the past three years, and reflects HSBC’s resilience. From a starting CET1 ratio of 11.9% at the end of 2015, the BoE showed projected minimum stressed CET1 ratios of 7.6% and 9.1% before and after the impact of strategic management actions. Results of Bank of England stress tests for the past three years CET1 ratio at scenario start point Minimum stressed CET1 ratio after strategic management actions Fall in CET1 ratio Source: Bank of England. 2016 % 11.9 9.1 2.8 2015 % 10.9 7.7 3.2 2014 % 10.8 8.7 2.1 Data is presented in terms of the minimum CET1 ratio reached net of strategic management actions as per the results published by the PRA. Internal stress tests are used intensively in our enterprise-wide risk management and capital management frameworks. Risks to our capital plan are assessed through a range of scenarios which explore risks that management needs to consider under stress. They include potential adverse macroeconomic, geopolitical and operational risk events, and potential events that are specific to HSBC. The selection of scenarios reflects our risk appetite relating to metrics such as profitability, capital or liquidity. Stress testing analysis helps management understand the nature and extent of any vulnerability. Using this information, management decides whether risks can or should be mitigated through management actions or, if they were to crystallise, should be absorbed through capital. This in turn informs decisions about preferred capital levels. We conduct reverse stress tests each year at Group and, where required, subsidiary entity level in order to understand which potential extreme conditions would make our business model non-viable. Reverse stress testing identifies potential stresses and vulnerabilities we might face, and helps inform early warning triggers, management actions and contingency plans designed to mitigate risks. In addition to the Group-wide stress testing scenarios, each major HSBC subsidiary conducts regular macroeconomic and event-driven scenario analyses specific to its region. They also participate as required in the regulatory stress testing programmes of the jurisdictions in which they operate, such as the Comprehensive Capital Analysis and Review and Dodd- Frank Act Stress Test programmes in the US, and the stress tests of the Hong Kong Monetary Authority. Global functions and businesses also perform bespoke stress testing to inform their assessment of risks in potential scenarios. The Group stress testing programme is overseen by the GRC and results are reported, where appropriate, to the RMM and GRC. Our material banking and insurance risks The material risk types associated with our banking and insurance manufacturing operations are described in the following tables: Description of risks – banking operations Risks Arising from Measurement, monitoring and management of risk Credit risk (see page 73) Credit risk is the risk of financial loss if a customer or counterparty fails to meet an obligation under a contract. Credit risk arises principally from direct lending, trade finance and leasing business, but also from certain other products such as guarantees and derivatives. Credit risk is: • measured as the amount which could be lost if a customer or counterparty fails to make repayments; • monitored using various internal risk management measures and within limits approved by individuals within a framework of delegated authorities; and • managed through a robust risk control framework which outlines clear and consistent policies, principles and guidance for risk managers. Liquidity and funding risk (see page 75) Liquidity risk is the risk that we do not have sufficient financial resources to meet our obligations as they fall due or that we can only do so at an excessive cost. Funding risk is the risk that funding considered to be sustainable, and therefore used to fund assets, is not sustainable over time. Liquidity risk arises from mismatches in the timing of cash flows. Funding risk arises when illiquid asset positions cannot be funded at the expected terms and when required. Liquidity and funding risk is: • measured using a range of metrics including liquidity coverage ratio and net stable funding ratio; • monitored against the Group’s liquidity and funding risk framework; and • managed on a stand-alone basis with no reliance on any Group entity (unless pre- committed) or central bank unless this represents routine established business-as- usual market practice. Market risk (see page 77) Market risk is the risk that movements in market factors, such as foreign exchange rates, interest rates, credit spreads, equity prices and commodity prices, will reduce our income or the value of our portfolios. Exposure to market risk is separated into two portfolios: • trading portfolios; and • non-trading portfolios. Market risk exposures arising from our insurance operations are discussed on page 123. Market risk is: • measured in terms of value at risk (‘VaR’), which measures the potential losses on risk positions over a specified time horizon for a given level of confidence, and assessed using stress testing; • monitored using VaR, stress testing and other measures including the sensitivity of net interest income and the sensitivity of structural foreign exchange; and • managed using risk limits approved by the RMM and the risk management meeting in various global businesses. Operational risk (see page 80) Operational risk is the risk to achieving our strategy or objectives as a result of inadequate or failed internal processes, people and systems or from external events. Operational risk arises from day-to-day operations or external events, and is relevant to every aspect of our business. Regulatory compliance risk and financial crime compliance risk are discussed below. Operational risk is: • measured using the risk and control assessment process, which assesses the level of risk and effectiveness of controls; • monitored using key indicators and other internal control activities; and • managed primarily by global business and functional managers that identify and assess risks, implement controls to manage them and monitor the effectiveness of these controls using the operational risk management framework. HSBC Holdings plc Annual Report and Accounts 2016 71 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Description of risks – banking operations Risks Arising from Measurement, monitoring and management of risk Regulatory compliance risk (see page 81) Regulatory compliance risk is the risk that we fail to observe the letter and spirit of all relevant laws, codes, rules, regulations and standards of good market practice, and incur fines and penalties and suffer damage to our business as a consequence. Regulatory compliance risk is part of operational risk, and arises from the risks associated with breaching our duty to clients and other counter-parties, inappropriate market conduct and breaching other regulatory requirements. Financial crime risk (see page 81) Financial crime risk is the risk that we knowingly or unknowingly help parties to commit or to further potentially illegal activity through HSBC. Financial crime risk is part of operational risk and arises from day-to-day banking operations. Other material risks Reputational risk (see page 83) Reputational risk is the risk of failure to meet stakeholder expectations as a result of any event, behaviour, action or inaction, either by HSBC itself, our employees or those with whom we are associated, that might cause stakeholders to form a negative view of the Group. Primary reputational risks arise directly from an action or inaction by HSBC, its employees or associated parties that are not the consequence of another type of risk. Secondary reputational risks are those arising indirectly and are a result of a failure to control any other risks. Pension risk (see page 84) Pension risk is the risk of increased costs to HSBC from the post-employment benefit plans that HSBC has established for its employees. Pension risk arises from investments delivering an inadequate return, adverse changes in interest rates or inflation, or members living longer than expected. Pension risk also includes operational and reputational risk of sponsoring pension plans. Regulatory compliance risk is: • measured by reference to identified metrics, incident assessments, regulatory feedback and the judgement and assessment of our Regulatory Compliance teams; • monitored against our regulatory compliance risk assessments and metrics, the results of the monitoring and control activities of the second line of defence functions, and the results of internal and external audits and regulatory inspections; and • managed by establishing and communicating appropriate policies and procedures, training employees in them, and monitoring activity to help ensure their observance. Proactive risk control and/or remediation work is undertaken where required. Financial crime risk is: • measured by reference to identified metrics, incident assessments, regulatory feedback and the judgement and assessment of our Financial Crime Risk teams; • monitored against our financial crime compliance risk appetite statement and metrics, the results of the monitoring and control activities of the second line of defence functions, and the results of internal and external audits and regulatory inspections; and • managed by establishing and communicating appropriate policies and procedures, training employees in them, and monitoring activity to help ensure their observance. Proactive risk control and/or remediation work is undertaken where required. Reputational risk is: • measured by reference to our reputation as indicated by our dealings with all relevant stakeholders, including media, regulators, customers and employees; • monitored through a reputational risk management framework that is integrated into the Group’s broader risk management framework; and • managed by every member of staff, and covered by a number of policies and guidelines. There is a clear structure of committees and individuals charged with mitigating reputational risk. Pension risk is: • measured in terms of the scheme’s ability to generate sufficient funds to meet the cost of their accrued benefits; • monitored through the specific risk appetite that has been developed at both Group and regional levels; and • managed locally through the appropriate pension risk governance structure and globally through the Global Pensions Oversight Committee and ultimately the RMM. Sustainability risk (see page 84) Sustainability risk is the risk that financial services provided to customers by the Group indirectly result in unacceptable impacts on people or the environment. Sustainability risk arises from the provision of financial services to companies or projects which indirectly result in unacceptable impacts on people or on the environment. Sustainability risk is: • measured by assessing the potential sustainability effect of a customer’s activities and assigning a Sustainability Risk Rating to all high risk transactions; • monitored quarterly by the RMM and monthly by the Group’s Sustainability Risk function; and • managed using sustainability risk policies covering project finance lending and sector-based sustainability policies for sectors and themes with potentially large environmental or social impacts. Our insurance manufacturing subsidiaries are regulated separately from our banking operations. Risks in our insurance entities are managed using methodologies and processes that are subject to Group oversight. Our insurance operations are also subject to some of the same risks as our banking operations, which are covered by the Group’s risk management processes. 72 HSBC Holdings plc Annual Report and Accounts 2016 Description of risks – insurance manufacturing operations Risks Arising from Measurement, monitoring and management of risk Financial risk (see page 123) Our ability to effectively match liabilities arising under insurance contracts with the asset portfolios that back them is contingent on the management of financial risks and the extent to which these are borne by policyholders. Exposure to financial risk arises from: • market risk affecting the fair values of financial assets or their future cash flows; • credit risk; and • liquidity risk of entities not being able to make payments to policyholders as they fall due. Financial risk is: • measured (i) for credit risk, in terms of economic capital and the amount that could be lost if a counterparty fails to make repayments; (ii) for market risk, in terms of economic capital, internal metrics and fluctuations in key financial variables; and (iii) for liquidity risk, in terms of internal metrics including stressed operational cash flow projections; • monitored through a framework of approved limits and delegated authorities; and • managed through a robust risk control framework which outlines clear and consistent policies, principles and guidance. This includes using product design, asset liability matching and bonus rates. Insurance risk (see page 125) Insurance risk is the risk that, over time, the cost of the contract, including claims and benefits, may exceed the total amount of premiums and investment income received. The cost of claims and benefits can be influenced by many factors, including mortality and morbidity experience, as well as lapse and surrender rates. Insurance risk is: • measured in terms of life insurance liabilities and economic capital allocated to insurance underwriting risk; • monitored through a framework of approved limits and delegated authorities; and • managed through a robust risk control framework which outlines clear and consistent policies, principles and guidance. This includes using product design, underwriting, reinsurance and claims-handling procedures. Credit risk management Credit quality of financial instruments Details of changes in our credit risk profile in 2016 can be found on page 85, in ‘Key developments and risk profile in 2016’. There were no material changes to the policies and practices for the management of credit risk in 2016. Credit risk sub-function (Audited) Credit approval authorities are delegated by the Board to the Group Chief Executive together with the authority to sub- delegate them. The Credit Risk sub-function in Global Risk is responsible for the key policies and processes for managing credit risk, which include formulating Group credit policies and risk rating frameworks, guiding the Group’s appetite for credit risk exposures, undertaking independent reviews and objective assessment of credit risk, and monitoring performance and management of portfolios. The principal objectives of our credit risk management are: • • • to maintain across HSBC a strong culture of responsible lending, and robust risk policies and control frameworks; to both partner and challenge our businesses in defining, implementing and continually re-evaluating our risk appetite under actual and scenario conditions; and to ensure there is independent, expert scrutiny of credit risks, their costs and their mitigation. Concentration of exposure (Audited) Concentrations of credit risk arise when a number of counterparties or exposures have comparable economic characteristics, or such counterparties are engaged in similar activities or operate in the same geographical areas or industry sectors so that their collective ability to meet contractual obligations is uniformly affected by changes in economic, political or other conditions. We use a number of controls and measures to minimise undue concentration of exposure in our portfolios across industries, countries and global businesses. These include portfolio and counterparty limits, approval and review controls, and stress testing. (Audited) Our risk rating system facilitates the internal ratings-based approach under the Basel framework adopted by the Group to support calculation of our minimum credit regulatory capital requirement. The customer risk rating (‘CRR’) 10-grade scale summarises a more granular underlying 23-grade scale of obligor probability of default (‘PD’). All corporate customers are rated using the 10- or 23-grade scale, depending on the degree of sophistication of the Basel II approach adopted for the exposure. Each CRR band is associated with an external rating grade by reference to long-run default rates for that grade, represented by the average of issuer-weighted historical default rates. This mapping between internal and external ratings is indicative and may vary over time. The expected loss (‘EL’) 10-grade scale for retail business summarises a more granular underlying EL scale for this customer segment. This combines obligor and facility/product risk factors in a composite measure. For the five credit quality classifications defined, each encompasses a range of granular internal credit rating grades assigned to wholesale and retail lending businesses, and the external ratings attributed by external agencies to debt securities. For debt securities and certain other financial instruments, external ratings have been aligned to the five quality classifications based upon the mapping of related CRR to external credit rating. The mapping is reviewed on a regular basis and the most recent review resulted in sovereign BBB+ and BBB exposures previously mapped to Credit Quality band ‘Good’ being mapped to Credit Quality Band ‘Strong’. Sovereign BB+ and BB exposures previously mapped to Credit Quality band ‘Satisfactory’ being mapped to Credit Quality Band ‘Good’. This represents a change in disclosure mapping unrelated to changes in counterparty creditworthiness. Had this mapping been applied in 2015, sovereign exposures would be changed as follows: ‘Satisfactory’ $1.4bn decrease, ‘Good’ $4.3bn decrease and $5.7bn ‘Strong’ increase. HSBC Holdings plc Annual Report and Accounts 2016 73 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Credit quality classification Sovereign debt securities and bills Other debt securities and bills Wholesale lending and derivatives Retail lending Footnotes External credit rating External credit rating Internal credit rating 12-month probability of default % Internal credit rating Expected loss % Quality classification Strong Good Satisfactory Sub-standard Impaired 1, 2 BBB and above A– and above CRR1 to CRR2 0 – 0.169 EL1 to EL2 0 – 0.999 BB to BBB– BBB+ to BBB– CRR3 0.170 – 0.740 EL3 1.000 – 4.999 BB- to B and unrated BB+ to B and unrated CRR4 to CRR5 0.741 – 4.914 EL4 to EL5 5.000 – 19.999 3 B– to C Default B– to C CRR6 to CRR8 4.915 – 99.999 EL6 to EL8 20.000 – 99.999 Default CRR9 to CRR10 100 EL9 to EL10 100+ or defaulted 1 2 3 Customer risk rating. Expected loss (‘EL’). The EL percentage is derived through a combination of probability of default (‘PD’) and loss given default (‘LGD’), and may exceed 100% in circumstances where the LGD is above 100% reflecting the cost of recoveries. Quality classification definitions • • • • • ‘Strong’ exposures demonstrate a strong capacity to meet financial commitments, with negligible or low probability of default and/or low levels of expected loss. ‘Good’ exposures require closer monitoring and demonstrate a good capacity to meet financial commitments, with low default risk. ‘Satisfactory’ exposures require closer monitoring and demonstrate an average to fair capacity to meet financial commitments, with moderate default risk. ‘Sub-standard’ exposures require varying degrees of special attention and default risk is of greater concern. ‘Impaired’ exposures have been assessed as impaired, as described on page 90. These also include retail accounts classified as EL1 to EL8 that are delinquent by more than 90 days, unless individually they have been assessed as not impaired; and renegotiated loans that have met the requirements to be disclosed as impaired and have not yet met the criteria to be returned to the unimpaired portfolio (see below). Renegotiated loans and forbearance (Audited) Where a loan is modified due to significant concerns about the borrower’s ability to meet contractual payments when due, a range of forbearance strategies is employed in order to improve the management of customer relationships, maximise collection opportunities and, if possible, avoid default, foreclosure or repossession. Identifying renegotiated loans Loans are identified as renegotiated loans when we modify the contractual payment terms due to significant credit distress of the borrower. ‘Forbearance’ describes concessions made on the contractual terms of a loan in response to an obligor’s financial difficulties. We classify and report loans on which concessions have been granted under conditions of credit distress as ‘renegotiated loans’ when their contractual payment terms have been modified because we have significant concerns about the borrowers’ ability to meet contractual payments when due. When considering modification terms, the borrower’s continued ability to repay is assessed and where they are unrelated to payment arrangements, whilst potential indicators of impairment, these loans are not considered as renegotiated loans. In HSBC Finance, loan modification and re-age policies, renegotiated real estate loans are not eligible for a subsequent renegotiation for six or 12 months depending upon the action, with a maximum of five renegotiations permitted within a five- year period. Loans that have been identified as renegotiated retain this designation until maturity or derecognition. A loan that is renegotiated is derecognised if the existing agreement is cancelled and a new agreement is made on substantially different terms or if the terms of an existing agreement are modified such that the renegotiated loan is substantially a different financial instrument. Any new loans that arise following derecognition events will continue to be disclosed as renegotiated loans. Credit quality of renegotiated loans On execution of the renegotiation, the loan will also be classified as impaired if it is not already so classified. In wholesale lending, all of the facilities with a customer, including loans which have not been modified, are considered impaired 74 HSBC Holdings plc Annual Report and Accounts 2016 following the provision of a renegotiated loan. In our US CML run-off portfolio in HSBC Finance, loans which are in the early stages of delinquency (less than 60 days delinquent) and typically have the equivalent of two payments deferred for the first time are not considered impaired, as the contractual payment deferrals are deemed to be insignificant compared with payments due on the loan as a whole. Those loans that are considered impaired retain the impaired classification for a minimum of one year. Renegotiated loans will continue to be disclosed as impaired until there is sufficient evidence to demonstrate a significant reduction in the risk of non-payment of future cash flows (the evidence typically comprises a history of payment performance against the original or revised terms), and there are no other indicators of impairment. In our US CML run-off portfolio in HSBC Finance, all modified loans with terms of more than two years are considered to be permanently impaired. Renegotiated loans and recognition of impairment allowances (Audited) For retail lending, renegotiated loans are segregated from other parts of the loan portfolio for collective impairment assessment to reflect the higher rates of losses often encountered in these segments. For wholesale lending, renegotiated loans are typically assessed individually. Credit risk ratings are intrinsic to the impairment assessment. The individual impairment assessment takes into account the higher risk of the non-payment of future cash flows inherent in renegotiated loans. Impairment assessment (Audited) For details of our impairment policies on loans and advances and financial investments, see Note 1 to the Financial Statements. Write-off of loans and advances (Audited) For details of our policy on the write-off of loans and advances, see Note 1 to the Financial Statements. In HSBC Finance, the carrying amounts of residential mortgages and second lien loans in excess of net realisable value are written off at or before the time foreclosure is completed or settlement is reached with the borrower. If there is no reasonable expectation of recovery, and foreclosure is pursued, the loan is normally written off no later than the end of the month in which the loan becomes 180 days contractually past due. Unsecured personal facilities, including credit cards, are generally written off at between 150 and 210 days past due. The standard period runs until the end of the month in which the account becomes 180 days contractually delinquent. Write- off periods may be extended, generally to no more than 360 days past due but, in very exceptional circumstances, to longer in a few countries where local regulation or legislation constrain earlier write-off, or where the realisation of collateral for secured real estate lending takes this time. For secured personal facilities, final write-off should generally occur within 60 months of the default at the latest. In the event of bankruptcy or analogous proceedings, write-off may occur earlier than the periods stated above. Collection procedures may continue after write-off. Impairment methodologies for available-for-sale asset- backed securities (‘ABSs’) (Audited) To identify objective evidence of impairment for available-for- sale ABSs, an industry standard valuation model is normally applied which uses data with reference to the underlying asset pools and models their projected future cash flows. The estimated future cash flows of the securities are assessed at the specific financial asset level to determine whether any of them are unlikely to be recovered as a result of loss events occurring on or before the reporting date. The principal assumptions and inputs to the models are typically the delinquency status of the underlying loans, the probability of delinquent loans progressing to default, the prepayment profiles of the underlying assets and the loss severity in the event of default. However, the models utilise other variables relevant to specific classes of collateral to forecast future defaults and recovery rates. Management uses externally available data and applies judgement when determining the appropriate assumptions in respect of these factors. We use a modelling approach which incorporates historically observed progression rates to default to determine if the decline in aggregate projected cash flows from the underlying collateral will lead to a shortfall in contractual cash flows. In such cases, the security is considered to be impaired. In respect of collateralised debt obligations (‘CDOs’), expected future cash flows for the underlying collateral are assessed to determine whether there is likely to be a shortfall in the contractual cash flows of the CDO. When a security benefits from a contract provided by a monoline insurer that insures payments of principal and interest, the expected recovery on the contract is assessed in determining the total expected credit support available to the ABS. Liquidity and funding risk management Details of changes in our liquidity and funding risk profile in 2016 can be found on page 85, in ‘Key developments and risk profile in 2016’. Liquidity and funding risk management framework HSBC has an internal liquidity and funding risk management framework (‘LFRF’) which aims to allow it to withstand very severe liquidity stresses. It is designed to be adaptable to changing business models, markets and regulations. The management of liquidity and funding is primarily undertaken locally (by country) in our operating entities in compliance with the Group’s LFRF, and with practices and limits set by the GMB through the RMM and approved by the Board. Our general policy is that each defined operating entity should be self-sufficient in funding its own activities. Where transactions exist between operating entities, they are reflected symmetrically in both entities. As part of our asset, liability and capital management (‘ALCM’) structure, we have established asset and liability committees (‘ALCO’) at Group level, in the regions and in operating entities. The terms of reference of all ALCOs include the monitoring and control of liquidity and funding. The primary responsibility for managing liquidity and funding within the Group’s framework and risk appetite resides with the local operating entities’ ALCOs, Holdings ALCO and the RMM. The remaining smaller operating entities are overseen by regional ALCOs, with appropriate escalation of significant issues to Holdings ALCO and the RMM. Operating entities are predominantly defined on a country basis to reflect our local management of liquidity and funding. Typically, an operating entity will be defined as a single legal entity. However, to take account of the situation where operations in a country are booked across multiple subsidiaries or branches: • an operating entity may be defined as a wider sub- consolidated group of legal entities if they are incorporated in the same country, liquidity and funding are freely fungible between the entities and permitted by local regulation, and the definition reflects how liquidity and funding are managed locally; or • an operating entity may be defined more narrowly as a principal office (branch) of a wider legal entity operating in multiple countries, reflecting the local country management of liquidity and funding. The RMM reviews and agrees annually the list of entities it directly oversees and the composition of these entities. Key developments in 2016 On 1 January 2016, the Group implemented a new LFRF. It uses the liquidity coverage ratio (‘LCR’) and net stable funding ratio (‘NSFR’) regulatory framework as a foundation, but adds extra metrics, limits and overlays to address firm-specific risks: The LFRF is delivered using the following key aspects: • stand-alone management of liquidity and funding by operating entity; • operating entity classification by inherent liquidity risk (‘ILR’) categorisation; • minimum LCR requirement depending on ILR categorisation; • minimum NSFR requirement depending on ILR categorisation; • • legal entity depositor concentration limit; three-month and 12-month cumulative rolling term contractual maturity limits covering deposits from banks, deposits from non-bank financial institutions and securities issued; • annual individual liquidity adequacy assessment by principal operating entity; • minimum LCR requirement by currency; • • intra-day liquidity; and forward-looking funding assessments. The new internal LFRF and the risk tolerance limits were approved by the Board on the basis of recommendations made by the Group Risk Committee. Our annual individual liquidity adequacy assessment process aims to: HSBC Holdings plc Annual Report and Accounts 2016 75 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk • identify risks that are not reflected in the LFRF, and, where required, to assess additional limits required locally; and borrowing receivables and derivative assets’ and ‘Cannot be pledged as collateral’. • validate the risk tolerance at the operating entity level by demonstrating that reverse stress testing scenarios are acceptably remote and ensuring vulnerabilities have been assessed through the use of severe stress scenarios. Management of liquidity and funding risk Liquidity coverage ratio The HSBC application of the LCR metric involves the following two key assumptions about the definition of operational deposits and the ability to transfer liquidity from non-EU legal entities: • we define operational deposits as transactional (current) accounts arising from the provision of custody services by HSBC Security Services or Global Liquidity and Cash Management, where the operational component is assessed to be the lower of the current balance and the separate notional values of debits and credits across the account in the previous calculation period; and • we assume no transferability of liquidity from non-EU entities other than to the extent currently permitted. Net stable funding ratio HSBC uses the NSFR as a basis for establishing stable funding around the Group. Liquid assets of HSBC’s principal operating entities Liquid assets are held and managed on a stand-alone operating entity basis. Most are held directly by each operating entity’s Balance Sheet Management (‘BSM’) department, primarily for the purpose of managing liquidity risk in line with the LFRF. The liquid asset buffer may also include securities in held-to- maturity portfolios. To qualify as part of the liquid asset buffer, held-to-maturity portfolios must have a deep and liquid repo market in the underlying security. Liquid assets also include any unencumbered liquid assets held outside BSM departments for any other purpose. The LFRF gives ultimate control of all unencumbered assets and sources of liquidity to BSM. Sources of funding Customer deposits in the form of current accounts and savings deposits payable on demand or at short notice form the significant part of our stable funding, and we place considerable importance on maintaining their stability. For deposits, stability depends upon maintaining depositor confidence in our capital strength and liquidity, and on competitive and transparent pricing. We also access wholesale funding markets by issuing senior secured and unsecured debt securities (publicly and privately) and borrowing from the secured repo markets against high- quality collateral, in order to obtain funding for non-banking subsidiaries that do not accept deposits, to align asset and liability maturities and currencies, and to maintain a presence in local wholesale markets. Ordinary share capital and retained reserves, non-core capital instruments and total loss-absorbing capacity (‘TLAC’) eligible debt securities are also a source of stable funding. Analysis of on-balance sheet encumbered and unencumbered assets and off-balance sheet collateral An asset is defined as encumbered if it has been pledged as collateral against an existing liability and, as a result, is no longer available to the Group to secure funding, satisfy collateral needs or be sold to reduce the funding requirement. An asset is therefore categorised as unencumbered if it has not been pledged against an existing liability. Unencumbered assets are further segmented into four separate sub-categories: ‘Readily realisable assets’, ‘Other realisable assets’, ‘Reverse repo/stock 76 HSBC Holdings plc Annual Report and Accounts 2016 Liquidity behaviouralisation All stable deposits are assumed under the Group’s frameworks to have a liquidity behaviouralised life beyond one year and to represent a homogeneous source of stable funding. The behaviouralisation of assets is far more granular and seeks to differentiate the period for which we must assume that we will need stable funding for the asset. Funds transfer pricing Our funds transfer pricing policies give rise to a two-stage funds transfer pricing approach, reflecting the fact that we separately manage interest rate risk and liquidity and funding risk under different assumptions. They have been developed to be consistent with our risk management frameworks. Each operating entity is required to apply the Group’s transfer pricing policy framework to determine for each material currency the most appropriate interest rate risk transfer pricing curve, a liquidity premium curve (which is the spread over the interest rate risk transfer pricing curve) and a liquidity recharge assessment (which is the spread under or over the interest rate risk transfer pricing curve). Repos and stock lending GB&M provides collateralised security financing services to its clients, providing them with cash financing or specific securities. When cash is provided to clients against collateral in the form of securities, the cash provided is recognised on the balance sheet as a reverse repo. When securities are provided to clients against cash collateral, the cash received is recognised on the balance sheet as a repo or, if the securities are equity securities, as stock lending. Each operating entity manages its collateral through a central collateral pool, in line with the LFRF. When specific securities need to be delivered and the entity does not have them currently available within the central collateral pool, the securities are borrowed on a collateralised basis. When securities are borrowed against cash collateral, the cash provided is recognised on the balance sheet as a reverse repo or, if the securities are equity securities, as stock borrowing. Operating entities may also borrow cash against collateral in the form of securities, using the securities available in the central collateral pool. Repos and stock lending can be used in this way to fund the cash requirement arising from securities owned outright by Markets to facilitate client business, and the net cash requirement arising from financing client securities activity. Reverse repos, stock borrowing, repos and stock lending are reported net when the IFRS offsetting criteria are met. In some cases, transactions to borrow or lend securities are collateralised using securities. These transactions are off- balance sheet. Any security accepted as collateral for a reverse repo or stock borrowing transaction must be of very high quality and its value subject to an appropriate haircut. Securities borrowed under reverse repo or stock borrowing transactions can only be recognised as part of the liquidity asset buffer for the duration of the transactions and only if the security received is eligible under the liquid asset policy within the LFRF. Credit controls are in place to ensure that the fair value of any collateral received remains appropriate to collateralise the cash or fair value of securities given. HSBC Holdings HSBC Holdings’ primary sources of cash are dividends received from subsidiaries, interest on and repayment of intra-group loans and securities, and interest earned on its own liquid funds. HSBC Holdings also raises ancillary funds in the debt capital markets through subordinated and senior debt issuances. Cash is primarily used for the provision of capital and subordinated funding to subsidiaries, interest payments to debt holders and dividend payments to shareholders. HSBC Holdings is also subject to contingent liquidity risk by virtue of credit-related commitments and guarantees and similar contracts issued. Such commitments and guarantees are only issued after due consideration of HSBC Holdings’ ability to finance the commitments and guarantees and the likelihood of the need arising. HSBC Holdings actively manages the cash flows from its subsidiaries to optimise the amount of cash held at the holding company level. During 2016, consistent with the Group’s capital plan, the Group’s subsidiaries did not experience any significant restrictions on paying dividends or repaying loans and advances. Also, there are no foreseen restrictions envisaged with regard to planned dividends or payments. However, the ability of subsidiaries to pay dividends or advance monies to HSBC Holdings depends on, among other things, their respective local regulatory capital and banking requirements, exchange controls, statutory reserves, and financial and operating performance. None of the subsidiaries that are excluded from our regulatory consolidation has capital resources below its minimum regulatory requirement. Market risk management Details of changes in our market risk profile in 2016 can be found on page 85, in ‘Key developments and risk profile in 2016’. There were no material changes to our policies and practices for the management of market risk in 2016. Market risk in global businesses The diagram below summarises the main business areas where trading and non-trading market risks reside, and the market risk measures used to monitor and limit exposures. Risk types Trading risk Non-trading risk • Foreign exchange and commodities • Interest rates • Credit spreads • Equities • Structural foreign exchange • Interest rates1 • Credit spreads Global business GB&M and BSM2 GB&M, BSM2, GPB, CMB and RBWM Risk measure VaR | Sensitivity | Stress Testing VaR | Sensitivity | Stress Testing 1 2 The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included in the Group VaR. The management of this risk is described on page 106. BSM, for external reporting purposes, forms part of Corporate Centre while daily operations and risk are managed within GB&M. Where appropriate, we apply similar risk management policies and measurement techniques to both trading and non-trading portfolios. Our objective is to manage and control market risk exposures to optimise return on risk while maintaining a market profile consistent with our established risk appetite. The nature of the hedging and risk mitigation strategies performed across the Group corresponds to the market risk management instruments available within each operating jurisdiction. These strategies range from the use of traditional market instruments, such as interest rate swaps, to more sophisticated hedging strategies to address a combination of risk factors arising at the portfolio level. Market risk governance (Audited) Market risk is managed and controlled through limits approved by the RMM for HSBC Holdings. These limits are allocated across business lines and to the Group’s legal entities. General measures HSBC Holdings Board Group Chairman/ Group Chief Executive Risk Management Meeting of the GMB Group traded risk Entity risk management committee Specific measures Principal office manager Business/desk/trader GB&M manages market risk, where the majority of HSBC’s total value at risk (excluding insurance) and almost all trading VaR resides, using risk limits approved by the RMM. VaR limits are set for portfolios, products and risk types, with market liquidity being a primary factor in determining the level of limits set. Global Risk is responsible for setting market risk management policies and measurement techniques. Each major operating entity has an independent market risk management and control sub-function which is responsible for measuring market risk exposures, monitoring and reporting these exposures against the prescribed limits on a daily basis. The market risk limits are governed according to the framework illustrated to the left. Each operating entity is required to assess the market risks arising on each product in its business and to transfer them to either its local GB&M unit for management, or to separate books managed under the supervision of the local ALCO. Model risk is governed through Model Oversight Committees (‘MOCs’) at the regional and global Wholesale Credit and Market Risk levels. They have direct oversight and approval responsibility for all traded risk models used for risk measurement and management and stress testing. We are committed to the ongoing development of our in-house risk models. The Markets MOC reports into the Group MOC, which oversees all model risk types at Group level. The Group MOC informs the RMM about material issues at least two times a year. The RMM is the Group’s ‘Designated Committee’ according to regulatory rules and has delegated day-to-day governance of all traded risk models to the Markets MOC. Global Risk enforces trading in permissible instruments approved for each site, new product approval procedures, restricting trading in the more complex derivative products only to offices with appropriate levels of product expertise and robust control systems. HSBC Holdings plc Annual Report and Accounts 2016 77 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Market risk measures Monitoring and limiting market risk exposures Our objective is to manage and control market risk exposures while maintaining a market profile consistent with our risk appetite. We use a range of tools to monitor and limit market risk exposures including sensitivity analysis, value at risk and stress testing. Sensitivity analysis Sensitivity analysis measures the impact of individual market factor movements on specific instruments or portfolios, including interest rates, foreign exchange rates and equity prices, such as the effect of a one basis point change in yield. We use sensitivity measures to monitor the market risk positions within each risk type. Sensitivity limits are set for portfolios, products and risk types, with the depth of the market being a principal factor in determining the level. Value at risk (Audited) Value at risk (‘VaR’) is a technique for estimating potential losses on risk positions as a result of movements in market rates and prices over a specified time horizon and to a given level of confidence. The use of VaR is integrated into market risk management and calculated for all trading positions regardless of how we capitalise them. Where there is not an approved internal model, we use the appropriate local rules to capitalise exposures. In addition, we calculate VaR for non-trading portfolios to have a complete picture of risk. Where we do not calculate VaR explicitly, we use alternative tools as summarised in the ‘Stress testing’ section below. Our models are predominantly based on historical simulation which incorporate the following features: • historical market rates and prices are calculated with reference to foreign exchange rates, commodity prices, interest rates, equity prices and the associated volatilities; • potential market movements utilised for VaR are calculated with reference to data from the past two years; and • VaR measures are calculated to a 99% confidence level and use a one-day holding period. The models also incorporate the effect of option features on the underlying exposures. The nature of the VaR models means that an increase in observed market volatility will lead to an increase in VaR without any changes in the underlying positions. VaR model limitations Although a valuable guide to risk, VaR should always be viewed in the context of its limitations. For example: • use of historical data as a proxy for estimating future events may not encompass all potential events, particularly extreme ones; • • the use of a holding period assumes that all positions can be liquidated or the risks offset during that period, which may not fully reflect the market risk arising at times of severe illiquidity, when the holding period may be insufficient to liquidate or hedge all positions fully; the use of a 99% confidence level does not take into account losses that might occur beyond this level of confidence; and • VaR is calculated on the basis of exposures outstanding at the close of business and therefore does not necessarily reflect intra-day exposures. Risk not in VaR framework The risks not in VaR (‘RNIV’) framework aims to capture and capitalise material market risks that are not adequately covered in the VaR model, such as the LIBOR tenor basis. 78 HSBC Holdings plc Annual Report and Accounts 2016 Risk factors are reviewed on a regular basis and either incorporated directly in the VaR models, where possible, or quantified through the VaR-based RNIV approach or a stress test approach within the RNIV framework. The outcome of the VaR-based RNIV is included in the VaR calculation and back- testing; a stressed VaR RNIV is also computed for the risk factors considered in the VaR-based RNIV approach. Stress-type RNIVs include a gap risk exposure measure to capture risk on non-recourse margin loans and a de-peg risk measure to capture risk to pegged and heavily-managed currencies. Stress testing Stress testing is an important procedure that is integrated into our market risk management framework to evaluate the potential impact on portfolio values of more extreme, although plausible, events or movements in a set of financial variables. In such scenarios, losses can be much greater than those predicted by VaR modelling. Stress testing is implemented at legal entity, regional and overall Group levels. A set of scenarios is used consistently across all regions within the Group. Scenarios are tailored to capture the relevant potential events or market movements at each level. The risk appetite around potential stress losses for the Group is set and monitored against referral limits. Market risk reverse stress tests are undertaken on the premise that there is a fixed loss. The stress testing process identifies which scenarios lead to this loss. The rationale behind the reverse stress test is to understand scenarios that are beyond normal business settings and could have contagion and systemic implications. Stressed VaR and stress testing, together with reverse stress testing and the management of gap risk, provide management with insights regarding the ‘tail risk’ beyond VaR, for which HSBC’s appetite is limited. Trading portfolios Back-testing We routinely validate the accuracy of our VaR models by back- testing them against both actual and hypothetical profit and loss against the corresponding VaR numbers. Hypothetical profit and loss excludes non-modelled items such as fees, commissions and revenues of intra-day transactions. We would expect, on average, to see two or three profits and two or three losses in excess of VaR at the 99% confidence level over a one-year period. The actual number of profits or losses in excess of VaR over this period can therefore be used to gauge how well the models are performing. We back-test our Group VaR at various levels that reflect a full legal entity scope of HSBC, including entities that do not have local permission to use VaR for regulatory purposes. Structural foreign exchange exposures Structural foreign exchange exposures represent net investments in subsidiaries, branches and associates, the functional currencies of which are currencies other than the US dollar. An entity’s functional currency is that of the primary economic environment in which the entity operates. Exchange differences on structural exposures are recognised in ‘Other comprehensive income’. We use the US dollar as our presentation currency in our consolidated financial statements because the US dollar and currencies linked to it form the major currency bloc in which we transact and fund our business. Our consolidated balance sheet is, therefore, affected by exchange differences between the US dollar and all the non-US dollar functional currencies of underlying subsidiaries. We hedge structural foreign exchange exposures only in limited circumstances. Our structural foreign exchange exposures are managed with the primary objective of ensuring, where practical, that our consolidated capital ratios and the capital ratios of individual banking subsidiaries are largely protected from the effect of changes in exchange rates. Interest rate risk in the banking book The Asset, Liability and Capital Management (‘ALCM’) function is responsible for measuring and controlling interest rate risk in the banking book under the supervision of the RMM. The component of the interest rate risk in the banking book outside Balance Sheet Management (‘BSM’) or Global Markets that can be economically neutralised by fixed-rate government bonds or interest rate derivatives is transfer priced to and managed by BSM. The banking book interest rate risk transferred to BSM is reflected in the Group’s non-traded VaR measure. BSM is overseen by the Market Risk and Product Control functions in exactly the same way as Global Markets. The price at which interest rate risk is transferred to BSM is determined by the entity’s prevailing interest rate risk transfer pricing curve defined by operating entities Asset and Liability Management Committee (‘ALCO’), in accordance with the Group’s funds transfer pricing policies. The transfer price seeks to reflect the price at which BSM could neutralise the risk in the market at the point of transfer. The banking book interest rate risk within HSBC Holdings is not transferred to BSM and is managed as an ALCO book. Interest rate risk behaviouralisation In assessing the banking book interest rate risk outside BSM and Global Markets, interest rate repricing behaviouralisation techniques are used where the interest repricing profile is uncertain due to customer/bank optionality or where non- interest bearing balances are withdrawable. The maximum tenor to which any individual tranche of a non- interest bearing withdrawable/repayable customer balance or equity can be behaviouralised is 10 years. The maximum weighted average behaviouralised tenor for any portfolio is five years. Interest-bearing managed/administered rate balances are behaviouralised to tenors less than one year, typically one month or three months. The maximum percentage of any portfolio that can be behaviouralised is 90% with the residual treated as contractual, meaning overnight. Unlike liquidity risk, which is assessed on the basis of a very severe stress scenario, banking book interest rate risk is assessed and managed according to business-as-usual conditions. In many cases, the contractual profile of banking book assets/liabilities arising from assets/liabilities created outside Markets or BSM does not reflect the behaviour observed. Where there is no certainty with regard to interest rate repricing profile, behaviouralisation is used to assess the market interest rate risk of banking book assets/liabilities and this assessed market risk is transferred to BSM, in accordance with the rules governing the transfer of interest rate risk from the global businesses to BSM. Behaviouralisation is applied in three key areas: • • • the assessed repricing frequency of managed rate balances; the assessed duration of non-interest bearing balances, typically capital and current accounts; and the base case expected prepayment behaviour or pipeline take-up rate for fixed-rate balances with embedded optionality. Interest rate behaviouralisation policies have to be formulated in line with the Group’s behaviouralisation policies and approved at least annually by local ALCOs. The extent to which balances can be behaviouralised is driven by: • • • the amount of the current balance that can be assessed as constant under business-as-usual conditions; and for managed rate balances, the historical market interest rate repricing behaviour observed; or for non-interest bearing balances, the duration for which the balance is expected to remain under business-as-usual conditions. This assessment is often driven by the re- investment tenors available to BSM to neutralise the risk through the use of fixed-rate government bonds or interest rate derivatives, and for derivatives the availability of cash flow hedging capacity. Measurement of interest rate risk in the banking book Interest rate risk in the banking book is measured and controlled using three metrics: • non-traded VaR; • net interest income sensitivity; and • economic value of equity. Non-traded VaR excludes the non-traded interest rate risk not transferred to BSM and the non-traded interest rate risk of HSBC Holdings. Net interest income (‘NII’) sensitivity captures the expected impact of changes in interest rates on base case projected net interest income. Economic value of equity (‘EVE’) captures the expected impact of changes in interest rates on base case economic value. It captures all non-traded items irrespective of the profit and loss accounting treatment. Balance Sheet Management Effective governance across BSM is supported by the dual reporting lines it has to the Chief Executive Officer of GB&M and to the Group Treasurer. In each operating entity, BSM is responsible for managing liquidity and funding under the supervision of the local ALCO (which usually meets on a monthly basis). It also manages the banking book interest rate positions transferred to it within a Markets limit structure. In executing the management of the liquidity risk on behalf of ALCO, and managing the banking book interest rate positions transferred to it, BSM invests in highly rated liquid assets in line with the Group’s liquid asset policy. The majority of the liquidity is invested in central bank deposits and government, supranational and agency securities, with most of the remainder held in short-term interbank and central bank loans. Withdrawable central bank deposits are accounted for as cash balances. Interbank loans, statutory central bank reserves and loans to central banks are accounted for as loans and advances to banks. BSM’s holdings of securities are accounted for as available-for-sale or, to a lesser extent, held-to-maturity assets. Statutory central bank reserves are not recognised as liquid assets. The statutory reserves that would be released in line with the Group’s stressed customer deposit outflow assumptions are reflected as stressed inflows. BSM is permitted to use derivatives as part of its mandate to manage interest rate risk. Derivative activity is predominantly through the use of vanilla interest rate swaps which are part of cash flow hedging and fair value hedging relationships. Credit risk in BSM is predominantly limited to short-term bank exposure created by interbank lending, exposure to central banks and high-quality sovereigns, supranationals or agencies which constitute the majority of BSM’s liquidity portfolio. BSM does not manage the structural credit risk of any Group entity balance sheet. BSM is permitted to enter into single name and index credit derivatives activity, but it does so to manage credit risk on the HSBC Holdings plc Annual Report and Accounts 2016 79 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk exposure specific to its securities portfolio in limited circumstances only. The risk limits are extremely limited and closely monitored. At 31 December 2016, BSM had no open credit derivative index risk. VaR is calculated on positions held in BSM and is calculated by applying the same methodology used for the Markets business and utilised as a tool for market risk control purposes. The vast majority of BSM’s VaR arises from banking book portfolios and is classified as non-traded VaR. BSM is predominantly involved in managing liquidity in accordance with the LFRF, managing the daily cash position and managing the non-traded interest rate risk transferred to it, within non-traded market risk limits. Net interest income sensitivity A principal part of our management of non-traded interest rate risk is to monitor the sensitivity of expected net interest income under varying interest rate scenarios (simulation modelling), where all other economic variables are held constant. This monitoring is undertaken at an entity level by local ALCOs. Entities apply a combination of scenarios and assumptions relevant to their local businesses, and standard scenarios which are required throughout HSBC. The latter are consolidated to illustrate the combined pro forma effect on our consolidated net interest income. Projected net interest income sensitivity figures represent the effect of the pro forma movements in projected yield curves based on a static balance sheet size and structure assumption, other than instances where the size of the balances or repricing is deemed interest rate sensitive (non-interest bearing current account migration and fixed rate loan early prepayment) and where non-traded VaR is assumed to contractually run off. This effect, however, does not incorporate actions which would probably be taken by BSM or in the business units to mitigate the effect of interest rate risk. In reality, BSM proactively seeks to change the interest rate risk profile to optimise net revenues. The net interest income sensitivity calculations assume that interest rates of all maturities move by the same amount in the ‘up-shock’ scenario. Rates are not assumed to become negative in the ‘down-shock’ scenario unless the central bank rate is already negative and then not assumed to go further negative, which may, in certain currencies, effectively result in non- parallel shock. In addition, the net interest income sensitivity calculations take account of the effect on net interest income of anticipated differences in changes between interbank interest rates and interest rates over which the entity has discretion in terms of the timing and extent of rate changes. Economic value of equity An economic value of equity (‘EVE value’) represents the present value of future banking book cash flows that could be distributed to equity providers under a managed run-off scenario, which represents the current book value of equity plus the present value of future net interest income under a managed run-off scenario. The present value of net interest income under a managed run-off and under any interest rate scenario can therefore be assessed by deducting the book value of equity from the EVE value calculated. An EVE sensitivity is the extent to which the EVE value will change due to a pre-specified movement in interest rates, where all other economic variables are held constant. The EVE sensitivity represents the sensitivity of discounted net interest income plus the sensitivity of the net present value of any transactions used to hedge the interest income earned on equity. If the EVE sensitivity is adjusted to remove the sensitivity in net present value of any transactions used to hedge the interest income earned on equity, the resulting adjusted EVE sensitivity represents the extent to which, under a managed run-off scenario, discounted net interest income is sensitive to a pre-specified movement in interest rates. 80 HSBC Holdings plc Annual Report and Accounts 2016 When assessing the sensitivity of economic value of equity to interest rate movements, the timing of principal cash flows can vary but the amount remains constant. Operating entities are required to monitor EVE sensitivity as a percentage of total capital resources and adjusted EVE sensitivity as a percentage of the present value of future net interest income (base case EVE minus book value of equity) under a managed run-off assumption. EVE can also be used for assessing the economic capital required to support interest rate risk in the banking book (‘IRRBB’): • Where EVE under any scenario is higher than the current balance sheet carrying value of equity, the banking book income stream is positive (i.e. profit) and therefore capital accretive under that scenario and no economic capital for IRRBB is required. • Where EVE of any scenario is lower than the current balance sheet carrying value of equity, the banking book income stream is negative (i.e. loss) and therefore capital deductive under that scenario and economic capital for IRRBB should be held against this loss. Where banking book assets/liabilities are fair valued through profit and loss or where the fair value changes impact capital resources (i.e. available for sale), economic capital for this interest rate sensitivity is additionally assessed using a stressed VaR approach. HSBC Holdings As a financial services holding company, HSBC Holdings has limited market risk activity. Its activities predominantly involve maintaining sufficient capital resources to support the Group’s diverse activities; allocating these capital resources across our businesses; earning dividend and interest income on its investments in our businesses; providing dividend payments to its equity shareholders and interest payments to providers of debt capital; and maintaining a supply of short-term capital resources for deployment under extraordinary circumstances. It does not take proprietary trading positions. The main market risks to which HSBC Holdings is exposed are banking book interest rate risk and foreign currency risk. Exposure to these risks arises from short-term cash balances, funding positions held, loans to subsidiaries, investments in long-term financial assets and financial liabilities including debt capital issued. The objective of HSBC Holdings’ market risk management strategy is to reduce exposure to these risks and minimise volatility in capital resources, cash flows and distributable reserves. Market risk for HSBC Holdings is monitored by Holdings ALCO in accordance with its risk appetite statement. HSBC Holdings uses interest rate swaps and cross-currency interest rate swaps to manage the interest rate risk and foreign currency risk arising from its long-term debt issues. Operational risk management Details of our operational risk profile in 2016 can be found on page 121, in ‘Operational risk exposures in 2016’. Responsibility for minimising operational risk lies with all HSBC’s employees. Specifically, all staff are required to manage the operational risks of the business and operational activities for which they are responsible. Overview The objective of our operational risk management is to manage and control operational risk in a cost-effective manner within targeted levels of operational risk consistent with our risk appetite, as defined by the GMB. Key developments in 2016 Regulatory compliance risk management HSBC’s operational risk management framework (‘ORMF’) is our overarching approach for managing operational risk, the purpose of which is to: • • identify and manage our non-financial operational risks in an effective manner; remain within the Group’s operational risk appetite, which helps the organisation understand the level of risk it is willing to accept; and • drive forward-looking risk awareness and assist management focus during 2016. Activity to strengthen our risk culture and better embed the use of the ORMF was further implemented in 2016, in particular the use of the activity-based three lines of defence model, which sets out roles and responsibilities for managing operational risks on a daily basis. Further information on the three lines of defence model can be found in the ‘Our risk management framework’ section on page 68. Governance and structure The ORMF defines minimum standards and processes, and the governance structure for the management of operational risk and internal control in our geographical regions, global businesses and global functions. The ORMF has been codified in a high-level standards manual, supplemented with detailed policies, which describes our approach to identifying, assessing, monitoring and controlling operational risk and gives guidance on mitigating action to be taken when weaknesses are identified. Operational risk is organised as a specific risk discipline within Global Risk, and a formal governance structure provides oversight over its management. The Global Operational Risk sub-function supports the Group Chief Risk Officer and the Global Operational Risk Committee. It is responsible for leading the embedding of the ORMF and assurance of adherence to associated policies and processes across the first and second lines. It is also responsible for preparation of operational risk reporting at Group level, including reports for consideration by the RMM and the Group Risk Committee. The Global Operational Risk Committee meets at least quarterly to discuss key risk issues and review the effective implementation of the ORMF. Key risk management processes Business managers throughout the Group are responsible for maintaining an acceptable level of internal control commensurate with the scale and nature of operations, and for identifying and assessing risks, designing controls and monitoring the effectiveness of these controls. The ORMF helps managers to fulfil these responsibilities by defining a standard risk assessment methodology and providing a tool for the systematic reporting of operational loss data. A centralised database is used to record the results of the operational risk management process. Operational risk and control self-assessments are inputted and maintained by business units. Business and functional management and business risk and control managers monitor the progress of documented action plans to address shortcomings. To help ensure that operational risk losses are consistently reported and monitored at Group level, all Group companies are required to report individual losses when the net loss is expected to exceed $10,000, and to aggregate all other operational risk losses under $10,000. Losses are entered into the Group operational risk database and reported to the RMM on a monthly basis. Overview The Regulatory Compliance sub-function (‘RC’) provides independent, objective oversight and challenge and promotes a compliance-orientated culture, supporting the business in delivering fair outcomes for customers, maintaining the integrity of financial markets and achieving HSBC’s strategic objectives. Key developments in 2016 In the second half of 2016, we restructured part of our Global Risk function. The Financial Crime Compliance sub-function became part of our new Financial Crime Risk function, which reports directly to the Group Chief Executive (see ‘Financial crime risk management’ below). The RC sub-function remains part of Global Risk, and continues to oversee management of regulatory compliance risk. Governance and structure The Global Head of RC reports to the Group Chief Risk Officer. To align with our global business structure and help ensure coverage of local regulatory requirements, RC is structured as a global function with regional and country RC teams, which support and advise each global business and global function. Key risk management processes We regularly review our policies and procedures. Global policies and procedures require the prompt identification and escalation of any actual or potential regulatory breach to RC. Reportable events are escalated to the RMM and the Group Risk Committee, as appropriate. Matters relating to the Group’s regulatory conduct of business are reported to the Conduct & Values Committee. Conduct of business In 2016, we continued to take steps to raise our standards relating to conduct, which included: • designing further global mandatory conduct training for delivery to all employees in 2017; • • • incorporating the assessment of expected values and behaviours as key determinants in recruitment, performance appraisal and remuneration processes; improving our Group-wide market surveillance capability; introducing policies and procedures to strengthen support for potentially vulnerable customers; • enhancing the quality and depth of conduct management information and how it is used across the Group; • implementing an assessment process to check the effectiveness of our conduct initiatives across the Group; and • assessing conduct standards and practices within our key third-party suppliers and distributors. The Board maintained oversight of conduct matters through the Conduct & Values Committee. Further information on our conduct is provided in the Strategic Report on page 22 and www.hsbc.com. For conduct-related costs relating to significant items, see page 62. Financial crime risk management Overview In the second half of 2016, we established a Financial Crime Risk (‘FCR’) function and appointed a Group Head of FCR, who reports to the Group Chief Executive and chairs the Global Standards Steering Meeting. FCR is a global function that brings together all areas of financial crime risk management at HSBC and is dedicated to implementing the most effective global standards to combat financial crime. The function has been set up to enable us to build on our achievements in managing financial crime risk effectively across the bank and HSBC Holdings plc Annual Report and Accounts 2016 81 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk to continue to strengthen financial crime detection, and anti- money laundering (‘AML’), sanctions and anti-bribery and corruption compliance. Key developments in 2016 The FCR function encompasses FCR Assurance, Financial Crime Compliance, Financial Crime Threat Mitigation, the Global Standards programme, the Monitor Liaison Office, FCR Strategy Implementation, FCR Chief of Staff and FCR COO. The structure has been designed around the following key principles: • FCR sets policy and standards, provides subject matter expertise and guidance, drives execution at country level via regions, and maintains line of business subject matter expertise in support of the global businesses. • Country-level execution accountability is driven by a common set of global principles with material variations managed by exception. • Sub-functions within FCR are leveraged across the global function, ensuring consistency and utilising expertise and resourcing. Key risk management processes We continue to embed policies and procedures, introduce new technology solutions and support the cultural change needed to effectively manage financial crime risk. A key enhancement during 2016 was the deployment of our global customer due diligence system to 35 markets for RBWM, 52 for CMB, 36 for GB&M and two for GPB. This, along with the enhanced financial crime risk training that we have taken more than 3,500 senior leaders through globally, will help ensure our people have the guidance and tools that they need. The Group Head of FCR attends the Financial System Vulnerabilities Committee (‘FSVC’), which reports to the Board on matters relating to financial crime and financial system abuse and provides a forward-looking perspective on financial crime risk, as well as cyber and information security. In 2016, the FSVC assumed responsibility from the CVC for oversight of controls relating to anti-bribery and corruption. Throughout the year the Committee received regular reports from country chief executives on the actions being taken by management to address local financial crime risk issues and vulnerabilities, and also received reports on specific issues. The Monitor Under the agreements entered into with the DoJ and the FCA in 2012, including the five-year US DPA, the Monitor was appointed in July 2013 for an expected five-year period to produce annual assessments of the effectiveness of the Group’s AML and sanctions compliance programme. In February 2017, the Monitor delivered his third annual follow- up review report based on various thematic and country reviews he had conducted over the course of 2016. In his report, the Monitor concluded that, in 2016, HSBC continued to make progress in enhancing its financial crime compliance controls, including improvements to its Global AML policies and procedures. However, the Monitor also expressed significant concerns about the pace of that progress, instances of potential financial crime that the DoJ and HSBC are reviewing further and on-going systems and control deficiencies that in his view raised questions as to whether HSBC is adhering to its obligations under the US DPA - a matter that would be determined by the DoJ in its sole discretion. The Monitor also found that there remain substantial challenges for HSBC to meet its goal of developing a reasonably effective and sustainable AML and sanctions compliance programme. In addition, the Monitor did not certify as to HSBC’s implementation of and adherence to remedial measures specified in the US DPA. The ‘US deferred prosecution 82 HSBC Holdings plc Annual Report and Accounts 2016 agreement and related agreements and consent orders’ are discussed in ‘Top and emerging risks’ on page 64. Throughout 2016, the FSVC received regular reports on HSBC’s relationship with the Monitor and its compliance with the US DPA. The FSVC received regular updates on the preliminary findings arising from the Monitor’s third annual review, and has received the Monitor’s third annual review report. Insurance manufacturing operations risk management Details of changes in our insurance manufacturing operations risk profile in 2016 can be found on page 121, in ‘Insurance manufacturing operations risk profile’. There were no material changes to our policies and practices for the management of risks arising in our insurance manufacturing operations in 2016. Governance (Audited) Insurance risks are managed to a defined risk appetite, which is aligned to the Group risk appetite and risk management framework, including the Group three lines of defence model. For details of the Group’s governance framework, see page 68. The Group Insurance Risk Management Meeting oversees the control framework globally and is accountable to the RBWM Risk Management Meeting on risk matters relating to the insurance business. The monitoring of the risks within the insurance operations is carried out by insurance risk teams. Specific risk functions, including Wholesale Credit & Market Risk, Operational Risk, Information Security Risk and Financial Crime Risk, support Insurance Risk teams in their respective areas of expertise. Stress and scenario testing (Audited) Stress testing forms a key part of the risk management framework for the insurance business. We participate in local and Group-wide regulatory stress tests, including the Bank of England stress test of the banking system, the Hong Kong Monetary Authority stress test, the European Insurance and Occupational Pensions Authority stress test, and individual country insurance regulatory stress tests. These have highlighted that a key risk scenario for the insurance business is a prolonged low interest rate environment. In order to mitigate the impact of this scenario, the insurance operations have a range of strategies that could be employed including the hedging of investment risk, repricing current products to reflect lower interest rates, improving risk diversification, moving towards less capital intensive products, and developing investment strategies to optimise the expected returns against the cost of economic capital. Management and mitigation of key risk types Market risk (Audited) All our insurance manufacturing subsidiaries have market risk mandates which specify the investment instruments in which they are permitted to invest and the maximum quantum of market risk which they may retain. They manage market risk by using, among others, some or all of the techniques listed below, depending on the nature of the contracts written: • For products with discretionary participating features (‘DPF’), adjusting bonus rates to manage the liabilities to policyholders. The effect is that a significant portion of the market risk is borne by the policyholder. • Asset and liability matching where asset portfolios are structured to support projected liability cash flows. The group manages its assets using an approach that considers asset quality, diversification, cash flow matching, liquidity, volatility and target investment return. It is not always possible to match asset and liability durations due to uncertainty over the receipt of all future premiums and the timing of claims; and also because the forecast payment dates of liabilities may exceed the duration of the longest dated investments available. We use models to assess the effect of a range of future scenarios on the values of financial assets and associated liabilities, and ALCOs employ the outcomes in determining how to best structure asset holdings to support liabilities. • Using derivatives to protect against adverse market movements or better match liability cash flows. • For new products with investment guarantees, considering the cost when determining the level of premiums or the price structure. • Periodically reviewing products identified as higher risk, which contain investment guarantees and embedded optionality features linked to savings and investment products. • Designing new products to mitigate market risk, such as changing the investment return sharing portion between policyholders and the shareholder. • Exiting, to the extent possible, investment portfolios whose risk is considered unacceptable. • Repricing premiums charged to policyholders. Credit risk (Audited) Our insurance manufacturing subsidiaries are responsible for the credit risk, quality and performance of their investment portfolios. Our assessment of the creditworthiness of issuers and counterparties is based primarily upon internationally recognised credit ratings and other publicly available information. Investment credit exposures are monitored against limits by our local insurance manufacturing subsidiaries, and are aggregated and reported to the Group Insurance Credit Risk and Group Credit Risk functions. Stress testing is performed by Group Insurance on the investment credit exposures using credit spread sensitivities and default probabilities. We use a number of tools to manage and monitor credit risk. These include a credit report which contains a watch-list of investments with current credit concerns. The report is circulated monthly to senior management in Group Insurance and the individual country chief risk officers to identify investments which may be at risk of future impairment. Liquidity risk (Audited) Risk is managed by cash flow matching and maintaining sufficient cash resources, investing in high credit-quality investments with deep and liquid markets, monitoring investment concentrations and restricting them where appropriate, and establishing committed contingency borrowing facilities. Insurance manufacturing subsidiaries are required to complete quarterly liquidity risk reports for the Group Insurance Risk function and an annual review of the liquidity risks to which they are exposed. Insurance risk HSBC Insurance primarily uses the following techniques to manage and mitigate insurance risk: • product design, pricing and overall proposition management (for example, management of lapses by introducing surrender charges); • underwriting policy; • claims management processes; and • reinsurance which cedes risks above our acceptable thresholds to an external reinsurer thereby limiting our exposure. Reputational risk management There were no material changes to our policies and practices for the management of reputational risk in 2016. Overview Reputational risk relates to stakeholders’ perceptions, whether fact-based or otherwise. Stakeholders’ expectations change constantly, and so reputational risk is dynamic and varies between geographical regions, groups and individuals. We have an unwavering commitment to operating at the high standards we set for ourselves in every jurisdiction. Any lapse in standards of integrity, compliance, customer service or operating efficiency represents a potential reputational risk. Governance and structure The development of policies, management and mitigation of reputational risk are coordinated through the Group Reputational Risk Policy Committee, which is chaired by the Group Chairman. In parallel, the Global Risk Resolution Committee, chaired by the Chief Risk Officer, is the highest decision-making forum in the Group for matters arising from clients or transactions that either present a serious potential reputational risk to the Group, or merit a Group-led decision to ensure a consistent risk management approach across our regions and global businesses. Both committees keep the RMM apprised of areas and activities presenting significant reputational risk and, where appropriate, make recommendations to the RMM to mitigate such risks. Significant issues posing reputational risk are also reported to the Board and the Conduct & Values Committee, where appropriate. Key risk management processes The External Affairs function maintains policies and gives policy advice for the issues that might affect HSBC’s reputation and standing with customers, employees, opinion formers and the public. It oversees the identification, management and control of reputational risk for all HSBC Group entities in the areas of media relations and engagement with non-governmental organisations and other external stakeholders. Our Reputational Risk and Client Selection (‘RRCS’) team, which is jointly managed by the Global Head of Financial Crime Compliance and the Global Head of Regulatory Compliance, oversees the identification, management and control of all other significant reputational risks across HSBC Group. It is responsible for setting policies to guide the Group’s reputational risk management, devising strategies to protect against reputational risk, and advising the global businesses and global functions to help them identify, assess and mitigate such risks, where possible. It is led by a headquarters-based team. This is supported by teams in each business line and region, which help ensure that issues are directed to the appropriate forums, that decisions are made and implemented effectively, and that management information is generated to aid senior management in the businesses and regions in understanding where reputational risk exists. Each global business has established a governance process that empowers the RRCS’s committees to address reputational risk issues at the right level, escalating decisions where appropriate. The global functions manage and escalate reputational risks within established operational risk frameworks. Our policies set out our risk appetite and operational procedures for all areas of reputational risk, including financial crime prevention, regulatory compliance, conduct-related concerns, environmental impacts, human rights matters and employee relations. We have taken, and are taking, measures to address the requirements of the US DPA and enhance our AML, sanctions HSBC Holdings plc Annual Report and Accounts 2016 83 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk and other regulatory compliance frameworks. These measures should also enhance our reputational risk management in the future. For further details on our financial crime risk, see ‘Financial crime risk management’ on page 81. Pension risk management There were no material changes to our policies and practices for the management of pension risk in 2016. Further details can be found at www.hsbc.com. Sustainability risk management Overview Assessing the environmental and social impacts of providing finance to our customers is integral to our overall risk management processes. Key developments in 2016 In 2016, we issued a revised mining and metals policy. It replaced the one introduced in 2007, and responds to increasing concerns regarding climate change by addressing thermal coal mining, and provides more details on how we deal with human rights issues in the sector. We also created a new training module for relevant relationship managers globally on our sustainability risk policies and their responsibilities, to ensure consistent implementation. Furthermore, we continued to improve the way sustainability risk is recorded in our information management system. Governance and structure The Global Risk function, with input from the Global Corporate Sustainability function, is mandated to manage sustainability risk globally, working through local offices as appropriate. Sustainability risk managers have regional or national responsibilities for advising on and managing environmental and social risks. Key risk management processes The Global Risk function’s responsibilities in relation to sustainability risk include: • Formulating sustainability risk policies. This includes work in several key areas: overseeing our sustainability risk standards; overseeing our application of the Equator Principles, which provide a framework for banks to assess and manage the social and environmental impact of large projects they provide finance to; overseeing our application of our sustainability policies, covering agricultural commodities, chemicals, defence, energy, forestry, freshwater infrastructure, mining and metals, UNESCO World Heritage Sites and the Ramsar Convention on Wetlands; undertaking independent reviews of transactions where sustainability risks are assessed to be high; and supporting our operating companies to assess similar risks of a lesser magnitude. • Building and implementing systems-based processes to ensure consistent application of policies, reduce the costs of sustainability risk reviews, and capture management information to measure and report on the effect of our lending and investment activities on sustainable development. • Providing training and capacity building within our operating companies to ensure sustainability risks are identified and mitigated consistently to appropriate standards. Governance and structure A global pension risk framework and accompanying global policies on the management of risks related to defined benefit and defined contribution plans is in place. Pension risk is managed by a network of local and regional pension risk forums. The Global Pensions Oversight Committee is responsible for the governance and oversight of all pension plans sponsored by HSBC around the world. Key risk management processes Our global pensions strategy is to move from defined benefit to defined contribution plans, where local law allows and it is considered competitive to do so. In defined contribution pension plans, the contributions that HSBC is required to make are known, while the ultimate pension benefit will vary, typically with investment returns achieved by investment choices made by the employee. While the market risk to HSBC of defined contribution plans is low, the Group is still exposed to operational and reputational risk. In defined benefit pension plans, the level of pension benefit is known. Therefore, the level of contributions required by HSBC will vary due to a number of risks, including: • • investments delivering a return below that required to provide the projected plan benefits; the prevailing economic environment leading to corporate failures, thus triggering write-downs in asset values (both equity and debt); • a change in either interest rates or inflation expectations, causing an increase in the value of plan liabilities; and • plan members living longer than expected (known as longevity risk). Pension risk is assessed using an economic capital model that takes into account potential variations in these factors. The impact of these variations on both pension assets and pension liabilities is assessed using a one-in-200-year stress test. Scenario analysis and other stress tests are also used to support pension risk management. To fund the benefits associated with defined benefit plans, sponsoring Group companies, and in some instances employees, make regular contributions in accordance with advice from actuaries and in consultation with the plan’s trustees where relevant. These contributions are normally set to ensure that there are sufficient funds to meet the cost of the accruing benefits for the future service of active members. However, higher contributions are required when plan assets are considered insufficient to cover the existing pension liabilities. Contribution rates are typically revised annually or once every three years, depending on the plan. The defined benefit plans invest contributions in a range of investments designed to limit the risk of assets failing to meet a plan’s liabilities. Any changes in expected returns from the investments may also change future contribution requirements. In pursuit of these long-term objectives, an overall target allocation of the defined benefit plan assets between asset classes is established. In addition, each permitted asset class has its own benchmarks, such as stock-market or property valuation indices. The benchmarks are reviewed at least once every three years and more frequently if required by local legislation or circumstances. The process generally involves an extensive asset and liability review. 84 HSBC Holdings plc Annual Report and Accounts 2016 Key developments and risk profile in 2016 Key developments in 2016 In 2016, HSBC undertook a number of initiatives to enhance its approach to the management of risk. These included: • Implementing a new internal liquidity and funding risk management framework which uses the liquidity coverage ratio and net stable funding ratio regulatory framework as a foundation, as described on page 75 of the ‘Liquidity and funding risk management’ section. • Undertaking activities to strengthen our risk culture and further embed the use of the operational risk management framework, as described on page 81 of the ‘Operational risk management’ section. • Implementing a number of initiatives to raise our standards in relation to the conduct of our business, as described on page 81 of the ‘Regulatory compliance risk management’ section. • Restructuring part of our Global Risk function. The Financial Crime Compliance sub-function became part of our new Financial Crime Risk (‘FCR’) function. The Regulatory Compliance sub-function remains part of Global Risk, and continues to oversee management of regulatory compliance risk. • Establishing an FCR function and appointing a Group Head of FCR, who chairs the Global Standards Steering Meeting and reports to the Group Chief Executive, to oversee all areas of financial crime risk management at HSBC. The FCR function is dedicated to implementing the most effective global standards to combat financial crime, as described on page 81 of the ‘Financial crime risk management’ section. • Issuing a revised mining and metals policy and creating a new training module for relevant relationship managers globally on our sustainability risk policies and their responsibilities, to ensure consistent implementation, as described on page 84 in the ‘Sustainability risk management’ section. There were no material changes to our policies and practices for the management of credit risk, market risk, insurance manufacturing operations risk, reputational risk and sustainability risk in 2016. Credit risk profile Credit risk in 2016 Credit exposure Wholesale lending Personal lending HSBC Finance Supplementary information HSBC Holdings Securitisation exposures and other structured products Credit risk in 2016 Page 85 86 94 100 102 104 105 105 Credit risk is the risk of financial loss if a customer or counterparty fails to meet an obligation under a contract. It arises principally from direct lending, trade finance and leasing business, but also from other products, such as guarantees and credit derivatives and from holding assets in the form of debt securities. A summary of our current policies and practices regarding the management of credit risk is set out on pages 73 to 75. The effect of commodity price movements in the oil and gas sectors is provided in ‘Areas of special interest’ on page 67. Gross loans and advances declined by $67bn, mainly due to foreign exchange effects reducing balances by $68bn. Loan impairment charges and other credit provisions for the year were $3.4bn. In wholesale lending, balances declined by $33bn mainly due to foreign exchange movements of $41bn. Excluding foreign exchange movements, lending balances decreased in North America, and in Middle East and North Africa but were more than offset by increases in Asia and Latin America. Europe lending balances were broadly unchanged. In personal lending, balances decreased by $34bn, mainly due to foreign exchange movements of $26bn and $13bn in North America largely due to continued repayments and loan sales in the US CML run-off portfolio. Excluding foreign exchange movements and the US CML run-off portfolio, lending balances increased in Europe, Asia and Latin America and were offset by a decrease in Middle East and North Africa. Information on constant currency movements is provided on page 30. Summary of credit risk At 31 Dec Maximum exposure to credit risk – total assets subject to credit risk – off-balance sheet commitments subject to credit risk Gross loans and advances – personal lending – wholesale lending Impaired loans – personal lending – wholesale lending Impaired loans as a % of gross loans and advances – personal lending – wholesale lending – personal and wholesale lending Impairment allowances – personal lending – wholesale lending Loans and advances net of impairment allowances For year ended 31 Dec Loan impairment charge – personal lending – wholesale lending Other credit risk provisions Page 86 101 95 90 94 101 96 92 2016 $bn 2,898 2,205 693 958 340 618 18 6 12 % 1.8 1.9 1.9 $bn 7.9 2.0 5.9 2015 $bn 2,947 2,234 713 1,024 374 650 24 12 12 % 3.1 1.9 2.3 $bn 9.6 2.9 6.7 950 1,015 3.3 1.7 1.6 0.1 3.4 3.6 1.8 1.8 0.1 3.7 HSBC Holdings plc Annual Report and Accounts 2016 85 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Gross loans to customers and banks over five years ($bn) Loan impairment charges by industry ($bn) Personal Wholesale Unimpaired Impaired Loan impairment charge over five years ($bn) 2016 2015 Loan impairment allowances over five years ($bn) Personal Wholesale Personal Wholesale Loan impairment charges by geographical region ($bn) 2016 2015 86 HSBC Holdings plc Annual Report and Accounts 2016 Loan impairment allowances as a percentage of impaired loans Loan impairment allowances ($bn) Credit exposure Maximum exposure to credit risk (Audited) The table that follows provides information on balance sheet items, offsets, and loan and other credit-related commitments. Commentary on balance sheet movements is provided on page 42. The offset on derivatives remains in line with the movements in maximum exposure amounts. The offset on corporate and commercial loans to customers decreased by $17bn. This reduction was mainly related to corporate overdraft balances where a small number of clients benefited from the use of net interest arrangements across overdrafts and deposits. As a result, net risk exposures are usually stable, while gross balances can be volatile. ‘Maximum exposure to credit risk’ table The following table presents our maximum exposure before taking account of any collateral held or other credit enhancements (unless such enhancements meet accounting offsetting requirements). The table excludes financial instruments whose carrying amount best represents the net exposure to credit risk; and it excludes equity securities as they are not subject to credit risk. For the financial assets recognised on the balance sheet, the maximum exposure to credit risk equals their carrying amount; for financial guarantees and similar contracts granted, it is the maximum amount that we would have to pay if the guarantees were called upon. For loan commitments and other credit-related commitments, it is generally the full amount of the committed facilities. The offset in the table relates to amounts where there is a legally enforceable right of offset in the event of counterparty default and where, as a result, there is a net exposure for credit risk purposes. However, as there is no intention to settle these balances on a net basis under normal circumstances, they do not qualify for net presentation for accounting purposes. No offset has been applied to off-balance sheet collateral. In the case of derivatives the offset column also includes collateral received in cash and other financial assets. Other credit risk mitigants While not disclosed as an offset in the following ‘Maximum exposure to credit risk’ table, other arrangements are in place which reduce our maximum exposure to credit risk. These include a charge over collateral on borrowers’ specific assets such as residential properties, collateral held in the form of financial instruments that are not held on balance sheet and short positions in securities. In addition, for financial assets held as part of linked insurance/investment contracts the risk is predominantly borne by the policyholder. See Note 30 and pages 198 and 201 of the Financial Statements for further details of collateral in respect of certain loans and advances and derivatives. Maximum exposure to credit risk (Audited) Derivatives Loans and advances to customers held at amortised cost – personal – corporate and commercial – non-bank financial institutions Loans and advances to banks held at amortised cost Reverse repurchase agreements – non-trading Total balance sheet exposure to credit risk Total off-balance sheet – financial guarantees and similar contracts – loan and other credit-related commitments At 31 Dec Maximum exposure $m 290,872 861,504 337,826 460,209 63,469 88,126 2016 Offset $m (262,233) (33,657) (3,629) (27,686) (2,342) (248) Net $m 28,639 827,847 334,197 432,523 61,127 87,878 Maximum exposure $m 288,476 924,454 371,203 493,078 60,173 90,401 160,974 (4,764) 156,210 146,255 2015 Offset $m (258,755) (52,190) (5,373) (44,260) (2,557) (53) (900) Net $m 29,721 872,264 365,830 448,818 57,616 90,348 145,355 2,204,751 (300,902) 1,903,849 2,234,409 (311,898) 1,922,511 692,915 37,072 655,843 — — — 692,915 37,072 655,843 712,546 46,116 666,430 — — — 712,546 46,116 666,430 2,897,666 (300,902) 2,596,764 2,946,955 (311,898) 2,635,057 Concentration of exposure • derivatives, see page 99 and Note 14 to the Financial The geographical diversification of our lending portfolio, and our broad range of global businesses and products, ensured that we did not overly depend on a few markets to generate growth in 2016. For an analysis of: • financial investments, see Note 15 to the Financial Statements; • trading assets, see Note 10 to the Financial Statements; Statements; and • loans and advances by industry sector and by the location of the principal operations of the lending subsidiary (or, in the case of the operations of The Hongkong and Shanghai Banking Corporation, HSBC Bank plc, HSBC Bank Middle East Limited and HSBC Bank USA, by the location of the lending branch) see page 94 for wholesale lending and page 100 for personal lending. HSBC Holdings plc Annual Report and Accounts 2016 87 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Credit quality of financial instruments (Audited) We assess the credit quality of all financial instruments that are subject to credit risk. Additional credit quality information in respect of our consolidated holdings of ABSs is provided on page 105. For the purpose of the following disclosure, loans past due up to 90 days and not otherwise classified as impaired are separately classified as past due but not impaired, irrespective Distribution of financial instruments by credit quality (Audited) of their credit quality grade. Trading assets, financial assets designated at fair value and financial investments exclude equity securities as they are not subject to credit risk. The changes to the mapping of sovereign external ratings to credit quality bands, described on page 73, mainly impacts the credit quality of financial investments in 2016 with an increase in the ‘Strong’ rating band and a decrease in the ‘Good’ and ‘Satisfactory’ rating bands. Neither past due nor impaired Strong Good Satisfactory Sub- standard Past due but not impaired Impaired Cash and balances at central banks Items in the course of collection from other banks Hong Kong Government certificates of indebtedness $m 126,838 4,656 31,228 $m 711 14 — $m 444 329 — $m 16 4 — Trading assets 127,997 20,345 21,947 1,232 $m $m Total gross amount $m 128,009 Impairment allowances $m Total $m 128,009 5,003 5,003 31,228 171,521 14,451 94,054 24,769 38,247 4,472 290,872 31,228 171,521 14,451 94,054 24,769 38,247 4,472 290,872 13,595 73,171 672 7,746 138 12,741 15,356 6,119 3,250 25,875 5,808 5,818 3,249 367 236,693 45,961 542 7,368 46 396 44 746 314 850 437,531 200,385 185,717 18,831 290,313 24,544 12,505 884 8,662 5,062 18,228 869,354 6,490 339,798 (7,850) (1,972) 861,504 337,826 111,848 158,878 163,107 17,504 3,128 11,362 465,827 (5,618) 460,209 35,370 16,963 10,105 443 472 376 63,729 (260) 63,469 73,516 8,238 6,293 73 123,822 401,010 1,774 11,203 18,223 13,579 536 5,348 18,166 13,570 392 9,227 1,160 3,688 3,125 10,043 1,660 6,102 763 2,940 266 805 474 331 6 — — 236 124 35 89 — 88,126 — 160,974 1,031 1,030 221 432,130 4,234 26,928 92 8,574 129 18,354 — — (250) 88,126 160,974 432,130 3,984 26,928 8,574 18,354 At 31 Dec 2016 1,579,517 313,707 263,995 26,094 9,028 20,510 2,212,851 (8,100) 2,204,751 Percentage of total gross amount % % 71.4 14.2 % 11.9 % 1.2 % 0.4 % 0.9 % 100.0 88 HSBC Holdings plc Annual Report and Accounts 2016 – treasury and other eligible bills – debt securities – loans and advances to banks – loans and advances to customers Financial assets designated at fair value Derivatives Loans and advances to customers held at amortised cost – personal – corporate and commercial – non-bank financial institutions Loans and advances to banks held at amortised cost Reverse repurchase agreements – non-trading Financial investments Assets held for sale Other assets – endorsements and acceptances – accrued income and other Distribution of financial instruments by credit quality (continued) Neither past due nor impaired Good Satisfactory Sub- standard Past due but not impaired Impaired Cash and balances at central banks Items in the course of collection from other banks Hong Kong Government certificates of indebtedness Trading assets – treasury and other eligible bills – debt securities – loans and advances to banks – loans and advances to customers Financial assets designated at fair value Derivatives Loans and advances to customers held at amortised cost – personal – corporate and commercial – non-bank financial institutions Loans and advances to banks held at amortised cost Reverse repurchase agreements – non-trading Financial investments Assets held for sale Other assets – endorsements and acceptances – accrued income and other Strong $m 97,365 5,318 28,410 $m 583 32 — $m 939 416 — 116,633 21,243 19,894 6,749 77,088 790 10,995 14,546 4,391 18,250 5,067 3,037 701 248,101 32,056 190 10,656 3,239 5,809 736 7,209 $m $m $m 47 2 — 576 100 299 127 50 383 1,110 Impairment allowances $m Total gross amount $m 98,934 5,768 28,410 158,346 7,829 99,038 22,303 29,176 4,857 288,476 Total $m 98,934 5,768 28,410 158,346 7,829 99,038 22,303 29,176 4,857 288,476 472,691 214,152 309,720 29,322 194,393 15,021 16,836 12,179 944 7,568 23,758 11,507 934,009 374,082 (9,555) (2,879) 924,454 371,203 127,673 168,772 171,466 15,379 4,274 11,949 499,513 (6,435) 493,078 35,298 16,058 7,906 513 337 302 60,414 (241) 60,173 73,226 11,929 4,836 407 1 20 90,419 (18) 90,401 108,238 382,328 10,177 8,306 16,552 18,600 9,605 5,688 1,084 3,850 7,222 1,838 20,931 16,341 17,279 10,204 3,798 6,406 46 4,525 1,635 632 343 289 — — 703 147 22 125 488 1,326 2,133 333 52 281 146,255 423,120 41,532 25,310 9,149 16,161 — (1,454) 146,255 423,120 40,078 25,310 9,149 16,161 At 31 Dec 2015 1,553,830 331,141 293,178 26,199 13,030 28,058 2,245,436 (11,027) 2,234,409 Percentage of total gross amount % 69.2 % 14.7 % 13.1 % 1.2 % 0.6 % 1.2 % 100.0 Past due but not impaired gross financial instruments (Audited) Past due but not impaired gross financial instruments are those loans where, although customers have failed to make payments in accordance with the contractual terms of their facilities, they have not met the impaired loan criteria described on page 90. In North America, past due but not impaired balances decreased, mainly due to the continued repayments and loan sales in the US CML run-off portfolio. Past due but not impaired gross financial instruments by geographical region (Audited) At 31 Dec 2016 At 31 Dec 2015 Europe $m 1,206 1,599 Asia $m 3,484 3,444 MENA $m 1,260 1,263 North America Latin America $m 2,549 5,474 $m 529 1,250 Total $m 9,028 13,030 HSBC Holdings plc Annual Report and Accounts 2016 89 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Ageing analysis of days for past due but not impaired gross financial instruments (Audited) Loans and advances to customers and banks held at amortised cost – personal – corporate and commercial – financial Assets held for sale – disposal group – non-current assets held for sale Other financial instruments At 31 Dec 2016 Loans and advances to customers and banks held at amortised cost – personal – corporate and commercial – financial Assets held for sale – disposal group – non-current assets held for sale Other financial instruments At 31 Dec 2015 Impaired loans (Audited) Impaired loans and advances are those that meet any of the following criteria: • Wholesale loans and advances classified as customer risk rating (‘CRR’) 9 or CRR 10: these grades are assigned when HSBC considers that the customer is either unlikely to pay their credit obligations in full without recourse to security, or is more than 90 days past due on any material credit obligation to HSBC. • Retail loans and advances classified as expected loss (‘EL’) 9 or EL 10: these grades are typically assigned to retail loans Movement in impaired loans by industry sector 60-89 days 90-179 days 180 days and over $m $m Up to 29 days $m 6,743 3,696 2,593 454 194 11 183 70 30-59 days $m 1,320 986 316 18 29 3 26 18 $m 587 380 201 6 13 3 10 10 7,007 1,367 610 9,403 5,665 3,432 306 476 476 — 80 1,917 1,401 505 11 137 136 1 35 727 502 225 — 90 89 1 14 11 — 11 — — — — 12 23 111 — 93 18 — — — 10 Total $m 8,668 5,062 3,128 478 236 17 219 124 9,028 12,179 7,568 4,274 337 703 701 2 148 13,030 7 — 7 — — — — 14 21 21 — 19 2 — — — 9 30 9,959 2,089 831 121 and advances more than 90 days past due unless they have been individually assessed as not impaired. • Renegotiated loans and advances: loans where we have changed the contractual cash flows due to credit distress of the obligor. Renegotiated loans remain classified as impaired until there is sufficient evidence to demonstrate a significant reduction in the risk of non-payment of future cash flows. In personal lending, the continued repayments and loan sales in the US CML run-off portfolio reduced impaired loan balances by a further $4.2bn. At 1 Jan Classified as impaired during the year Transferred from impaired to unimpaired during the year Amounts written off Net repayments and other At 31 Dec 2016 Corporate and commercial $m 11,949 6,032 (922) (1,720) (3,977) 11,362 Personal $m 11,507 3,521 (1,210) (1,252) (6,076) 6,490 Financial Total Personal $m 322 133 (7) (11) (61) $m 23,778 9,686 (2,139) (2,983) (10,114) $m 15,160 5,995 (2,346) (2,263) (5,039) 376 18,228 11,507 2015 Corporate and commercial Financial $m 13,795 5,469 (922) (1,424) (4,969) 11,949 $m 375 96 (38) (14) (97) 322 Total $m 29,330 11,560 (3,306) (3,701) (10,105) 23,778 90 HSBC Holdings plc Annual Report and Accounts 2016 Impaired loans by industry sector and geographical region Non-renegotiated impaired loans – personal – corporate and commercial – financial Renegotiated impaired loans – personal – corporate and commercial – financial At 31 Dec 2016 Impaired loans % of total gross loans and advances Non-renegotiated impaired loans – personal – corporate and commercial – financial Renegotiated impaired loans – personal – corporate and commercial – financial At 31 Dec 2015 Impaired loans % of total gross loans and advances Currency translation adjustment 31 Dec 2015 at 31 Dec 2016 exchange rates Movement – constant currency basis 31 Dec 2016 as reported Renegotiated loans and forbearance The most significant portfolio of renegotiated loans was in North America, substantially all of which were retail loans held by HSBC Finance Corporation (‘HSBC Finance’). The ongoing repayments and loan sales in the US CML run-off portfolio reduced renegotiated loans by $8.7bn during 2016. Renegotiated loans and advances to customers by industry sector Neither past due nor impaired Past due but not impaired Impaired At 31 Dec 2016 Impairment allowances on renegotiated loans Neither past due nor impaired Past due but not impaired Impaired At 31 Dec 2015 Impairment allowances on renegotiated loans Europe $m 4,354 1,239 3,029 86 3,708 648 2,868 192 8,062 2.3% 4,583 1,361 3,135 87 4,682 878 3,607 197 9,265 2.3% (1,170) 8,095 (33) 8,062 Asia $m 1,771 453 1,291 27 728 113 614 1 2,499 0.6% 1,760 385 1,368 7 615 131 480 4 2,375 0.6% (22) 2,353 146 2,499 MENA $m 1,042 459 582 1 1,188 72 1,052 64 2,230 5.5% 1,051 475 552 24 1,127 41 1,086 — 2,178 4.6% (194) 1,984 246 2,230 North America Latin America $m 1,913 1,043 865 5 2,929 2,213 716 — 4,842 4.1% 2,177 1,786 389 2 6,753 6,208 545 — 8,930 6.5% 12 8,942 (4,100) 4,842 $m 399 220 179 — 196 30 166 — 595 2.9% 623 211 411 1 407 31 376 — 1,030 4.8% (162) 868 (273) 595 Total $m 9,479 3,414 5,946 119 8,749 3,076 5,416 257 18,228 1.9% 10,194 4,218 5,855 121 13,584 7,289 6,094 201 23,778 2.3% (1,536) 22,242 (4,014) 18,228 The following tables show the gross carrying amounts of the Group’s holdings of renegotiated loans and advances to customers by industry sector, geography, credit quality classification and arrangement type. First lien residential mortgages Other personal lending Corporate and commercial Non-bank financial institutions $m 976 346 2,751 4,073 267 3,973 1,753 6,556 12,282 870 $m 282 78 325 685 150 716 243 733 1,692 252 $m 1,848 301 5,416 7,565 1,667 2,152 123 6,094 8,369 2,098 $m 260 — 257 517 130 391 24 201 616 119 Total $m 3,366 725 8,749 12,840 2,214 7,232 2,143 13,584 22,959 3,339 Total $m 12,840 22,959 Renegotiated loans and advances to customers by geographical region At 31 Dec 2016 At 31 Dec 2015 Europe $m 5,855 7,121 Asia $m 1,046 943 MENA $m 1,871 1,945 North America Latin America $m 3,736 12,372 $m 332 578 A range of forbearance strategies are employed in order to improve the management of customer relationships, maximise collection opportunities and, if possible, avoid default, foreclosure or repossession. The tables below show renegotiated loans by arrangement type as a percentage of the total value of arrangements offered. In personal lending, renegotiated loans have been allocated to the single most dominant arrangement type. HSBC Holdings plc Annual Report and Accounts 2016 91 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Impairment of loans and advances (Audited) For an analysis of loan impairment charges and other credit risk provisions by global business, see page 38. The tables below analyse the loan impairment charges for the year by industry sector for impaired loans and advances that are either individually or collectively assessed, and for collective impairment allowances on loans and advances that are classified as not impaired. Report of the Directors | Risk Renegotiated loans by arrangement type: personal lending Interest rate and terms modifications Payment concessions Collection re-age Modification re-age Other At 31 Dec 2016 % 21.9 14.3 19.2 34.6 10.0 100.0 Corporate renegotiated loans often require the granting of more than one arrangement type as part of an effective strategy. The percentages reported in the table below include the effect of loans being reported in more than one arrangement type. Renegotiated loans by arrangement type: corporate and commercial, and financial Maturity term extensions Reductions in margin, principal forgiveness, debt equity swaps and interest, fees or penalty payment forgiveness Other changes to repayment profile Interest only conversion Other At 31 Dec 2016 % 37.3 21.4 19.4 9.3 12.6 100.0 Loan impairment charge to the income statement by industry sector Personal – first lien residential mortgages – other personal Corporate and commercial – manufacturing and international trade and services – commercial real estate and other property-related – other commercial Financial At 31 Dec 2016 Personal – first lien residential mortgages – other personal Corporate and commercial – manufacturing and international trade and services – commercial real estate and other property-related – other commercial Financial At 31 Dec 2015 Europe $m 162 1 161 337 38 (15) 314 34 533 109 (8) 117 415 138 33 244 14 538 Asia $m 264 (1) 265 388 306 (28) 110 2 654 309 (1) 310 372 250 18 104 — 681 MENA North America Latin America $m 226 10 216 53 105 (16) (36) 13 292 276 50 226 212 127 49 36 (18) 470 $m 219 149 70 500 81 3 416 (10) 709 157 70 87 319 26 24 269 (7) 469 $m 832 7 825 330 195 25 110 — Total $m 1,703 166 1,537 1,608 725 (31) 914 39 1,162 3,350 983 41 942 451 305 47 99 — 1,834 152 1,682 1,769 846 171 752 (11) 1,434 3,592 Charge for impairment losses as a percentage of average gross loans and advances to customers by geographical region New allowances net of allowance releases Recoveries At 31 Dec 2016 Amount written off net of recoveries New allowances net of allowance releases Recoveries At 31 Dec 2015 Amount written off net of recoveries Europe % 0.23 (0.08) 0.15 0.26 0.26 (0.11) 0.15 0.22 Asia % 0.23 (0.04) 0.19 0.14 0.23 (0.05) 0.18 0.12 MENA % 0.93 (0.13) 0.80 0.84 1.35 (0.14) 1.21 1.17 North America Latin America % 0.62 (0.06) 0.56 0.48 0.41 (0.06) 0.35 0.45 % 7.02 (0.56) 6.46 2.99 5.37 (0.50) 4.87 3.94 Total % 0.46 (0.07) 0.39 0.32 0.48 (0.09) 0.39 0.37 92 HSBC Holdings plc Annual Report and Accounts 2016 Movement in impairment allowances by industry sector and by geographical region At 1 Jan 2016 Amounts written off Personal – first lien residential mortgages – other personal Corporate and commercial – manufacturing and international trade and services – commercial real estate and other property-related – other commercial Financial Total amounts written off Recoveries of amounts written off in previous years Personal – first lien residential mortgages – other personal Corporate and commercial – manufacturing and international trade and services – commercial real estate and other property-related – other commercial Financial Total recoveries of amounts written off in previous years Charge to income statement Exchange and other movements At 31 Dec 2016 Impairment allowances against banks: – individually assessed Impairment allowances against customers: – individually assessed – collectively assessed Impairment allowances at 31 Dec 2016 At 1 Jan 2015 Amounts written off Personal – first lien residential mortgages – other personal Corporate and commercial – manufacturing and international trade and services – commercial real estate and other property-related – other commercial Financial Total amounts written off Recoveries of amounts written off in previous years Personal – first lien residential mortgages – other personal Corporate and commercial – manufacturing and international trade and services – commercial real estate and other property-related – other commercial Financial Total recoveries of amounts written off in previous years Charge to income statement Exchange and other movements At 31 Dec 2015 Impairment allowances against banks: – individually assessed Impairment allowances against customers: – individually assessed – collectively assessed Impairment allowances at 31 Dec 2015 North America Latin America Asia $m 1,525 MENA $m 1,810 Europe $m 3,477 (412) (10) (402) (730) (380) (109) (241) (1) (1,143) 225 3 222 35 15 9 11 1 261 533 (339) 2,789 (208) (3) (205) (137) (78) (54) (5) (18) (363) 34 — 34 10 5 — 5 — (358) (6) (352) (285) (172) (31) (82) (5) (648) 124 4 120 24 23 — 1 1 149 654 (45) 1,635 44 292 (102) 1,681 73 709 (886) 1,272 — — — — 2,060 729 2,789 1,038 597 1,635 1,137 544 1,681 540 732 1,272 $m 720 (340) (12) (328) (297) (10) (223) (64) — (637) 78 8 70 22 16 — 6 — 100 1,162 (872) 473 — 157 316 473 Total $m 9,573 (1,602) (173) (1,429) (1,830) (765) (452) (613) (24) (3,456) 515 41 474 109 68 11 30 3 627 3,350 (2,244) 7,850 — 4,932 2,918 7,850 3,971 1,356 1,890 2,640 2,529 12,386 (468) (12) (456) (644) (233) (244) (167) (12) (1,124) 320 6 314 46 16 24 6 2 368 538 (276) 3,477 (416) (6) (410) (179) (149) (5) (25) — (595) 135 4 131 30 20 5 5 — 165 681 (82) 1,525 (273) (1) (272) (235) (215) (8) (12) — (508) 50 — 50 3 2 — 1 — 53 470 (95) 1,810 — — 18 — 2,572 905 3,477 908 617 1,525 1,157 635 1,810 327 1,714 2,041 (554) (344) (210) (106) (28) (57) (21) (2) (996) (24) (972) (309) (213) (30) (66) — (2,707) (387) (2,320) (1,473) (838) (344) (291) (14) (662) (1,305) (4,194) 119 (17) 136 27 15 2 10 — 146 1,434 (2,084) 720 — 438 282 720 681 19 662 124 61 36 27 3 808 3,592 (3,019) 9,573 18 5,402 4,153 9,573 $m 2,041 (284) (142) (142) (381) (125) (35) (221) — (665) 54 26 28 18 9 2 7 1 57 26 31 18 8 5 5 1 76 469 (482) 2,041 HSBC Holdings plc Annual Report and Accounts 2016 93 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Movement in impairment allowances on loans and advances to customers and banks (Audited) Banks individually assessed 2016 Customers Individually assessed Collectively assessed Banks individually assessed 2015 Customers Individually assessed Collectively assessed $m 5,402 (1,831) 107 1,831 (577) 4,932 $m 4,153 (1,607) 520 1,519 (1,667) 2,918 Total $m 9,573 (3,456) 627 3,350 (2,244) 7,850 $m 6,195 (1,368) 86 1,516 (1,027) 5,402 $m 6,142 (2,826) 722 2,087 (1,972) 4,153 Total $m 12,386 (4,194) 808 3,592 (3,019) 9,573 $m 49 — — (11) (20) 18 — 0.6% 0.3% 0.8% 0.6% 0.4% 0.9% causes of the decline were mainly in Turkey, where some portfolios are being reduced, and in the UAE, where we sold loans and exited certain customer relationships. These decreases were partly offset by loan growth mainly in Egypt and Oman. In Asia, lending balances increased by $13bn. This reflected strong credit growth in the fourth quarter of 2016 across a range of industries, and principally in Hong Kong, partly offset by foreign exchange decreases of $3.8bn. At 1 Jan Amounts written off Recoveries of loans and advances previously written off Charge to income statement Exchange and other movements At 31 Dec Impairment allowances % of loans and advances Wholesale lending $m 18 (18) — — — — — Total wholesale lending balances declined by $33bn including foreign exchange movements of $41bn, of which $31bn related to the UK. In North America, lending decreased by $6.1bn, mainly in the US as paydowns and maturities exceeded new loan originations. This reflected our efforts to improve returns with more disciplined lending. In Middle East and North Africa, overall lending fell by $5.8bn, including $3.4bn of foreign exchange movements. Other 94 HSBC Holdings plc Annual Report and Accounts 2016 Total wholesale lending gross loans Corporate and commercial – manufacturing – international trade and services – commercial real estate – other property-related – government – other commercial Financial – non-bank financial institutions – banks Gross loans at 31 Dec 2016 Loan and other credit-related commitments – corporate and commercial – financial Corporate and commercial – manufacturing – international trade and services – commercial real estate – other property-related – government – other commercial Financial – non-bank financial institutions – banks Gross loans at 31 Dec 2015 Currency translation adjustment 31 Dec 2015 at 31 Dec 2016 exchange rates Movement – constant currency basis 31 Dec 2016 as reported Loan and other credit-related commitments – corporate and commercial – financial Europe $m Asia $m MENA $m 161,653 212,848 22,078 27,005 55,875 21,460 7,025 3,009 47,279 43,666 31,307 12,359 205,319 135,394 112,229 23,165 32,564 72,166 32,798 37,628 2,919 34,773 79,254 19,517 59,737 292,102 183,508 167,298 16,210 187,508 211,224 36,623 61,598 26,148 7,129 3,653 52,357 50,447 33,345 17,102 34,272 72,199 32,371 35,206 1,132 36,044 68,321 13,969 54,352 237,955 279,545 (32,287) (3,846) 205,668 275,699 (349) 205,319 125,029 104,832 20,197 16,403 292,102 171,566 159,947 11,619 2,941 8,448 724 1,856 1,619 6,490 10,370 2,599 7,771 32,448 18,562 18,474 88 26,525 4,884 10,621 798 2,102 1,695 6,425 11,761 2,597 9,164 38,286 (3,446) 34,840 (2,392) 32,448 20,829 20,610 219 North America $m 58,276 15,348 11,035 7,849 8,823 354 14,867 14,823 9,750 5,073 73,099 124,720 96,301 28,419 62,882 17,507 11,505 7,032 8,982 203 17,653 16,308 9,822 6,486 79,190 Latin America $m Total $m 10,972 465,827 2,785 2,518 1,340 306 541 3,482 3,742 556 3,186 14,714 9,849 9,174 675 11,374 2,572 3,096 1,577 45 772 3,312 3,996 681 3,315 80,643 150,042 64,171 55,638 8,442 106,891 151,855 63,729 88,126 617,682 472,033 403,476 68,557 499,513 95,858 159,019 67,926 53,464 7,455 115,791 150,833 60,414 90,419 15,370 650,346 557 (2,316) (41,338) 79,747 (6,648) 73,099 126,912 102,369 24,543 13,054 1,660 14,714 19,151 18,155 996 609,008 8,674 617,682 463,487 405,913 57,574 As a % of total gross loans % 48.6 8.4 15.6 6.7 5.8 0.9 11.2 15.9 6.7 9.2 64.5 48.8 9.4 15.5 6.7 5.2 0.7 11.3 14.7 5.9 8.8 63.5 HSBC Holdings plc Annual Report and Accounts 2016 95 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Total wholesale lending impairment allowances Corporate and commercial – manufacturing – international trade and services – commercial real estate – other property-related – government – other commercial Financial – non-bank financial institutions – banks Impairment allowances at 31 Dec 2016 Impairment allowances % of impaired loans Corporate and commercial – manufacturing – international trade and services – commercial real estate – other property-related – government – other commercial Financial – non-bank financial institutions – banks Impairment allowances at 31 Dec 2015 Impairment allowances % of impaired loans Currency translation adjustment 31 Dec 2015 at 31 Dec 2016 exchange rates Movement – on constant currency basis 31 Dec 2016 as reported Europe $m 2,048 411 473 402 167 2 593 216 216 — Asia $m 1,343 342 647 11 34 — 309 9 9 — MENA $m 1,137 174 476 144 202 1 140 15 15 — North America Latin America $m 880 139 81 67 37 — 556 20 20 — $m 210 38 35 36 55 1 45 — — — 2,264 36.7% 1,352 69.9% 1,152 67.8% 900 56.7% 210 60.9% 2,638 1,256 1,254 459 796 613 234 6 530 194 194 — 2,832 40.3% (502) 2,330 (66) 2,264 254 599 35 72 — 296 13 13 — 1,269 68.3% (21) 1,248 104 1,352 204 456 145 270 — 179 22 4 18 1,276 77.7% (101) 1,175 (23) 1,152 777 140 123 76 55 — 383 30 30 — 510 49 48 343 1 2 67 — — — 807 86.2% 510 64.7% (21) 786 114 900 (78) 432 (222) 210 Total $m 5,618 1,104 1,712 660 495 4 1,643 260 260 — 5,878 50.0% 6,435 1,106 2,022 1,212 632 8 1,455 259 241 18 6,694 54.6% (723) 5,971 (93) 5,878 Commercial real estate Our commercial real estate lending disclosures focus on the regions containing the majority of our balances for loans and advances. Europe, Asia and North America accounted for 97% of our total commercial real estate lending at 31 December 2016 (31 December 2015: 97%). Commercial real estate lending Gross loans and advances Neither past due nor impaired Past due but not impaired Impaired loans Total gross loans and advances – of which: renegotiated loans Impairment allowances 31 Dec 2016 Total $m of which: Europe $m Asia $m North America $m 62,342 20,208 32,688 7,650 221 1,608 64,171 1,525 660 41 1,212 21,461 1,117 403 88 22 89 110 32,798 7,849 — 11 118 67 31 Dec 2015 Total $m 64,926 454 2,546 67,926 2,134 1,212 of which: Europe $m Asia $m 24,426 32,182 89 1,633 26,148 1,586 613 119 70 32,371 6 35 North America $m 6,659 212 161 7,032 150 76 Commercial real estate lending includes the financing of corporate, institutional and high net worth customers who are investing primarily in income-producing assets and, to a lesser extent, in their construction and development. The portfolio is globally diversified with larger concentrations in Hong Kong, the UK, the US and Canada. Our global exposure is centred largely on cities with economic, political or cultural significance. In many less-developed markets, industry is moving from the development and rapid construction of recent years to an increasing focus on investment stock consistent with more developed markets. In more developed markets, our exposure mainly comprises the financing of investment assets, the redevelopment of existing stock and the augmentation of both commercial and residential markets to support economic and population growth. In less- developed commercial real estate markets, our exposures comprise lending for development assets on relatively short tenors with a particular focus on supporting larger, better capitalised developers involved in residential construction or assets supporting economic expansion. Commercial real estate lending was $3.8bn lower, largely because of a fall in the value of sterling contributing to a foreign exchange movement of $4.0bn. Total lending balances in Europe declined by $4.7bn, including foreign exchange movements of $3.5bn, partly offset by increases in lending in Asia and North America. 96 HSBC Holdings plc Annual Report and Accounts 2016 Refinance risk in commercial real estate Commercial real estate lending tends to require the repayment of a significant proportion of the principal at maturity. Typically, a customer will arrange repayment through the acquisition of a new loan to settle the existing debt. Refinance risk is the risk Commercial real estate loans and advances maturity analysis that a customer, being unable to repay the debt on maturity, fails to refinance it at commercial rates. We monitor our commercial real estate portfolio closely, assessing indicators for signs of potential issues with refinancing. 31 Dec 2016 Total $m 17,636 9,531 26,829 10,175 64,171 of which: Asia $m 7,773 5,075 13,691 6,259 32,798 Europe $m 5,687 2,904 10,846 2,024 21,461 North America $m 3,568 1,453 1,733 1,095 7,849 31 Dec 2015 Total $m 19,579 11,408 25,268 11,671 67,926 of which: Asia $m 8,811 5,934 11,399 6,227 32,371 Europe $m 6,757 4,354 11,442 3,595 26,148 North America $m 2,992 939 2,037 1,064 7,032 On demand, overdrafts or revolving < 1 year 1-2 years 2-5 years > 5 years Gross loans and advances Collateral on loans and advances Collateral held is analysed separately for commercial real estate and for other corporate, commercial and financial (non-bank) lending. The following tables include commitments, primarily undrawn credit lines. sheet loan The collateral measured in the following tables consists of fixed first charges on real estate, and charges over cash and marketable financial instruments. The values in the tables represent the expected market value on an open market basis; no adjustment has been made to the collateral for any expected costs of recovery. Marketable securities are measured at their fair value. Other types of collateral such as unsupported guarantees and floating charges over the assets of a customer’s business are not measured in the tables below. While such mitigants have value, often providing rights in insolvency, their assignable value is not sufficiently certain and they are therefore assigned no value for disclosure purposes. For impaired loans, the collateral values cannot be directly compared with impairment allowances recognised. The loan- to-value (‘LTV’) figures use open market values with no adjustments. Impairment allowances are calculated on a different basis, by considering other cash flows and adjusting collateral values for costs of realising collateral as explained further on page 179. Commercial real estate loans and advances The value of commercial real estate collateral is determined by using a combination of external and internal valuations and physical inspections. For CRR 1-7, local valuation policies determine the frequency of review on the basis of local market conditions because of the complexity of valuing collateral for commercial real estate. For CRR 8 and 9-10, almost all collateral would have been revalued within the last three years. In Hong Kong, market practice is typically for lending to major property companies to be either secured by guarantees or unsecured. In Europe, facilities of a working capital nature are generally not secured by a first fixed charge, and are therefore disclosed as not collateralised. HSBC Holdings plc Annual Report and Accounts 2016 97 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Commercial real estate loans and advances including loan commitments by level of collateral (Audited) Rated CRR/EL 1 to 7 Not collateralised Fully collateralised Partially collateralised (A) – collateral value on A Total Rated CRR/EL 8 Not collateralised Fully collateralised – LTV ratio: less than 50% – 51% to 75% – 76% to 90% – 91% to 100% Partially collateralised (B) – collateral value on B Total Rated CRR/EL 9 to 10 Not collateralised Fully collateralised – LTV ratio: less than 50% – 51% to 75% – 76% to 90% – 91% to 100% Partially collateralised (C) – collateral value on C Total At 31 Dec 31 Dec 2016 Total $m 18,313 60,330 3,917 2,571 of which: Asia $m 12,714 27,296 1,106 552 Europe $m 3,887 21,815 1,360 1,021 North America $m 561 10,618 1,388 991 82,560 27,062 41,116 12,567 13 196 58 77 44 17 102 71 311 75 1,118 141 624 88 265 412 202 12 190 54 76 44 16 91 70 293 62 764 79 571 64 50 384 148 1,605 84,476 1,210 28,565 — — — — — — — — — 3 14 7 5 1 1 5 5 1 6 4 1 — 1 11 1 18 4 85 5 34 7 39 21 13 22 110 31 Dec 2015 Total $m 17,834 62,618 6,265 4,270 86,717 28 682 92 385 174 31 122 87 832 422 1,124 221 513 156 234 1,032 555 2,578 of which: Asia $m 12,329 26,270 1,924 1,175 40,523 Europe $m 4,493 25,735 2,961 2,045 33,189 North America $m 8 9,997 1,264 981 11,269 28 668 86 377 174 31 120 87 816 65 899 174 425 139 161 716 397 — 4 — 4 — — 1 — 5 51 18 10 2 2 4 5 3 — 9 5 4 — — 1 — 10 2 76 15 27 10 24 66 35 1,680 35,685 74 40,602 144 11,423 41,138 12,695 90,127 98 HSBC Holdings plc Annual Report and Accounts 2016 Other corporate, commercial and financial (non-bank) loans are analysed separately in the table below, which focuses on the regions containing the majority of our loans and advances balances. For financing activities in other corporate and commercial lending, collateral value is not strongly correlated to principal repayment performance. Collateral values are generally refreshed when an obligor’s general credit performance deteriorates and we have to assess the likely performance of secondary sources of repayment should it prove necessary to rely on them. Accordingly, the table below reports values only for customers with CRR 8 to 10, recognising that these loans and advances generally have valuations that are comparatively recent. Other corporate, commercial and non-bank financial institutions loans and advances including loan commitments by level of collateral rated CRR/EL 8 to 10 only (Audited) Rated CRR/EL 8 Not collateralised Fully collateralised – LTV ratio: less than 50% – 51% to 75% – 76% to 90% – 91% to 100% Partially collateralised (A) – collateral value on A Total Rated CRR/EL 9 to 10 Not collateralised Fully collateralised – LTV ratio: less than 50% – 51% to 75% – 76% to 90% – 91% to 100% Partially collateralised (B) – collateral value on B Total At 31 Dec 31 Dec 2016 Total Europe $m $m of which: Asia $m North America $m 31 Dec 2015 Total $m of which: Europe $m Asia $m 5,283 600 249 168 96 87 465 57 1,766 141 86 34 10 11 191 23 405 2,976 2,529 1,611 164 3 2 1 — — 12 3 362 151 118 79 14 242 26 930 174 430 214 112 336 148 349 58 267 20 4 99 65 41 13 8 18 2 47 17 North America $m 609 454 95 85 168 106 179 58 6,348 2,098 420 3,580 3,795 2,059 252 1,242 3,508 2,545 838 615 414 678 2,368 1,034 8,421 14,769 1,439 1,394 570 412 180 232 478 322 848 447 126 104 86 131 642 268 154 488 59 85 53 291 771 353 3,311 5,409 1,937 2,357 1,413 4,993 4,877 1,853 514 553 231 555 3,079 1,374 9,809 13,604 2,805 789 270 336 87 96 1,667 770 5,261 7,320 889 440 94 149 74 123 506 236 1,835 2,087 80 323 47 47 27 202 423 283 826 2,068 During the year, a number of counterparties were downgraded to CRR 8, mainly in the US’ energy, commodities and Latin American portfolios. In the UK, a single large counterparty balance was settled which partly reduced the CRR 9 balance. Other credit risk exposures In addition to collateralised lending, other credit enhancements are employed and methods used to mitigate credit risk arising from financial assets. These are summarised below: • Some securities issued by governments, banks and other financial institutions benefit from additional credit enhancement provided by government guarantees that cover the assets. • Debt securities issued by banks and financial institutions include ABSs and similar instruments which are supported by underlying pools of financial assets. Credit risk associated with ABSs is reduced through the purchase of credit default swap (‘CDS’) protection. Disclosure of the Group’s holdings of ABSs and associated CDS protection is provided on page 105. • Trading loans and advances mainly consist of cash collateral posted to satisfy margin requirements. There is limited credit risk on cash collateral posted since in the event of default of the counterparty these would be set-off against the related liability. Reverse repos and stock borrowing are by their nature collateralised. Collateral accepted as security that the Group is permitted to sell or repledge under these arrangements is described on page 231 of the Financial Statements. • The Group’s maximum exposure to credit risk includes financial guarantees and similar contracts granted, as well as loan and other credit-related commitments. Depending on the terms of the arrangement, we may use additional credit mitigation if a guarantee is called upon or a loan commitment is drawn and subsequently defaults. For further information on these arrangements, see Note 33 on the Financial Statements. Derivatives HSBC participates in transactions exposing us to counterparty credit risk. Counterparty credit risk is the risk of financial loss if the counterparty to a transaction defaults before satisfactorily settling it. It arises principally from over-the-counter (‘OTC’) derivatives and securities financing transactions and is calculated in both the trading and non-trading books. Transactions vary in value by reference to a market factor such as an interest rate, exchange rate or asset price. The counterparty risk from derivative transactions is taken into account when reporting the fair value of derivative positions. The adjustment to the fair value is known as the credit value adjustment (‘CVA’). For an analysis of CVAs, see Note 11 on the Financial Statements. The table below reflects by risk type the fair values and gross notional contract amounts of derivatives cleared through an exchange, central counterparty and non-central counterparty. HSBC Holdings plc Annual Report and Accounts 2016 99 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Notional contract amounts and fair values of derivatives by product type Foreign exchange – exchange traded – central counterparty cleared OTC – non-central counterparty cleared OTC Interest rate – exchange traded – central counterparty cleared OTC – non-central counterparty cleared OTC Equity – exchange traded – non-central counterparty cleared OTC Credit – central counterparty cleared OTC – non-central counterparty cleared OTC Commodity and other – exchange traded – non-central counterparty cleared OTC Total OTC derivatives – total OTC derivatives cleared by central counterparties – total OTC derivatives not cleared by central counterparties Total exchange traded derivatives Gross Offset At 31 Dec Notional amount $m 2016 Fair value Assets Liabilities $m $m Notional amount $m 5,846,095 127,413 119,781 5,690,354 12,657 66,209 5,767,229 13,944,763 1,075,299 8,207,550 4,661,914 472,169 250,810 221,359 448,220 122,832 325,388 62,009 5,596 56,413 209 698 126,506 255,385 277 120,017 135,091 7,410 919 6,491 5,199 1,954 3,245 2,020 117 1,903 65 748 195,612 29,263 118,968 5,465,479 250,022 14,675,036 214 1,259,888 122,022 127,786 8,774,674 4,640,474 9,240 2,173 7,067 5,767 1,941 3,826 1,564 — 1,564 501,834 265,129 236,705 463,344 90,863 372,481 51,683 8,136 43,547 19,428,894 8,396,591 11,032,303 1,344,362 395,905 122,669 273,236 1,522 383,922 19,653,486 124,711 8,894,800 259,211 10,758,686 2,452 1,728,765 2015 Fair value Assets Liabilities $m 96,341 167 406 95,768 279,154 49 117,877 161,228 8,732 1,888 6,844 6,961 1,779 5,182 3,148 38 3,110 392,194 120,062 272,132 2,142 $m 95,598 76 443 95,079 271,367 8 117,695 153,664 10,383 2,601 7,782 6,884 2,069 4,815 2,699 — 2,699 384,246 120,207 264,039 2,685 20,773,256 397,427 386,374 21,382,251 394,336 386,931 (106,555) (106,555) 290,872 279,819 (105,860) (105,860) 288,476 281,071 The purposes for which HSBC uses derivatives are described in Note 16 on the Financial Statements. The International Swaps and Derivatives Association (‘ISDA’) Master Agreement is our preferred agreement for documenting derivatives activity. It is common, and our preferred practice, for the parties to execute a Credit Support Annex (‘CSA’) in conjunction with the ISDA Master Agreement. Under a CSA, collateral is passed between the parties to mitigate the counterparty risk inherent in outstanding positions. The majority of our CSAs are with financial institutional clients. We manage the counterparty exposure on our OTC derivative contracts by using collateral agreements with counterparties and netting agreements. Currently, we do not actively manage our general OTC derivative counterparty exposure in the credit markets, although we may manage individual exposures in certain circumstances. We place strict policy restrictions on collateral types and as a consequence the types of collateral received and pledged are, by value, highly liquid and of a strong quality, being predominantly cash. Where a collateral type is required to be approved outside the collateral policy, approval is required from a committee of senior representatives from Markets, Legal and Risk. See page 251 and Note 30 on the Financial Statements for details regarding legally enforceable right of offset in the event of counterparty default and collateral received in respect of derivatives. Personal lending On a reported basis, total personal lending reduced by $34bn, mainly due to foreign exchange movements of $26bn and the ongoing repayments and loan sales of our US CML run-off portfolio in North America of $13bn. Loan impairment allowances reduced by $0.9bn, largely due to the reduction in our US CML run-off portfolio. Loan impairment charges for personal lending, remained flat at $1.7bn for 2016. For further analysis of loan impairment charges and other credit risk provisions by global business, see page 38. 100 HSBC Holdings plc Annual Report and Accounts 2016 While the tables are presented on a reported basis, the commentary that follows is on a constant currency basis and excludes the effect of the ongoing run-off and loan sales in the US CML run-off portfolio. Overall, personal lending increased by $5.6bn compared with 31 December 2015. The growth was in mortgage balances which increased by $7.5bn across the Group. UK mortgage balances increased by $4.2bn as we grew our UK mortgage market share through increased sales across various channels including the expanded use of broker relationships. Mortgages in Hong Kong and China grew by $4.5bn as a result of successful marketing campaigns and business growth initiatives. This growth was offset by a $1.4bn reduction in Singapore, following a decision to continue to constrain the size of our mortgage portfolio. The quality of both our Hong Kong and UK mortgage books remained high, with negligible defaults and impairment allowances. The average LTV ratio on new mortgage lending in Hong Kong was 47% compared with an estimated 29% for the overall mortgage portfolio. The LTV ratio on new lending in the UK was 59% compared with the average of 40% for the total mortgage portfolio. Group credit policy prescribes the range of acceptable residential property LTV thresholds, with the maximum upper limit for new loans set at between 75% and 95%. Specific LTV thresholds and debt-to-income ratios are managed at regional and country levels. They must comply with the Group’s policies, strategy and risk appetite, but vary to reflect the local factors: economic and housing market conditions, regulations, portfolio performance, pricing and product features. Other personal lending balances declined by $1.9bn, mainly due to reductions resulting from the continued repositioning of the Global Private Bank. This was offset by growth in RBWM, in other personal lending products including $0.7bn in the UK and $0.5bn in Mexico. Total personal lending gross loans First lien residential mortgages – of which: interest only (including offset) affordability including ARMs Other personal lending – other – credit cards – second lien residential mortgages – motor vehicle finance At 31 Dec 2016 Loan and other credit-related commitments First lien residential mortgages – of which: interest only (including offset) affordability including ARMs Other personal lending – other – credit cards – second lien residential mortgages – motor vehicle finance At 31 Dec 2015 Europe $m Asia $m MENA $m North America Latin America $m $m Total $m As a % of total gross loans 108,008 98,072 2,535 39,239 1,924 249,778 26.1 33,045 297 38,491 29,297 9,096 97 1 876 3,427 36,628 26,059 10,438 24 107 146,499 49,029 134,700 111,123 92 — 5,209 3,072 1,816 2 319 7,744 4,291 113 14,182 5,717 3,061 993 1,631 32 44,956 13,944 — — 3,975 2,018 1,595 — 362 5,899 5,423 34,126 17,906 90,020 63,507 23,938 1,754 821 339,798 183,810 3.6 1.9 9.4 6.6 2.5 0.2 0.1 35.5 125,098 94,606 2,704 50,117 1,986 274,511 26.8 40,906 356 42,568 31,763 10,803 — 2 936 3,966 38,101 27,682 10,189 33 197 — — 6,861 4,246 2,241 2 372 180 17,041 8,069 3,284 996 3,762 27 — — 3,972 1,816 1,780 — 376 42,022 21,363 99,571 68,791 26,009 3,797 974 167,666 132,707 9,565 58,186 5,958 374,082 4.1 2.1 9.7 6.7 2.5 0.4 0.1 Currency translation adjustment 31 Dec 2015 at 31 Dec 2016 exchange rates Movement - constant currency basis 31 Dec 2016 as reported Loan and other credit-related commitments (24,032) (1,145) 143,634 131,562 (810) 8,755 519 58,705 (950) (26,418) 5,008 347,664 2,865 146,499 67,787 3,138 (1,011) (13,749) 134,700 103,153 7,744 5,318 44,956 14,510 891 5,899 12,175 (7,866) 339,798 202,943 Total personal lending impairment allowances First lien residential mortgages Other personal lending – other – credit cards – second lien residential mortgages – motor vehicle finance At 31 Dec 2016 Impairment allowances % of impaired loans First lien residential mortgages Other personal lending – other – credit cards – second lien residential mortgages – motor vehicle finance At 31 Dec 2015 Impairment allowances % of impaired loans Currency translation adjustment 31 Dec 2015 at 31 Dec 2016 exchange rates Movement – constant currency basis 31 Dec 2016 as reported MENA North America Latin America Europe $m 225 300 224 76 — — Asia $m 34 249 122 127 — — $m 81 448 226 217 — 5 525 27.8% 283 50.0% 529 99.6% 276 374 296 78 — — 650 29.0% (82) 568 (43) 525 29 227 104 122 — 1 256 26 507 285 216 — 6 533 49.6% 103.3% (4) 252 31 283 (53) 480 49 529 $m 289 83 23 34 26 — 372 $m 14 249 128 117 — 4 263 11.4% 105.2% 991 241 31 30 180 — 1,232 15.4% 2 1,234 (862) 372 22 186 80 102 — 4 208 86.0% (35) 173 90 263 Total $m 643 1,329 723 571 26 9 1,972 30.4% 1,344 1,535 796 548 180 11 2,879 25.0% (172) 2,707 (735) 1,972 HSBC Holdings plc Annual Report and Accounts 2016 101 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Exposure to UK interest-only mortgage loans The profile of expiring UK interest-only loans was as follows. Of total UK mortgage lending, interest-only mortgage products contributed $32bn, including $12bn of offset mortgages in First Direct and $1.2bn of endowment mortgages. The following information is presented for HSBC Bank plc interest-only mortgage loans with balances of $15bn at the end of 2016. During the year, $0.17bn of interest-only mortgages matured. Of these, 1,416 loans with total balances of $0.07bn were repaid in full, 106 loans with balances of $0.01bn have agreed future repayment plans and 529 loans with balances of $0.09bn are subject to ongoing individual assessment. UK interest-only mortgage loans Expired interest-only mortgage loans Interest-only mortgage loans by maturity – 2017 – 2018 – 2019 – 2020 – 2021-2025 – Post 2025 At 31 Dec 2016 HSBC Finance Gross loan portfolio of HSBC Finance real estate secured balances $m 209 248 517 567 570 3,071 9,347 14,529 At 31 Dec 2016 At 31 Dec 2015 Re-aged Modified and re-aged Modified Total renegotiated loans Total non- renegotiated loans $m 876 4,858 $m 1,015 5,257 $m 75 519 $m 1,966 10,634 $m 3,688 8,612 Total gross loans $m 5,654 19,246 Total impairment allowances Impairment allowances/ gross loans $m 190 986 % 3.4 5.1 Collateral and other credit enhancements held (Audited) The following table shows the values of the fixed charges we hold over specific assets where we have previously enforced, and are able to enforce, collateral in satisfying a debt because the borrower has failed to meet contractual obligations, and where the collateral is cash or can be realised by sale in an established market. The collateral valuation excludes any adjustments for obtaining and selling the collateral and, in particular, loans shown as not collateralised or partially collateralised may also benefit from other forms of credit mitigants. Residential mortgages, including second lien mortgages, decreased by $14bn to $6bn at 31 December 2016. In addition to the continued loan sales in the US CML run-off portfolio, we transferred a further $12bn to ‘Assets held for sale’ during 2016, of which $1.6bn remained at the year end due to be sold in February 2017. The average gain on sale of foreclosed properties that arose after we took title to the property was 2%. There was a decrease in impairment allowances from $1.0 bn at 31 December 2015 to $0.2bn at the end of 2016, reflecting reduced levels of delinquency, and lower levels of both new impaired loans and loan balances outstanding as a result of continued liquidation of the portfolio. Across the first and second lien residential mortgages in our US CML run-off portfolio, two months and over delinquent balances halved to $1.0bn during 2016. Renegotiated real estate secured accounts in HSBC Finance reduced by $8.7bn or 82% and represented 67% at 31 December 2016 (2015: 91%) of our total renegotiated loans in North America, of which $1.3bn were classified as impaired (2015: $5.1bn). During 2016, the aggregate number of renegotiated loans in HSBC Finance reduced due to the portfolio repayments and further loan sales in the US CML portfolio. 102 HSBC Holdings plc Annual Report and Accounts 2016 Residential mortgage loans including loan commitments by level of collateral (Audited) Non-impaired loans and advances Fully collateralised – LTV ratio: less than 50% – 51% to 60% – 61% to 70% – 71% to 80% – 81% to 90% – 91% to 100% Partially collateralised: Greater than 100% (A) – 101% to 110% – 111% to 120% – greater than120% Collateral on A Europe $m Asia $m MENA $m 111,799 104,122 2,333 63,404 19,129 14,437 9,029 4,963 837 430 150 64 216 342 63,009 18,198 10,908 7,370 3,463 1,174 41 20 2 19 27 617 369 505 659 148 35 69 15 11 43 40 North America $m 35,773 12,454 8,124 9,471 4,374 888 462 373 179 85 109 328 Latin America $m 1,813 676 316 366 253 144 58 26 17 5 4 25 Total $m UK $m 255,840 140,160 46,136 35,687 21,685 9,606 2,566 939 381 167 391 762 106,006 61,128 18,094 13,222 8,433 4,509 620 284 106 33 145 197 Hong Kong $m 65,480 44,732 10,656 3,851 2,958 2,324 959 1 1 — — 1 Non-impaired loans and advances 112,229 104,163 2,402 36,146 1,839 256,779 106,290 65,481 Impaired loans and advances Fully collateralised – LTV ratio: less than 50% – 51% to 60% – 61% to 70% – 71% to 80% – 81% to 90% – 91% to 100% Partially collateralised: Greater than 100% (B) – 101% to 110% – 111% to120% – greater than 120% Collateral on B 1,213 580 222 180 122 66 43 80 37 12 31 66 247 109 49 24 29 19 17 7 3 2 2 5 Impaired loans and advances 1,293 254 At 31 Dec 2016 113,522 104,417 Non impaired loans and advances Fully collateralised – LTV ratio: less than 50% – 51% to 60% – 61% to 70% – 71% to 80% – 81% to 90% – 91% to 100% Partially collateralised: Greater than 100% (A) – 101% to110% – 111% to 120% – greater than 120% Collateral on A 127,697 70,732 24,069 17,449 10,184 4,258 1,005 535 212 76 247 430 100,102 59,212 16,625 12,548 7,813 2,773 1,131 168 154 5 9 155 59 21 3 13 4 9 9 73 10 12 51 64 132 2,534 2,560 714 442 532 576 265 31 51 16 5 30 41 Non-impaired loans and advances 128,232 100,270 2,611 Impaired loans and advances Fully collateralised – LTV ratio: less than 50% – 51% to 60% – 61% to 70% – 71% to 80% – 81% to 90% – 91% to 100% Partially collateralised: Greater than 100% (B) – 101% to110% – 111% to 120% – greater than 120% Collateral value on B Impaired loans At 31 Dec 2015 1,392 513 270 249 171 102 87 178 130 11 37 160 1,570 222 105 38 29 18 25 7 8 3 2 3 6 230 59 23 8 10 6 7 5 18 1 3 14 13 77 129,802 100,500 2,688 2,905 825 527 540 449 336 228 182 94 38 50 152 3,087 39,233 41,567 12,369 8,266 10,472 6,279 2,556 1,625 1,208 709 288 211 1,147 42,775 6,713 1,247 990 1,199 1,257 1,184 836 628 375 147 106 547 7,341 50,116 85 8 3 4 3 67 — — — — — — 85 4,509 1,543 804 761 607 497 297 342 144 64 134 287 1,059 521 200 158 101 52 27 42 17 7 18 33 4,851 1,101 42 34 4 1 1 1 1 — — — — — 42 1,924 261,630 107,391 65,523 1,869 710 387 378 256 104 34 13 7 2 4 11 1,882 109 90 6 5 5 2 1 1 1 — 110 273,795 143,737 49,789 41,379 25,108 9,956 3,826 1,975 1,098 376 501 1,784 122,221 68,362 23,068 16,755 9,593 3,930 513 321 126 29 166 221 61,784 42,589 9,193 5,252 2,391 1,379 980 97 97 — — 95 275,770 122,542 61,881 8,495 1,978 1,312 1,492 1,457 1,320 936 833 510 163 160 726 1,191 469 254 204 143 72 49 49 15 5 29 36 9,328 1,240 46 42 2 1 1 — — — — — — — 46 1,992 285,098 123,782 61,927 HSBC Holdings plc Annual Report and Accounts 2016 103 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Supplementary information Gross loans and advances to customers by country Europe – UK – France – Germany – Switzerland – other Asia – Hong Kong – Australia – India – Indonesia – Mainland China – Malaysia – Singapore – Taiwan – other Middle East and North Africa (excluding Saudi Arabia) – Egypt – Turkey – UAE – other North America – US – Canada – other Latin America – Mexico – other At 31 Dec 2016 Europe – UK – France – Germany – Switzerland – other Asia – Hong Kong – Australia – India – Indonesia – Mainland China – Malaysia – Singapore – Taiwan – other Middle East and North Africa (excluding Saudi Arabia) – Egypt – Turkey – UAE – other North America – US – Canada – other Latin America – Mexico – other At 31 Dec 2015 First lien residential mortgages Other personal Property-related Commercial, international trade and other $m 108,008 101,822 2,676 1 506 3,003 98,072 63,566 10,134 1,280 63 7,192 2,719 6,194 4,036 2,888 2,535 — 301 1,981 253 39,239 22,756 15,220 1,263 1,924 1,803 121 $m 38,491 17,820 13,786 192 5,848 845 36,628 24,558 757 388 334 1,107 3,065 4,502 671 1,246 5,209 272 1,554 1,867 1,516 5,717 2,676 2,831 210 3,975 2,849 1,126 $m 28,485 21,707 5,220 413 213 932 70,426 54,219 2,164 1,040 165 4,788 1,693 2,920 55 3,382 2,580 73 247 1,883 377 16,672 11,835 4,586 251 1,646 1,528 118 $m 164,465 124,341 22,153 8,322 1,660 7,989 161,940 88,921 6,804 5,979 4,384 20,451 4,179 11,832 5,074 14,316 22,107 1,327 2,214 13,037 5,529 51,355 38,199 12,515 641 9,880 7,118 2,762 Total $m 339,449 265,690 43,835 8,928 8,227 12,769 367,066 231,264 19,859 8,687 4,946 33,538 11,656 25,448 9,836 21,832 32,431 1,672 4,316 18,768 7,675 112,983 75,466 35,152 2,365 17,425 13,298 4,127 249,778 90,020 119,809 409,747 869,354 125,098 117,346 3,606 4 511 3,631 94,606 60,943 9,297 1,248 56 5,716 2,792 7,743 3,866 2,945 2,704 1 446 1,854 403 50,117 34,382 14,418 1,317 1,986 1,881 105 42,568 20,797 12,130 203 8,045 1,393 38,101 24,389 726 431 346 1,645 3,113 5,392 629 1,430 6,861 549 2,414 2,286 1,612 8,069 4,813 3,029 227 3,972 2,828 1,144 33,277 25,700 6,070 347 224 936 67,577 50,825 1,592 637 71 6,185 1,993 3,334 126 2,814 2,900 104 302 1,833 661 16,014 11,435 4,315 264 1,622 1,498 124 187,576 149,327 20,380 7,941 834 9,094 157,616 80,609 6,448 5,728 4,965 23,703 4,947 11,021 5,291 14,904 26,222 2,097 4,231 14,199 5,695 56,690 42,439 13,490 761 10,433 7,844 2,589 388,519 313,170 42,186 8,495 9,614 15,054 357,900 216,766 18,063 8,044 5,438 37,249 12,845 27,490 9,912 22,093 38,687 2,751 7,393 20,172 8,371 130,890 93,069 35,252 2,569 18,013 14,051 3,962 274,511 99,571 121,390 438,537 934,009 The above tables analyse loans and advances by industry sector and by the location of the principal operations of the lending subsidiary or, in the case of the operations of The Hongkong and Shanghai Banking Corporation, HSBC Bank plc, HSBC Bank Middle East and HSBC Bank USA, by the location of the lending branch. 104 HSBC Holdings plc Annual Report and Accounts 2016 HSBC Holdings (Audited) Risk in HSBC Holdings is overseen by the HSBC Holdings Asset and Liability Management Committee (‘Holdings ALCO’). The major risks faced by HSBC Holdings are credit risk, liquidity risk and market risk (in the form of interest rate risk and foreign exchange risk), of which the most significant is credit risk. Credit risk in HSBC Holdings primarily arises from transactions with Group subsidiaries and from guarantees issued in support of obligations assumed by certain Group operations in the normal conduct of their business. It principally represents claims on Group subsidiaries in Europe and North America. In HSBC Holdings, all financial instruments carrying amount represents the maximum exposure to credit risk. Derivatives have an offset balance of $1.8bn at 31 December 2016 (2015: $2.5bn). Carrying amount of HSBC’s consolidated holdings of ABSs The credit quality of loans and advances and financial investments, both of which consist of intra-Group lending, is assessed as ‘strong’ or ‘good’, with 100% of the exposure being neither past due nor impaired (2015: 100%). Securitisation exposures and other structured products The following table summarises the carrying amount of our ABS exposure by categories of collateral and includes assets held in the GB&M legacy credit portfolio with a carrying value of $11bn (2015: $15bn). At 31 December 2016, the available-for-sale reserve in respect of ABSs was a deficit of $749m (2015: deficit of $1,021m). For 2016, the impairment write-back in respect of ABSs was $121m (2015: write-back of $85m). Trading Available for sale Held to maturity Designated at fair value through profit or loss Loans and receivables $m $m $m $m Mortgage-related assets: Sub-prime residential US Alt-A residential US Government agency and sponsored enterprises: MBSs Other residential Commercial property Leveraged finance-related assets Student loan-related assets Other assets At 31 Dec 2016 Mortgage-related assets: Sub-prime residential US Alt-A residential US Government agency and sponsored enterprises: MBSs Other residential Commercial property Leveraged finance-related assets Student loan-related assets Other assets At 31 Dec 2015 63 — 247 662 348 175 140 1,278 2,913 73 — 166 812 590 240 236 1,184 3,301 1,544 1,453 — 5 13,070 12,788 362 1,146 1,284 2,865 730 — — — — — 22,454 12,793 2,247 1,989 — 7 15,082 13,997 780 2,308 2,294 2,991 880 — — — — — 28,571 14,004 — — — — — — — 19 19 1 — — — — — — 23 24 Total $m 1,711 1,497 26,105 1,078 1,635 1,529 3,016 2,075 $m 104 39 — 54 141 70 11 48 467 38,646 132 55 — 108 201 149 25 128 798 2,453 2,051 29,245 1,700 3,099 2,683 3,252 2,215 46,698 Of which held through consolidated SEs $m 618 1,382 — 152 707 735 2,616 404 6,614 1,075 1,796 — 253 1,656 1,310 2,679 565 9,334 HSBC Holdings plc Annual Report and Accounts 2016 105 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Liquidity and funding risk profile Liquidity and funding risk in 2016 Management of liquidity and funding risk Sources of funding Analysis of on-balance sheet encumbered and unencumbered assets and off-balance sheet collateral Contractual maturity of financial liabilities HSBC Holdings Page 106 106 107 108 111 112 Liquidity and funding risk in 2016 A summary of our current policies and practices regarding the management of liquidity and funding risk is set out on page 106. The liquidity position of the Group remained strong in 2016. The amount of our unencumbered liquid assets was $560bn. We recognised $447bn of these liquid assets for the purposes of the Group consolidated LCR, which was 136%. Management of liquidity and funding risk Liquidity coverage ratio The Liquidity Coverage Ratio (‘LCR’) aims to ensure that a bank has sufficient unencumbered high-quality liquid assets (‘HQLA’) to meet its liquidity needs in a 30-calendar-day liquidity stress scenario. HQLA consist of cash or assets that can be converted into cash at little or no loss of value in markets. We reported a Group European Commission (‘EC’) LCR at 31 December 2016 of 136% (31 December 2015: 116%) to the PRA. We assume no transferability of liquidity from non-EU entities other than to the extent currently permitted. This results in $113bn of HQLA being excluded from the Group’s LCR. The ratio of total consolidated HQLA to the EC LCR denominator at 31 December 2016 was 171% (31 December 2015: 142%), reflecting the additional $113bn (31 December 2015: $94bn) of HQLAs excluded from the Group LCR. At 31 December 2016, all the Group’s principal operating entities were within the LCR risk tolerance level established by the Board and applicable under the Group’s internal liquidity and funding risk management framework (‘LFRF’). The liquidity position of the Group can also be represented by the stand-alone ratios of each of our principal operating entities. The Board and RMM decide the criteria for categorising an operating entity as a principal entity. The main criterion is a material balance sheet size. The following table displays the individual LCR levels for our principal operating entities on an EC LCR basis. The ratios for operating entities in non-EU jurisdictions can vary from local LCR measures due to differences in the way non-EU regulators have implemented the Basel III recommendations. Operating entities’ LCRs Footnotes 47 48 48 49 49 HSBC UK liquidity group The Hongkong and Shanghai Banking Corporation – Hong Kong Branch The Hongkong and Shanghai Banking Corporation – Singapore Branch HSBC Bank USA HSBC France Hang Seng Bank HSBC Canada HSBC Bank China HSBC Middle East – UAE Branch HSBC Mexico HSBC Private Bank For footnotes, see page 126. 2015 % 107 150 189 116 127 199 142 183 At Dec 2016 % 123 185 154 130 122 218 142 253 241 177 178 106 HSBC Holdings plc Annual Report and Accounts 2016 Net stable funding ratio The Net Stable Funding Ratio (‘NSFR’) requires institutions to maintain sufficient stable funding relative to required stable funding, and reflects a bank’s long-term funding profile (funding with a term of more than a year). It is designed to complement the LCR. At 31 December 2016, the Group’s principal operating entities were within the NSFR risk tolerance level established by the Board and applicable under the LFRF. The table below displays the NSFR levels for the principal HSBC operating entities. Our NSFR levels were not disclosed at the last year-end, so there are no comparatives. Operating entities’ NSFRs HSBC UK liquidity group The Hongkong and Shanghai Banking Corporation – Hong Kong Branch The Hongkong and Shanghai Banking Corporation – Singapore Branch HSBC Bank USA HSBC France Hang Seng Bank HSBC Canada HSBC Bank China HSBC Middle East – UAE Branch HSBC Mexico HSBC Private Bank Footnotes 47 48 48 49 49 At 31 Dec 2016 % 116 157 112 120 120 162 139 149 141 128 155 Depositor concentration and term funding maturity concentration The LCR and NSFR metrics assume a stressed outflow based on a portfolio of depositors within each deposit segment. The validity of these assumptions is challenged if the portfolio of depositors is not large enough to avoid depositor concentration. Operating entities are exposed to term re-financing concentration risk if the current maturity profile results in future maturities being overly concentrated in any defined period. At 31 December 2016, all principal operating entities were within the risk tolerance levels set for depositor concentration and term funding maturity concentration. These risk tolerances were established by the Board and are applicable under the LFRF. Liquid assets of HSBC’s principal operating entities The table below shows the unweighted liquidity value of assets categorised as liquid, which is used for the purposes of calculating the LCR metric. This reflects the stock of unencumbered liquid assets at the reporting date, using the regulatory definition of liquid assets. The amount recognised by entity at the Group level is different from the amount recognised at a solo entity level, reflecting where liquidity cannot be freely transferred up to Group. Total of HSBC’s other principal entities 50 Liquid assets of HSBC’s principal entities HSBC UK liquidity group Level 1 Level 2a Level 2b The Hongkong and Shanghai Banking Corporation – Hong Kong Branch Level 1 Level 2a Level 2b HSBC Bank USA Level 1 Level 2a Level 2b Hang Seng Bank Level 1 Level 2a Level 2b Level 1 Level 2a Level 2b For footnotes, see page 126. Sources of funding (Audited) Our primary sources of funding are customer current accounts and customer savings deposits payable on demand or at short notice. We issue wholesale securities (secured and unsecured) to supplement our customer deposits and change the currency mix, maturity profile or location of our liabilities. The following ‘Funding sources and uses’ table provides a consolidated view of how our balance sheet is funded, and should be read in light of the LFRF, which requires operating entities to manage liquidity and funding risk on a stand-alone basis. The table analyses our consolidated balance sheet according to the assets that primarily arise from operating activities and the sources of funding primarily supporting these activities. Assets and liabilities that do not arise from operating activities are presented as a net balancing source or deployment of funds. In 2016, the level of customer accounts continued to exceed the level of loans and advances to customers. The positive funding gap was predominantly deployed in liquid assets (cash and balances with central banks and financial investments) as required by the LFRF. Loans and advances to banks continued to exceed deposits by banks, meaning the Group remained a net unsecured lender to the banking sector. For a summary of sources and utilisation of repos and stock lending, see the Risk Management section on page 68. 31 Dec 2016 Recognised at Group and entity level Recognised at entity level only $m $m Footnotes 47 143,884 2,085 7,663 48,342 23,790 3,450 53,409 14,995 10 21,798 1,474 199 74,239 6,240 226 143,884 2,085 7,663 98,963 23,790 3,450 72,931 14,995 10 37,525 1,474 199 90,579 6,240 226 Funding sources and uses Sources Customer accounts Deposits by banks Repurchase agreements – non-trading Debt securities in issue Liabilities of disposal groups held for sale Subordinated liabilities Financial liabilities designated at fair value Liabilities under insurance contracts Trading liabilities – repos – stock lending – settlement accounts – other trading liabilities Total equity At 31 Dec Uses 2016 $m 2015 $m 1,272,386 1,289,586 59,939 88,958 65,915 2,790 20,984 86,832 75,273 54,371 80,400 88,949 36,840 22,702 66,408 69,938 153,691 141,614 1,428 3,643 15,271 133,349 182,578 442 8,859 10,530 121,783 197,518 2,009,346 2,048,326 Loans and advances to customers Loans and advances to banks 861,504 924,454 88,126 90,401 Reverse repurchase agreements – non-trading 160,974 146,255 Assets held for sale Trading assets – reverse repos – stock borrowing – settlement accounts – other trading assets Financial investments Cash and balances with central banks Net deployment in other balance sheet assets and liabilities At 31 Dec 4,389 43,900 235,125 224,837 4,780 5,427 17,850 207,068 436,797 128,009 438 7,118 12,127 205,154 428,955 98,934 94,422 90,590 2,009,346 2,048,326 HSBC Holdings plc Annual Report and Accounts 2016 107 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Wholesale term debt maturity profile The maturity profile of our wholesale term debt obligations is set out in the following table ‘Wholesale funding cash flows payable by HSBC under financial liabilities by remaining contractual maturities’. The balances in the table are not directly comparable with those in the consolidated balance sheet as the table presents gross cash flows relating to principal payments and not the balance sheet carrying value, which include debt securities and subordinated liabilities measured at fair value. Wholesale funding cash flows payable by HSBC under financial liabilities by remaining contractual maturities Due not more than 1 month Due over 1 month but not more than 3 months Due over 3 months but not more than 6 months Due over 6 months but not more than 9 months Due over 9 months but not more than 1 year Due over 1 year but not more than 2 years Due over 2 years but not more than 5 years Due over 5 years $m $m $m 7,462 10,110 11,834 691 837 1,088 1,584 3,196 11 55 13 13 — 5,906 1,706 1,675 — — 23 800 63 63 — 5,530 3,727 1,389 295 — 893 — 145 145 — $m 6,930 3,152 2,699 882 71 — 126 — — — — $m 8,043 2,384 3,580 2,066 — — 13 — 500 500 — Total $m $m $m $m 21,906 43,764 44,164 154,213 242 133 12 13,626 30,519 36,240 5,940 207 — 91 1,800 1,775 1,775 — 8,344 1,357 — 908 2,503 7,292 6,881 411 3,885 2,559 — 439 1,029 32,179 30,425 1,754 18,050 92,934 25,269 6,073 3,196 2,504 6,187 41,967 39,802 2,165 7,475 10,173 11,979 6,930 8,543 23,681 51,056 76,343 196,180 19,447 5,830 4,229 883 — 8,414 20 71 — — — 11,803 8,426 2,240 20,565 11,250 7,130 964 1,544 — — 173 — 816 — 816 — — 195 446 — — — 6,712 2,944 2,687 875 — — 206 — — — — 5,274 1,224 1,711 2,166 — — 173 — 34 34 — 20,150 955 10,850 4,158 2,074 — 313 1,800 648 648 — 43,463 108 27,239 9,741 1,619 — 1,554 3,202 6,826 6,338 488 19,447 12,619 20,565 6,712 5,308 20,798 50,289 27,398 154,812 10 18,407 5,262 2,577 — 114 1,028 34,423 32,494 1,929 61,821 30,747 74,493 25,593 6,270 8,414 2,748 6,547 42,747 39,514 3,233 197,559 Debt securities issued – unsecured CDs and CP – unsecured senior MTNs – unsecured senior structured notes – secured covered bonds – secured asset-backed commercial paper – secured ABS – others Subordinated liabilities – subordinated debt securities – preferred securities At 31 Dec 2016 Debt securities issued – unsecured CDs and CP – unsecured senior MTNs – unsecured senior structured notes – secured covered bonds – secured asset-backed commercial paper – secured ABS – others Subordinated liabilities – subordinated debt securities – preferred securities At 31 Dec 2015 Analysis of on-balance sheet encumbered and unencumbered assets and off-balance sheet collateral On-balance sheet encumbered and unencumbered assets The table on page 110, ‘Analysis of on-balance sheet encumbered and unencumbered assets’, summarises the total on-balance sheet assets capable of supporting future funding and collateral needs, and shows the extent to which they are currently pledged for this purpose. This disclosure aims to facilitate an understanding of available and unrestricted assets that could be used to support potential future funding and collateral needs. During 2016 cash collateral given and reported within loans and advances to banks and customers, reflecting initial and variable cash margins, was reclassified from ‘unencumbered assets’ to ‘encumbered assets’ to align with our Pillar 3 disclosure. Furthermore a portfolio of mortgages, classified as ‘unencumbered assets’ in 2015 was reclassified to ‘Assets positioned at central banks’ (i.e. pre-positioned plus encumbered) in 2016. Comparative data have been restated. Under ‘Off-balance sheet collateral’ below we discuss the off- balance sheet collateral received and re-pledged, and the level of available unencumbered off-balance sheet collateral. For a summary of our policy on collateral management and definition of encumbrance, see the Risk Management section on page 68. 108 HSBC Holdings plc Annual Report and Accounts 2016 Off-balance sheet collateral The fair value of assets accepted as collateral that we are permitted to sell or repledge in the absence of default was $269bn at 31 December 2016 (2015: $228bn). The fair value of any such collateral actually sold or re-pledged was $157bn (2015: $150bn). We are obliged to return equivalent securities. These transactions are conducted under terms that are usual and customary to standard reverse repo, stock borrowing and derivative transactions. The fair value of collateral received and re-pledged in relation to reverse repos, stock borrowing and derivatives is reported on a gross basis. The related balance sheet receivables and payables are reported on a net basis where required under IFRS offset criteria. As a consequence of reverse repo, stock borrowing and derivative transactions where the collateral received could be sold or re-pledged but had not been, we held $112bn (2015: $78bn) of unencumbered collateral available to support potential future funding and collateral needs at 31 December 2016. Under the terms of our current collateral obligations under derivative contracts (which are ISDA compliant CSA contracts and contracts entered into for pension obligations), and based on an estimate of the positions at 31 December 2016, we calculate that we could be required to post additional collateral of up to $0.3bn (2015: $0.4bn) in the event of a one-notch downgrade in third-party agencies’ credit rating of HSBC’s debt. This would increase to $0.8 bn (2015: $0.7bn) in the event of a two-notch downgrade. Encumbered and unencumbered assets Definitions of the categories included in the table ‘Analysis of on-balance sheet encumbered and unencumbered assets’: • • • • • • • • ‘Assets encumbered as a result of transactions with counterparties other than central banks as a result of covered bonds’ are any assets on our balance sheet pledged against our covered bonds issuance with a counterparty which is not central bank and as a result the assets are unavailable to the bank to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements. ‘Assets encumbered as a result of transactions with counterparties other than central banks as a result of securitisation’ are any assets on our balance sheet pledged against securitisations with a counterparty which is not central bank including asset-backed commercial paper, collateralised debt obligations, residential mortgage-backed securities, or structured investment vehicles paper and as a result the assets are unavailable to the bank to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements. ‘Assets encumbered as a result of transactions with counterparties other than central banks – Other’ are assets on our balance sheet (other than covered bonds and securitisation above) which have been pledged with a counterparty which is not central bank as a collateral against an existing liability, and as a result are assets which are unavailable to the bank to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements. Examples include assets pledged for sale and repurchase and stock lending transactions and certain property assets. ‘Assets positioned at central banks (i.e. pre-positioned plus encumbered)’ are any assets that are eligible for emergency central bank liquidity/ funding or under central bank pre-existing arrangements for funding without further due diligence work required. Any transferable customer loan that is central bank eligible such as pre-positioned central bank UK mortgages and US mortgages accepted by the Federal Reserve Bank and assets on our balance sheet which have been pledged with central bank as collateral against an existing liability, and as a result are assets which are unavailable to the bank to secure funding, satisfy collateral needs or be sold to reduce potential future funding requirements. ‘Unencumbered – readily available assets’ are assets considered by the bank to be readily available in the normal course of business to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, and are not subject to any restrictions on their use for these purposes. ‘Unencumbered – other assets capable of being encumbered’ are assets where there are no restrictions on their use to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements, but they are not readily realisable in the normal course of business in their current form. ‘Unencumbered – reverse repo/stock borrowing receivables and derivative assets’ are assets related specifically to reverse repo, stock borrowing and derivative transactions. They are shown separately as these on-balance sheet assets cannot be pledged but often give rise to the receipt of non-cash assets which are not recognised on the balance sheet, and can additionally be used to raise secured funding, meet additional collateral requirements or be sold. ‘Unencumbered – cannot be encumbered’ are assets that have not been pledged and which we have assessed could not be pledged and therefore could not be used to secure funding, meet collateral needs, or be sold to reduce potential future funding requirements. An example is assets held by the Group’s insurance subsidiaries that back liabilities to policyholders and support the solvency of these entities. Historically, the Group has not recognised any contingent liquidity value for assets other than those assets defined under the LFRF as being liquid assets, and any other negotiable instruments that under stress are assumed to be realisable after three months, even though they may currently be realisable. This approach has generally been driven by our appetite not to place any reliance on central banks. In a few cases, we have recognised the contingent value of discrete pools of assets, but the amounts involved are insignificant. As a result, we have reported the majority of our loans and advances to customers and banks in the category ‘Other realisable assets’ as management would need to perform additional actions in order to make the assets transferable and readily realisable. HSBC Holdings plc Annual Report and Accounts 2016 109 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Analysis of on-balance sheet encumbered and unencumbered assets Assets encumbered as a result of transactions with counterparties other than central banks Unencumbered assets not positioned at central banks Assets positioned at central banks (i.e. pre- positioned plus encumbered) Assets readily available for encumbrance Other assets capable of being encumbered $m $m 82 123,363 — — — — $m 326 — — Reverse repos/stock borrowing receivables and derivative assets Assets that cannot be encumbered $m $m Total $m — — — 4,228 128,009 5,003 5,003 31,228 31,228 As a result of securitisations $m — — — Other $m 10 — — — 62,962 2,504 131,420 7,419 10,207 20,613 235,125 — 981 — 34,144 — 2,645 — 10,532 — 14,660 — — — — — — — — — — — — 1 2,150 354 — — — — — — — — — 11,309 59,231 59,394 11 318 1,565 — — — — 7 — 14,451 94,054 63,604 1,331 1,910 5,386 5,610 24,769 155 835 150 442 243 — — 3,615 4,821 14,996 38,247 20 — — 20 — — — — — — — 290,872 23,901 24,756 54 204 3,747 20,021 4,189 20,284 79 — 79 290,872 3,903 6,719 2,051 50,824 2,045 22,583 88,126 6,258 8,365 10,425 67,208 15,941 732,242 4,027 17,038 861,504 — — — — — 160,974 — 160,974 — 16,537 17,983 331,154 10,765 — 537 3,766 93,566 — 16,000 14,217 236,003 — — — — — — — 2,358 — 345 — — — — — — — — 1,143 7,904 1,718 1,585 8,368 27,099 — 62 — — — 19,329 — — — — — — — — — — — 60,358 436,797 214 99,226 58,780 332,904 1,364 4,667 26,084 63,909 1,145 1,145 293 20,029 21,346 21,346 6,163 6,163 As a result of covered bonds $m — — — — — — — — — — — — — — — — — — — — — — — — — — Cash and balances at central banks Items in the course of collection from other banks Hong Kong Government certificates of indebtedness Trading assets – treasury and other eligible bills – debt securities – equity securities – loans and advances to banks – loans and advances to customers Financial assets designated at fair value – treasury and other eligible bills – debt securities – equity securities – loans and advances to banks and customers Derivatives Loans and advances to banks Loans and advances to customers Reverse repurchase agreements – non-trading Financial investments – treasury and other eligible bills – debt securities – equity securities Prepayments, accrued income and other assets Current tax assets Interest in associates and joint ventures Goodwill and intangible assets Deferred tax At 31 Dec 2016 6,258 8,366 96,540 94,496 613,194 848,024 468,125 239,983 2,374,986 110 HSBC Holdings plc Annual Report and Accounts 2016 — — — — — — — — — — — — — — — — Cash and balances at central banks Items in the course of collection from other banks Hong Kong Government certificates of indebtedness Trading assets – treasury and other eligible bills – debt securities – equity securities – loans and advances to banks – loans and advances to customers Financial assets – treasury and other eligible bills – debt securities – equity securities – loans and advances to banks and customers Derivatives Loans and advances to banks Loans and advances to customers Reverse repurchase agreements – non-trading Financial investments – treasury and other eligible bills – debt securities – equity securities Prepayments, accrued income and other assets Current tax assets Interest in associates and joint ventures Goodwill and intangible assets Deferred tax At 31 Dec 2015 Analysis of on-balance sheet encumbered and unencumbered assets (continued) Assets encumbered as a result of transactions with counterparties other than central banks Unencumbered assets not positioned at central banks As a result of covered bonds $m As a result of securitisations $m Assets positioned at central banks (i.e. pre- positioned plus encumbered) Assets readily available for encumbrance Other assets capable of being encumbered Other $m — — — $m 98 — — $m 95,545 — — 56,188 1,573 138,070 1,099 25,890 4,616 10,410 14,173 — — — — — — 984 492 — — 97 — — — — — — 5,618 72,377 59,430 456 189 1,775 258 1,327 178 12 — — — — — — — — — — — — — — — — Reverse repos/stock borrowing receivables and derivative assets Assets that cannot be encumbered $m $m Total $m — — — 7,520 — — — 2,941 98,934 5,768 5,768 28,410 13,217 28,410 224,837 — 46 — 7,829 99,038 66,491 2,763 5,784 22,303 4,757 — — — — — 288,476 7,387 20,833 138 2,749 17,838 29,176 23,852 396 4,341 18,995 108 — 120 288,476 $m 350 — — 8,269 128 233 2,445 2,890 2,573 1,244 — 265 979 — — 1,329 2,900 1,702 2,054 61,602 815 19,999 90,401 6,947 15,288 9,769 64,984 15,730 790,929 1,531 19,276 924,454 — — — — — — — — — — — — — — — — — — — — — 25,078 509 24,561 8 1,188 — — — — — 8,150 3,675 4,475 — — — — — — — — 146,255 — 146,255 325,101 14,753 98,866 224,355 1,880 1,177 11,124 2,452 4,685 65,190 — 51 — — — 18,794 — — — — — — — — — — — 55,873 428,955 324 104,551 54,054 1,495 27,235 1,221 318,569 5,835 98,298 1,221 294 19,139 24,605 6,051 24,605 6,051 6,947 16,617 95,123 76,507 583,011 961,131 444,597 225,723 2,409,656 Contractual maturity of financial liabilities The balances in the table below do not agree directly with those in our consolidated balance sheet as the table incorporates, on an undiscounted basis, all cash flows relating to principal and future coupon payments (except for trading liabilities and derivatives not treated as hedging derivatives). Undiscounted cash flows payable in relation to hedging derivative liabilities are classified according to their contractual maturities. Trading liabilities and derivatives not treated as hedging derivatives are included in the ‘On demand’ time bucket and not by contractual maturity. A maturity analysis of repos and debt securities in issue included in trading liabilities is presented in Note 29 on the Financial Statements. In addition, loans and other credit-related commitments, financial guarantees and similar contracts are generally not recognised on our balance sheet. The undiscounted cash flows potentially payable under financial guarantees and similar contracts are classified on the basis of the earliest date they can be called. HSBC Holdings plc Annual Report and Accounts 2016 111 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Cash flows payable by HSBC under financial liabilities by remaining contractual maturities (Audited) On demand $m 40,277 1,079,866 18,134 153,691 1,307 274,283 9 1 45,569 1,613,137 410,950 12,608 2,036,695 42,182 1,076,595 13,181 141,614 327 276,141 377 — 59,298 1,609,715 425,000 12,579 2,047,294 Due within 3 months Due between 3 and 12 months Due between 1 and 5 years Due after 5 years $m 10,222 145,932 66,801 — 2,265 287 13,118 400 15,844 254,869 95,751 4,647 355,267 6,643 160,368 64,109 — 4,077 255 25,910 803 17,476 279,641 93,149 5,727 378,517 $m 3,284 38,273 2,929 — 5,003 1,129 19,492 1,378 3,050 74,538 63,729 10,301 $m 5,233 8,676 1,048 — 34,707 2,472 29,487 10,302 1,525 93,450 57,019 8,138 $m 1,033 559 — — 61,929 1,727 8,089 21,552 843 95,732 28,395 1,378 148,568 158,607 125,505 1,452 43,289 2,144 — 6,149 970 23,886 971 7,226 86,087 73,115 15,091 4,029 10,964 535 — 24,642 1,721 35,499 10,151 10,188 97,729 60,078 9,915 174,293 167,722 107 263 543 — 41,365 1,652 6,993 28,132 1,014 80,069 15,089 2,805 97,963 to principal and future coupon payments (except for derivatives not treated as hedging derivatives). Undiscounted cash flows payable in relation to hedging derivative liabilities are classified according to their contractual maturities. Derivatives not treated as hedging derivatives are included in the ‘On demand’ time bucket. In addition, loan commitments and financial guarantees and similar contracts are generally not recognised on our balance sheet. The undiscounted cash flows potentially payable under financial guarantees and similar contracts are classified on the basis of the earliest date on which they can be called. Deposits by banks Customer accounts Repurchase agreements – non-trading Trading liabilities Financial liabilities designated at fair value Derivatives Debt securities in issue Subordinated liabilities Other financial liabilities Loan and other credit-related commitments Financial guarantees and similar contracts At 31 Dec 2016 Deposits by banks Customer accounts Repurchase agreements – non-trading Trading liabilities Financial liabilities designated at fair value Derivatives Debt securities in issue Subordinated liabilities Other financial liabilities Loan and other credit-related commitments Financial guarantees and similar contracts At 31 Dec 2015 HSBC Holdings Liquidity risk in HSBC Holdings is overseen by Holdings ALCO. This risk arises because of HSBC Holdings’ obligation to make payments to debt holders as they fall due. The liquidity risk related to these cash flows is managed by matching external debt obligations with internal loan cash flows and by maintaining an appropriate liquidity buffer that is monitored by Holdings ALCO. The balances in the table below are not directly comparable with those on the balance sheet of HSBC Holdings as the table incorporates, on an undiscounted basis, all cash flows relating 112 HSBC Holdings plc Annual Report and Accounts 2016 Cash flows payable by HSBC Holdings under financial liabilities by remaining contractual maturities (Audited) On demand Due within 3 months Due between 3 and 12 months Due between 1 and 5 years Due after 5 years Amounts owed to HSBC undertakings Financial liabilities designated at fair value Derivatives Debt securities in issue Subordinated liabilities Other financial liabilities Loan commitments Financial guarantees and similar contracts At 31 Dec 2016 Amounts owed to HSBC undertakings Financial liabilities designated at fair value Derivatives Debt securities in issue Subordinated liabilities Other financial liabilities Loan commitments Financial guarantees and similar contracts At 31 Dec 2015 $m — — 3,841 — — — 3,841 — 7,619 11,460 257 — 2,065 — — — 2,322 — 68,333 70,655 $m 2,051 314 — 157 196 1,343 4,061 — — 4,061 1,375 1,145 — 15 229 1,426 4,190 — — 4,190 $m — 960 — 478 598 164 2,200 — — 2,200 424 655 — 47 699 152 1,977 — — 1,977 $m 105 11,964 592 8,393 4,461 — 25,515 — — $m — 25,665 592 19,164 20,899 — 66,320 — — 25,515 66,320 110 5,202 213 250 5,149 — 10,924 — — 10,924 — 20,779 — 1,176 25,474 — 47,429 — — 47,429 HSBC Holdings plc Annual Report and Accounts 2016 113 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Market risk profile Market risk in 2016 Trading portfolios Non-trading portfolios Market risk balance sheet linkages Structural foreign exchange exposures Net interest income sensitivity Sensitivity of capital and reserves Third-party assets in BSM Defined benefit pension schemes Additional market risk measures applicable only to the parent company Page 114 114 115 116 116 117 118 118 118 118 Market risk in 2016 Market risk is the risk that movements in market factors, such as foreign exchange rates, interest rates, credit spreads, equity prices and commodity prices, will reduce our income or the value of our portfolios. Exposure to market risk is separated into two portfolios: • trading portfolios; and • non-trading portfolios. Market risk exposures arising from our insurance manufacturing operations are discussed on page 82. A summary of our current policies and practices regarding the management of market risk is set out on page 77. Global markets were influenced by the increase in US interest rates in line with market expectation. Bond yields continued to rise and global stock markets continued to be supported by expectations of fiscal expansion in the US in the wake of the new US presidential elections. The US monetary tightening contrasts with the ECB extending its quantitative easing programme, highlighting the divergence in monetary policies during the year. Daily VaR (trading portfolios), 99% 1 day ($m) In China, the prospect of a slowdown in the economy in the first half of 2016, and uncertainty around the trade relationship with the US, following the elections, led to further depreciation of the renminbi. Chinese policymakers will attempt to keep this process gradual in order to avoid disruptive capital outflows. In the UK, following the decision to leave the EU, concerns persist about the upcoming exit negotiations and the ultimate nature of the EU-UK relationship. Capital flows to the emerging markets remained weak, with some central banks increasing local interest rates to reduce reserve outflows. Trading value at risk (‘VaR’) spiked in quarter one, due to higher market volatility impacting the foreign exchange and credit spread asset classes. For the remainder of the year, exposures in all asset classes were managed down. Non-trading VaR increased during the year as higher interest rates, especially in US dollars, caused the duration of non-trading assets to increase. Trading portfolios Value at risk of the trading portfolios Trading VaR predominantly resides within Global Markets. It was relatively stable at 31 December 2016 compared with 31 December 2015. During the year, the trading VaR composition changed in that interest rate trading VaR increased but was offset by decreases in both credit spread and equity trading VaR components. The daily levels of total trading VaR over the last year are set out in the graph below. Trading VaR IR trading Equity trading CS trading FX trading Diversification 114 HSBC Holdings plc Annual Report and Accounts 2016 The Group trading VaR for the year is shown in the table below. Trading VaR, 99% 1 day51 (Audited) Balance at 31 Dec 2016 Average Maximum Minimum Balance at 31 Dec 2015 Average Maximum Minimum For footnotes, see page 126. Back-testing Foreign exchange (FX) and commodity Interest rate (IR) Equity (EQ) Credit spread (CS) Portfolio diversification52 Total53 $m 8.9 11.1 16.9 5.4 8.0 14.7 25.4 6.3 $m 49.7 42.8 64.2 31.8 34.9 46.0 57.0 32.6 $m 11.8 20.4 32.4 11.8 21.4 19.6 29.0 11.9 $m 5.9 13.5 28.1 5.0 13.9 15.5 23.3 9.8 $m (23.5) (30.3) (24.9) (35.7) $m 52.8 57.5 91.5 42.1 53.3 60.1 77.9 47.5 In 2016, the Group experienced two back-testing exceptions against hypothetical profit and loss: a loss exception in February, driven by Libor against overnight index spread widening on long positions; and a profit exception in June, driven by significant devaluations in sterling and the euro against the US dollar resulting from the UK’s referendum on EU membership. There was no evidence of model errors or control failures. The back-testing result excludes exceptions due to changes in fair value adjustments. Daily VaR (non-trading portfolios), 99% 1 day ($m) Non-trading portfolios Value at risk of the non-trading portfolios Non-trading VaR of the Group includes contributions from all global businesses. There is no commodity risk in the non- trading portfolios. The increase in non-trading VaR during 2016 was due primarily to the lengthening of the duration in the non- trading book from higher interest rates, especially US rates. The increase in non-trading interest rate was offset by a decrease in the credit spread VaR component and an increase in portfolio diversification effects. Non-trading VaR includes the interest rate risk in the banking book transferred to and managed by Balance Sheet Management (‘BSM’) and the non-trading financial instruments held by BSM. The management of interest rate risk in the banking book and the role of BSM are described further in Interest rate risk in the banking book section below. Non-trading VaR excludes the insurance operations which are discussed further on page 121 and the interest rate risk in the banking book arising from HSBC Holdings. The daily levels of total non-trading VaR over the last year are set out in the graph below. Non-trading VaR IR non-trading CS non-trading Diversification HSBC Holdings plc Annual Report and Accounts 2016 115 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk The Group non-trading VaR for the year is shown in the table below. Non-trading VaR, 99% 1 day (Audited) Balance at 31 Dec 2016 Average Maximum Minimum Balance at 31 Dec 2015 Average Maximum Minimum For footnotes, see page 126. Non-trading VaR excludes equity risk on available-for-sale securities, structural foreign exchange risk and interest rate risk on fixed-rate securities issued by HSBC Holdings. This section and the sections below describe the scope of HSBC’s management of market risks in non-trading books. Equity securities classified as available for sale Fair value of equity securities (Audited) Private equity holdings Investment to facilitate ongoing business Footnotes 54 55 Other strategic investments At 31 Dec For footnotes, see page 126. 2016 $bn 1.2 1.5 2.0 4.7 2015 $bn 1.9 1.9 2.1 5.9 The table above sets out the maximum possible loss on shareholders’ equity from available-for-sale equity securities. The fair value of equity securities classified as available for sale reduced from $5.9bn to $4.7bn. The decrease in private equity holdings was largely due to fund distributions and the reclassification of the investment in certain funds as an associate investment. The decrease in business facilitation equities was largely due to the sale of the Visa investment. Market risk balance sheet linkages Below are the balance sheet lines in the Group’s consolidated position that are subject to market risk. Trading assets and liabilities The Group’s trading assets and liabilities are in almost all cases originated by GB&M. These assets and liabilities are treated as traded risk for the purposes of market risk management, other than a limited number of exceptions, primarily in Global Banking where the short-term acquisition and disposal of the assets are linked to other non-trading related activities such as loan origination. Derivative assets and liabilities We undertake derivative activity for three primary purposes: to create risk management solutions for clients, to manage the portfolio risks arising from client business, and to manage and hedge our own risks. Most of our derivative exposures arise from sales and trading activities within GB&M, and are treated as traded risk for market risk management purposes. The assets and liabilities included in trading VaR give rise to a large proportion of the income included in net trading income. As set out on page 184, HSBC’s net trading income in 2016 was $9,452m (2015: $8,723m). Adjustments to trading income such as valuation adjustments do not feed the trading VaR model. 116 HSBC Holdings plc Annual Report and Accounts 2016 Interest rate (IR) Credit spread (CS) Portfolio diversification52 $m 157.0 131.6 171.9 100.2 114.1 97.5 131.5 70.5 $m 46.5 52.8 82.8 36.9 72.7 65.7 89.4 52.1 $m (32.1) (32.1) (54.0) (42.0) Total53 $m 171.4 152.3 182.1 123.3 132.8 121.2 156.8 91.5 For information on the accounting policies applied to financial instruments at fair value, see Note 13 on the Financial Statements. Structural foreign exchange exposures For our policies and procedures for managing structural foreign exchange exposures, see page 78 of the Risk management section. HSBC’s structural foreign exchange exposures are represented by the net asset value of its foreign exchange equity and subordinated debt investments in subsidiaries, branches, joint ventures and associates with non-US dollar functional currencies. Gains or losses on structural foreign exchange exposures are recognised in other comprehensive income. Net structural foreign exchange exposures Currency of structural exposure Hong Kong dollars Pound sterling1 Chinese renminbi Euros Indian rupees Mexican pesos Canadian dollars Saudi riyals Swiss francs Malaysian ringgit UAE dirhams Singapore dollars Taiwanese dollars Australian dollars Indonesian rupiah Korean won Argentine pesos Brazilian real Turkish lira Thai baht Others, each less than $700m At 31 Dec 2016 $m 32,472 27,527 24,504 17,397 3,901 3,826 3,734 3,690 2,226 2,079 2,073 1,995 1,753 1,667 1,439 1,260 860 755 734 736 5,728 140,356 2015 $m 28,270 32,701 24,117 19,966 3,645 4,228 3,595 3,109 2,642 1,994 1,898 1,454 1,702 1,396 1,303 1,296 875 2,865 1,006 662 6,038 144,762 1 During 2016, we entered into new forward exchange contracts amounting to $1.5bn (2015: $2.6bn) in order to manage our sterling structural foreign exchange exposure. Shareholders’ equity would decrease by $2,247m (2015: $2,633m) if euro and sterling foreign currency exchange rates weakened by 5% relative to the US dollar. Net interest income sensitivity The following table sets out the assessed impact on our base case projected net interest income (‘NII’) for 2016 (excluding insurance) of a series of four quarterly parallel shocks of 25 basis points to the current market-implied path of interest rates worldwide at the beginning of each quarter from 1 January 2017. The sensitivities shown represent our assessment as to the change in expected base case net interest income under the two rate scenarios, assuming that all other non-interest rate risk variables remain constant, and there are no management actions. In deriving our base case net interest income projections, the repricing rates of assets and liabilities used are derived from current yield curves, thereby reflecting current market expectations of the future path of interest rates. The scenarios therefore represent interest rate shocks to the current market implied path of rates. The NII sensitivities shown are indicative and based on simplified scenarios, including the assumption that the balance sheet size and structure remains static, other than instances where the size of the balances or repricing is deemed interest rate sensitive (non-interest bearing current account migration and fixed rate loan early prepayment) and where non-traded VaR is assumed to contractually run off. The limitations of this analysis are discussed within the ‘Risk management’ section on page 68. Assuming no management response, a sequence of such rises (‘up-shock’) would increase expected net interest income for 2016 by $1,709m (2015: $1,251m), while a sequence of such falls (‘down-shock’) would decrease planned net interest income by $2,406m (2015: $2,258m). The NII sensitivity of the Group can be split into three key components: the structural sensitivity arising from the four global businesses excluding BSM and Markets, the sensitivity of the funding of the trading book (Markets) and the sensitivity of BSM. Net interest income sensitivity56 (Audited) The structural sensitivity is positive in a rising rate environment and negative in a falling rate environment. The sensitivity of the funding of the trading book is negative in a rising rate environment and positive in a falling rate environment, and in terms of the impact on profit the change in NII would be expected to be offset by a similar change in net trading income. The sensitivity of BSM will depend on its position. Typically, assuming no management response, the sensitivity of BSM is negative in a rising rate environment and positive in a falling rate environment. The NII sensitivity figures also incorporate the effect of any interest rate behaviouralisation applied and the effect of any assumed repricing across products under the specific interest rate scenario. They do not incorporate the effect of any management decision to change the HSBC balance sheet composition. The NII sensitivity in BSM arises from a combination of the techniques that BSM use to mitigate the transferred interest rate risk and the methods they use to optimise net revenues in line with their defined risk mandate. The figures in the table below do not incorporate the effect of any management decisions within BSM, but in reality it is likely that there would be some short-term adjustment in BSM positioning to offset the NII effects of the specific interest rate scenario where necessary. The NII sensitivity arising from the funding of the trading book is comprised of the expense of funding trading assets, while the revenue from these trading assets is reported in net trading income. This leads to an asymmetry in the NII sensitivity figures which is cancelled out in our global business results, where we include both net interest income and net trading income. It is likely, therefore, that the overall effect on profit before tax of the funding of the trading book will be much less pronounced than the figures in the following table. Change in 2016 net interest income arising from a shift in yield curves of: +25 basis points at the beginning of each quarter –25 basis points at the beginning of each quarter 605 (1,024) Change in 2015 net interest income arising from a shift in yield curves of: +25 basis points at the beginning of each quarter –25 basis points at the beginning of each quarter For footnote, see page 126. 410 (691) 47 (41) 72 (74) US dollar bloc $m Rest of Americas bloc $m Hong Kong dollar bloc $m Rest of Asia bloc $m Sterling bloc $m 504 (797) 280 (292) 61 (261) Euro bloc $m 212 9 Total $m 1,709 (2,406) 217 (645) 369 (290) 135 (528) 49 (30) 1,251 (2,258) We expect NII to rise in the rising rate scenario and fall in the falling rate scenario. This is due to a structural mismatch between our assets and liabilities (on balance we would expect our assets to reprice more quickly, and to a greater extent, than our liabilities). Economic value of equity The table below sets out the assessed impact on our base case economic value of equity (‘EVE’) of an immediate parallel upward shock of 200 basis points (‘bps’) (up 200bps) and an immediate parallel downward shock of 200 basis points (down 200bps) to the market-implied path of interest rates worldwide on 1 January 2017. The economic value of equity remains higher than the book value of equity under base case, up 200bps and down 200bps scenarios. HSBC Holdings plc Annual Report and Accounts 2016 117 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Economic value of equity Change in economic value of equity as at 31 Dec 2016 arising from an immediate shift in yield curves of: +200 basis points –200 basis points US dollar bloc Rest of Americas bloc Hong Kong dollar bloc $m $m $m Rest of Asia bloc $m Sterling bloc $m Euro bloc $m Total $m 1,616 (7,455) (596) 531 1,492 (2,591) (103) (159) (684) (792) (597) 1,128 58 (10,408) Sensitivity of capital and reserves Under CRD IV, available-for-sale (‘AFS’) reserves are included as part of CET1 capital. We measure the potential downside risk to the CET1 ratio due to interest rate and credit spread risk in the AFS portfolio by the portfolio’s stressed VaR, using a 99% confidence level and an assumed holding period of one quarter. At December 2016, the stressed VaR of the portfolio was $3.2bn. We monitor the sensitivity of reported cash flow hedging reserves to interest rate movements on a monthly basis by assessing the expected reduction in valuation of cash flow hedges due to parallel movements of plus or minus 100bps in all yield curves. These particular exposures form only a part of our overall interest rate exposure. The following table describes the sensitivity of our cash flow hedge reported reserves to the stipulated movements in yield curves and the maximum and minimum month-end figures during the year. The sensitivities are indicative and based on simplified scenarios. Sensitivity of cash flow hedging reported reserves to interest rate movements At 31 Dec 2016 +100 basis point parallel move in all yield curves As a percentage of total shareholders’ equity –100 basis point parallel move in all yield curves As a percentage of total shareholders’ equity At 31 Dec 2015 +100 basis point parallel move in all yield curves As a percentage of total shareholders’ equity –100 basis point parallel move in all yield curves As a percentage of total shareholders’ equity $m (1,051) (0.6)% 1,080 0.6% (1,235) (0.66 )% 1,224 0.65% Maximum impact $m Minimum impact $m (1,173) (0.7)% 1,080 0.6% (1,259) (0.67 )% 1,232 0.65% (1,051) (0.6)% 1,145 0.7% (1,137) (0.60 )% 1,133 0.60% Third-party assets in Balance Sheet Management Defined benefit pension schemes For our BSM governance framework, see page 79 of ‘Risk management’. Third-party assets in BSM increased by 9% during 2016. Deposits with central banks increased by $28bn, predominantly in North America and Europe, due to deployment of increased commercial surplus, partly offset by decrease in the UK due to foreign exchange movements as sterling depreciated against the US dollar. Financial investments increased by $17bn due to increases in Europe and Asia, as commercial surplus was deployed into government bonds. Third-party assets in Balance Sheet Management Cash and balances at central banks Trading assets Loans and advances: – to banks – to customers Reverse repurchase agreements Financial investments Other At 31 Dec 2016 $m 98,996 414 37,287 2,564 35,143 2015 $m 71,116 639 42,059 2,773 29,760 352,419 335,543 4,555 4,277 531,378 486,167 At 31 Dec Average Minimum Maximum Market risk arises within our defined benefit pension schemes to the extent that the obligations of the schemes are not fully matched by assets with determinable cash flows. For details of our defined benefit schemes, including asset allocation, see Note 5 on the Financial Statements, and for pension risk management see page 84. Additional market risk measures applicable only to the parent company The principal tools used in the management of market risk are VaR for foreign exchange rate risk and the projected sensitivity of HSBC Holdings’ net interest income to future changes in yield curves and interest rate gap repricing tables for interest rate risk. Foreign exchange risk Total foreign exchange VaR arising within HSBC Holdings in 2016 was as follows: HSBC Holdings – foreign exchange VaR 2016 $m 32.1 44.4 32.1 58.2 2015 $m 45.6 42.3 32.9 47.1 The foreign exchange risk largely arises from loans to subsidiaries of a capital nature that are not denominated in the functional currency of either the provider or the recipient and which are accounted for as financial assets. Changes in the carrying amount of these loans due to foreign exchange rate differences are taken directly to HSBC Holdings’ income 118 HSBC Holdings plc Annual Report and Accounts 2016 statement. These loans, and most of the associated foreign exchange exposures, are eliminated on consolidation. Sensitivity of net interest income HSBC Holdings monitors NII sensitivity over a five-year time horizon reflecting the longer-term perspective on interest rate risk management appropriate to a financial services holding company. These sensitivities assume that any issuance where HSBC Holdings has an option to reimburse at a future call date is called at this date. The table below sets out the effect on HSBC Holdings’ future NII over a five-year time horizon of incremental 25 basis point parallel falls or rises in all yield curves worldwide at the beginning of each quarter during the 12 months from 1 January 2016. Assuming no management actions, a sequence of such rises would increase planned NII for the next five years by $746m (2015: increase of $247m), while a sequence of such falls would decrease planned NII by $723m (2015: decrease of $266m). Sensitivity of HSBC Holdings’ net interest income to interest rate movements56 US dollar bloc Sterling bloc Euro bloc $m $m $m Total $m Change in projected net interest income as at 31 Dec arising from a shift in yield curves 2016 of +25 basis points at the beginning of each quarter 0-1 year 2-3 years 4-5 years of -25 basis points at the beginning of each quarter 0-1 year 2-3 years 4-5 years 2015 of +25 basis points at the beginning of each quarter 0-1 year 2-3 years 4-5 years of -25 basis points at the beginning of each quarter 0-1 year 2-3 years 4-5 years For footnote, see page 126. 84 299 304 (84) (299) (304) 57 118 (23) (57) (118) 23 6 20 20 (4) (13) (19) 15 43 43 (14) (43) (43) 0 6 8 — — (1) — 7 (12) (6) (22) 15 90 325 332 (88) (312) (324) 72 168 8 (77) (183) (5) The interest rate sensitivities tabulated above are indicative and based on simplified scenarios. The figures represent hypothetical movements in NII based on our projected yield curve scenarios, HSBC Holdings’ current interest rate risk profile and assumed changes to that profile during the next five years. Changes to assumptions concerning the risk profile over the next five years can have a significant impact on the NII sensitivity for that period. However, the figures do not take into account the effect of actions that could be taken to mitigate this interest rate risk. HSBC Holdings plc Annual Report and Accounts 2016 119 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk Interest rate repricing gap table The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included within the Group VaR but is managed on a repricing gap basis. The interest rate repricing gap table below analyses the full-term structure of interest rate mismatches within HSBC Holdings’ balance sheet. From over 1 to 5 years From over 5 to 10 years More than 10 years Non-interest bearing $m $m $m — — 279 731 — 105 1,115 $m — — 405 8 — — 413 — — — — — — — Up to 1 year $m — — 72,288 2,675 — — 74,963 (105) (1,109) — (7,344) (12,588) (6,422) — — — (4,199) (2,997) (11,708) (3,916) — — — (5,413) (57,089) 12,461 12,461 242 — 42,661 2,985 — — 45,888 (781) (1,741) — — — — — (2,522) (22,748) 20,618 20,618 — — — (3,267) (2,000) (9,445) — (13,608) 13,608 1,115 13,576 — (26,296) 26,296 413 13,989 — (19,783) 13,441 (6,342) 7,647 — — 279 — — 109 388 — (3,239) — — (3,374) — — (6,613) 5,351 (874) 19,744 — — 405 731 — — 1,136 — (7,032) — (963) (3,500) — — (11,495) 10,722 363 20,107 — — — — — — — (4,312) — — (9,119) — — (13,332) 5,763 (7,569) 12,538 — 2,184 4,708 141 96,183 1,383 104,599 (2,052) (2,682) (5,018) 996 (1,628) (488) (105,118) (115,990) 3,743 (7,647) — — 2,467 1,005 569 97,770 971 102,782 (1,371) (3,628) (2,278) 3 98 (1,642) (107,414) (116,232) 912 (12,538) — Repricing gap analysis of HSBC Holdings Cash at bank and in hand: – balances with HSBC undertakings Derivatives Loans and advances to HSBC undertakings Financial investments in HSBC undertakings Investments in subsidiaries Other assets Total assets Amounts owed to HSBC undertakings Financial liabilities designated at fair values Derivatives Debt securities in issue Other liabilities Subordinated liabilities Total equity Total liabilities and equity Off-balance sheet items attracting interest rate sensitivity Net interest rate risk gap at 31 Dec 2016 Cumulative interest rate gap Cash at bank and in hand: – balances with HSBC undertakings Derivatives Loans and advances to HSBC undertakings Financial investments in HSBC undertakings Investments in subsidiaries Other assets Total assets Amounts owed to HSBC undertakings Financial liabilities designated at fair values Derivatives Debt securities in issue Other liabilities Subordinated liabilities Total equity Total liabilities and equity Off-balance sheet items attracting interest rate sensitivity Net interest rate risk gap at 31 Dec 2015 Cumulative interest rate gap Total $m — 2,184 77,680 3,555 96,183 1,488 181,090 (2,157) (30,145) (5,018) (21,824) (1,628) (15,200) (105,118) (181,090) 242 2,467 44,350 4,285 97,770 1,080 150,194 (2,152) (19,853) (2,278) (960) (15,895) (1,642) (107,414) (150,194) — — — 120 HSBC Holdings plc Annual Report and Accounts 2016 Operational risk profile Operational risk is the risk to achieving our strategy or objectives as a result of inadequate or failed internal processes, people and systems or from external events. It arises from day- to-day operations or external events, and is relevant to every aspect of our business. Responsibility for minimising operational risk lies with HSBC’s staff. All staff are required to manage the operational risks of the business and operational activities for which they are responsible. A summary of our current policies and practices regarding the management of operational risk is set out on page 80. Operational risk exposures in 2016 HSBC continued to strengthen those controls that manage our most material risks in 2016. Among other measures, we: • • • further embedded Global Standards into the operational risk management framework to ensure that we know our customers, ask the right questions and escalate concerns to prevent financial crime; implemented a number of initiatives to raise our standards in relation to the conduct of our business, as described on page 81 of the ‘Regulatory compliance risk management’ section; increased monitoring and enhanced detective controls to manage those fraud risks which arise from new technologies and new ways of banking; • strengthened internal security controls to prevent cyber- attacks; • improved controls and security to protect customers when using digital channels; and • enhanced third-party risk management capability to enable the consistent risk assessment of any third-party service. Further information on the nature of these risks is provided in ‘Top and emerging risks’ on page 64. Operational risk losses in 2016 Operational risk losses in 2016 are lower than in 2015, reflecting a reduction in losses incurred relating to large legacy conduct- related events. Conduct-related costs included in significant items are outlined on page 62. The profile of operational risk losses below shows the distribution of losses for 2015 and 2016 against event types. Operational risk losses Business disruption and system failures Clients, products and business practices Damage to physical assets Employee practices and workplace safety Execution, delivery and process management External fraud Internal fraud Total 2016 2015 % — 57 — 1 34 8 — % — 74 — 1 13 11 1 100 100 Insurance manufacturing operations risk profile Insurance manufacturing operations risk in 2016 HSBC’s bancassurance model Measurement Key risk types Market risk Credit risk Liquidity risk Insurance risk Page 121 121 121 123 123 124 124 125 Insurance manufacturing operations risk in 2016 The majority of the risk in our insurance business derives from manufacturing activities and can be categorised as financial risk or insurance risk. Financial risks include market risk, credit risk and liquidity risk. Insurance risk is the risk, other than financial risk, of loss transferred from the holder of the insurance contract to the issuer (HSBC). A summary of our current policies and practices regarding the management of insurance risk is set out on page 82. HSBC’s bancassurance model We operate an integrated bancassurance model that provides insurance products principally for customers with whom we have a banking relationship. The insurance contracts we sell relate to the underlying needs of our banking customers, which we can identify from our point-of-sale contacts and customer knowledge. The majority of sales are of savings and investment products and term and credit life contracts. By focusing largely on personal and SME lines of business, we are able to optimise volumes and diversify individual insurance risks. We choose to manufacture these insurance products in HSBC subsidiaries based on an assessment of operational scale and risk appetite. Manufacturing insurance allows us to retain the risks and rewards associated with writing insurance contracts by keeping part of the underwriting profit and investment income within the Group. We have life insurance manufacturing subsidiaries in nine countries (Argentina, mainland China, France, Hong Kong, Malaysia, Malta, Mexico, Singapore and the UK). We also have life insurance manufacturing associates in Saudi Arabia and India. Where we do not have the risk appetite or operational scale to be an effective insurance manufacturer, we engage with a handful of leading external insurance companies in order to provide insurance products to our customers through our banking network and direct channels. These arrangements are generally structured with our exclusive strategic partners and earn the Group a combination of commissions, fees and a share of profits. We distribute insurance products in all of our geographical regions. Insurance products are sold through all global businesses, but predominantly by RBWM and CMB through our branches and direct channels worldwide. The sale of our Brazilian insurance operations completed on 1 July 2016. These operations were reported as part of the disposal group held for sale at 31 December 2015. Measurement (Audited) The risk profile of our insurance manufacturing businesses is measured using an economic capital approach. Assets and liabilities are measured on a market value basis, and a capital requirement is defined to ensure that there is a less than one in HSBC Holdings plc Annual Report and Accounts 2016 121 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk 200 chance of insolvency over a one-year time horizon, given the risks that the businesses are exposed to. The methodology for the economic capital calculation is largely aligned to the pan-European Solvency II insurance capital regulations, which were applicable from January 2016. The economic capital coverage ratio (economic net asset value divided by the economic capital requirement) is a key risk appetite measure. The business has a current appetite to remain above 140% with a tolerance of 110%. In addition to economic capital, the regulatory solvency ratio is also a metric used to manage risk appetite on an entity basis. The tables below show the composition of assets and liabilities by contract type and by geographical region. Balance sheet of insurance manufacturing subsidiaries by type of contract63 (Audited) Financial assets – trading assets – financial assets designated at fair value – derivatives – financial investments – HTM – financial investments – AFS – other financial assets Reinsurance assets PVIF Other assets and investment properties Total assets Liabilities under investment contracts designated at fair value Liabilities under insurance contracts Deferred tax Other liabilities Total liabilities Total equity Total liabilities and equity at 31 Dec 2016 Financial assets – trading assets – financial assets designated at fair value – derivatives – financial investments – HTM – financial investments – AFS – other financial assets Reinsurance assets PVIF Other assets and investment properties Total assets Liabilities under investment contracts designated at fair value Liabilities under insurance contracts Deferred tax Other liabilities Total liabilities Total equity Total liabilities and equity at 31 Dec 2015 For footnotes, see page 126. Footnotes 59 59 60 61 62 59 59 60 61 62 With DPF $m 57,004 — 12,134 212 25,867 14,359 4,432 498 — 1,716 59,218 — 58,800 13 — 58,813 — 58,813 53,521 — 11,119 160 22,840 15,077 4,325 202 — 1,726 55,449 — 55,023 11 — 55,034 — 55,034 Unit-linked Other contracts57 Shareholder assets and liabilities58 $m 8,877 — 8,592 2 — — 283 322 — 5 9,204 2,197 6,949 3 — 9,149 — 9,149 8,840 — 8,435 1 — — 404 264 — 7 9,111 2,256 6,791 — — 9,047 — 9,047 $m 13,021 2 2,889 13 5,329 4,206 582 1,048 — 171 14,240 3,805 9,524 7 — 13,336 — 13,336 11,691 2 2,718 33 4,189 4,020 729 951 — 139 12,781 3,771 8,124 14 — 11,909 — 11,909 $m 5,141 — 684 46 2,919 1,355 137 — 6,502 525 12,168 — — 1,166 1,805 2,971 10,561 13,532 5,531 — 1,015 62 3,050 1,233 171 — 5,685 4,576 15,792 — — 1,056 5,553 6,609 10,534 17,143 Total $m 84,043 2 24,299 273 34,115 19,920 5,434 1,868 6,502 2,417 94,830 6,002 75,273 1,189 1,805 84,269 10,561 94,830 79,583 2 23,287 256 30,079 20,330 5,629 1,417 5,685 6,448 93,133 6,027 69,938 1,081 5,553 82,599 10,534 93,133 122 HSBC Holdings plc Annual Report and Accounts 2016 Balance sheet of insurance manufacturing subsidiaries by geographical region63, 64 (Audited) Financial assets – trading assets – financial assets designated at fair value – derivatives – financial investments – HTM – financial investments – AFS – other financial assets Reinsurance assets PVIF Other assets and investment properties Total assets Liabilities under investment contracts designated at fair value Liabilities under insurance contracts Deferred tax Other liabilities Total liabilities Total equity Total liabilities and equity at 31 Dec 2016 Financial assets – trading assets – financial assets designated at fair value – derivatives – financial investments – HTM – financial investments – AFS – other financial assets Reinsurance assets PVIF Other assets and investment properties Total assets Liabilities under investment contracts designated at fair value Liabilities under insurance contracts Deferred tax Other liabilities Total liabilities Total equity Total liabilities and equity at 31 Dec 2015 For footnotes, see page 126. Key risk types The key risk for the insurance operation is market risk, followed by insurance risk. Credit and liquidity risk, while significant for the bank, are minor for our insurance operations. Market risk (Audited) Description and exposure Market risk is the risk of changes in market factors affecting HSBC’s capital or profit. Market factors include interest rates, equity and growth assets, spread risk and foreign exchange rates. Our exposure varies depending on the type of contract issued. Our most significant life insurance products are contracts with discretionary participating features (‘DPF’) issued in France and Hong Kong. These products typically include some form of capital guarantee or guaranteed return on the sums invested by the policyholders, to which discretionary bonuses are added if allowed by the overall performance of the funds. These funds are primarily invested in bonds, with a proportion allocated to other asset classes to provide customers with the potential for enhanced returns. DPF products expose HSBC to the risk of variation in asset returns, which will impact our participation in the investment Footnotes 59 59 60 61 62 59 59 60 61 62 Europe $m 26,238 — 10,171 187 — 13,812 2,068 362 711 871 28,182 1,321 24,310 238 841 26,710 1,472 28,182 26,897 — 9,987 163 — 14,525 2,222 287 807 919 28,910 1,376 24,699 274 832 27,181 1,729 28,910 Asia $m 56,371 — 13,618 86 33,624 5,735 3,308 1,499 5,682 1,493 65,045 4,681 49,793 919 914 56,307 8,738 65,045 51,087 — 12,668 93 29,496 5,503 3,327 1,122 4,761 1,358 58,328 4,651 43,975 767 974 50,367 7,961 58,328 Latin America $m 1,434 2 510 — 491 373 58 7 109 53 1,603 — 1,170 32 50 1,252 351 1,603 1,599 2 632 — 583 302 80 8 117 4,171 5,895 — 1,264 40 3,747 5,051 844 5,895 Total $m 84,043 2 24,299 273 34,115 19,920 5,434 1,868 6,502 2,417 94,830 6,002 75,273 1,189 1,805 84,269 10,561 94,830 79,583 2 23,287 256 30,079 20,330 5,629 1,417 5,685 6,448 93,133 6,027 69,938 1,081 5,553 82,599 10,534 93,133 performance. In addition, in some scenarios the asset returns can become insufficient to cover the policyholders’ financial guarantees, in which case the shortfall has to be met by HSBC. Reserves are held against the cost of such guarantees, calculated by stochastic modelling. Where local rules require, these reserves are held as part of liabilities under insurance contracts. Any remainder is accounted for as a deduction from the present value of in-force (‘PVIF’) long-term insurance business on the relevant product. The table below shows the total reserve held for the cost of guarantees, the range of investment returns on assets supporting these products and the implied investment return that would enable the business to meet the guarantees. The cost of guarantees decreased to $625m (2015: $748m) primarily due to changes to the profit-sharing mechanism on DPF contracts with guarantees in Hong Kong, which primarily reduced the cost of guarantees on portfolios reported in the 2.1% to 4.0% category. In addition, there was a movement in cost of guarantees from the 2.1% to 4.0% category, to the 0.1% to 2.0% category due to reducing average guarantees on certain portfolios. The real annual return guarantees reported in 2015 relate to insurance operations in Brazil, which were sold on 1 July 2016. HSBC Holdings plc Annual Report and Accounts 2016 123 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk For unit-linked contracts, market risk is substantially borne by the policyholder, but some market risk exposure typically remains, as fees earned are related to the market value of the linked assets. Financial return guarantees63 (Audited) Capital Nominal annual return Nominal annual return Nominal annual return Real annual return At 31 Dec For footnotes, see page 126. Sensitivities 2016 2015 Investment returns implied by guarantee % 0.0 0.1 – 2.0 2.1 – 4.0 4.1 – 5.0 n/a Footnotes 65 66 Current yields % 0.0 – 3.0 3.7 – 3.8 3.0 – 4.4 3.0 – 4.1 n/a Cost of guarantees $m 59 64 426 76 n/a 625 Investment returns implied by guarantee % 0.0 0.1 – 1.9 2.0 – 4.0 4.1 – 5.0 0.0 – 6.0 Current yields % 0.0 – 3.8 3.9 – 3.9 3.8 – 4.0 3.8 – 4.1 5.9 – 6.1 Cost of guarantees $m 85 4 603 28 28 748 Changes in financial market factors, from the economic assumptions in place at the start of the year, had a negative impact on reported profit before tax of $386m (2015: $13m negative). The following table illustrates the effects of selected interest rate, equity price and foreign exchange rate scenarios on our profit for the year and the total equity of our insurance manufacturing subsidiaries. Where appropriate, the effects of the sensitivity tests on profit after tax and equity incorporate the impact of the stress on the PVIF. The relationship between the profit and total equity and the risk factors is non-linear, therefore the results disclosed should not be extrapolated to measure sensitivities to different levels of stress. For the same reason, the impact of the stress is not symmetrical on the upside and downside. The sensitivities are stated before allowance for management actions which may mitigate the effect of changes in the market environment. The sensitivities presented allow for adverse changes in policyholder behaviour that may arise in response to changes in market rates. Interest rate movements have a greater impact on total equity as changes in market value of available-for-sale bonds are not recognised in profit after tax. Changes in sensitivity compared to 2015 were primarily driven by the impact of decreasing yields in France on the projected cost of options and guarantees and by the adoption of a more market-aligned PVIF methodology in Singapore. Sensitivity of HSBC’s insurance manufacturing subsidiaries to market risk factors (Audited) +100 basis point parallel shift in yield curves –100 basis point parallel shift in yield curves 10% increase in equity prices 10% decrease in equity prices 10% increase in US dollar exchange rate compared with all currencies 10% decrease in US dollar exchange rate compared with all currencies For footnote, see page 126. Credit risk (Audited) Description and exposure Footnote 67 2016 2015 Effect on profit after tax Effect on total equity Effect on profit after tax Effect on total equity $m 63 (182) 189 (191) 19 (19) $m (494) 490 190 (191) 19 (19) $m 39 (213) 176 (158) 16 (16) $m (474) 404 176 (158) 16 (16) exposure is primarily related to liabilities under non-linked insurance and investment contracts and shareholders’ funds. The credit quality of insurance financial assets is included in the table on page 88. Credit risk is the risk of financial loss if a customer or counterparty fails to meet their obligation under a contract. It arises in two main areas for our insurance manufacturers: Liquidity risk (Audited) • • risk of default by debt security counterparties after investing premiums to generate a return for policyholders and shareholders; and risk of default by reinsurance counterparties and non- reimbursement for claims made after ceding insurance risk. The amounts outstanding at the balance sheet date in respect of these items are shown in the table on page 122. The credit quality of the reinsurers’ share of liabilities under insurance contracts is assessed as ‘satisfactory’ or higher (as defined on page 74), with 100% of the exposure being neither past due nor impaired (2015: 100%). Credit risk on assets supporting unit-linked liabilities is predominantly borne by the policyholder; therefore, our 124 HSBC Holdings plc Annual Report and Accounts 2016 Description and exposure Liquidity risk is the risk that an insurance operation, though solvent, either does not have sufficient financial resources available to meet its obligations when they fall due, or can secure them only at excessive cost. The following table shows the expected undiscounted cash flows for insurance liabilities at 31 December 2016. The liquidity risk exposure is wholly borne by the policyholder in the case of unit-linked business and is shared with the policyholder for non- linked insurance. The profile of the expected maturity of insurance contracts at 31 December 2016 remained comparable with 2015. The remaining contractual maturity of investment contract liabilities is included in Note 29. Expected maturity of insurance contract liabilities63 (Audited) Unit-linked With DPF and Other contracts At 31 Dec 2016 Unit-linked With DPF and Other contracts At 31 Dec 2015 For footnotes, see page 126. Insurance risk Description and exposure Insurance risk is the risk of loss through adverse experience, in either timing or amount, of insurance underwriting parameters (non-economic assumptions). These parameters include mortality, morbidity, longevity, lapses and unit costs. The principal risk we face is that, over time, the cost of the contract, including claims and benefits, may exceed the total amount of premiums and investment income received. The tables on pages 122 and 123 analyse our life insurance risk exposures by type of contract and by geographical region. The insurance risk profile and related exposures remain largely consistent with those observed at 31 December 2015. Sensitivities (Audited) The table below shows the sensitivity of profit and total equity to reasonably possible changes in non-economic assumptions across all our insurance manufacturing subsidiaries. Mortality and morbidity risk is typically associated with life insurance contracts. The effect on profit of an increase in mortality or morbidity depends on the type of business being written. Our largest exposures to mortality and morbidity risk exist in Hong Kong and Singapore. Within 1 year 1-5 years 5-15 years Over 15 years Expected cash flows (undiscounted) $m 630 5,582 6,212 549 5,356 5,905 $m 2,468 23,136 25,604 2,164 22,796 24,960 $m 5,101 40,621 45,722 5,945 37,585 43,530 $m 9,513 40,447 49,960 11,080 38,649 49,729 Total $m 17,712 109,786 127,498 19,738 104,386 124,124 Sensitivity to lapse rates depends on the type of contracts being written. For a portfolio of term assurance, an increase in lapse rates typically has a negative effect on profit due to the loss of future income on the lapsed policies. However, some contract lapses have a positive effect on profit due to the existence of policy surrender charges. We are most sensitive to a change in lapse rates on unit-linked and universal life contracts in Hong Kong and Singapore, and DPF contracts in France. Expense rate risk is the exposure to a change in the cost of administering insurance contracts. To the extent that increased expenses cannot be passed on to policyholders, an increase in expense rates will have a negative effect on our profits. Sensitivity analysis (Audited) Effect on profit after tax and total equity at 31 Dec 10% increase in mortality and/or morbidity rates 10% decrease in mortality and/or morbidity rates 10% increase in lapse rates 10% decrease in lapse rates 10% increase in expense rates 10% decrease in expense rates 2016 $m 2015 $m (71) 75 (80) 93 (89) 87 (70) 75 (90) 102 (85) 83 HSBC Holdings plc Annual Report and Accounts 2016 125 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Risk / Capital Footnotes to Risk Liquidity and funding 47 The HSBC UK Liquidity Group shown comprises four legal entities: HSBC Bank plc (including all overseas branches, and SPEs consolidated by HSBC Bank plc for Financial Statement purposes), Marks and Spencer Financial Services plc, HSBC Private Bank (UK) Ltd and HSBC Trust Company (UK) Limited, managed as a single operating entity, in line with the application of UK liquidity regulation as agreed with the UK PRA. 48 The Hongkong and Shanghai Banking Corporation – Hong Kong branch and The Hongkong and Shanghai Banking Corporation – Singapore branch represent the material activities of the Hongkong and Shanghai Banking Corporation. Each branch is monitored and controlled for liquidity and funding risk purposes as a stand-alone operating entity. 49 HSBC France and HSBC Canada represent the consolidated banking operations of the Group in France and Canada, respectively. HSBC France and HSBC Canada are each managed as single distinct operating entities for liquidity purposes. 50 The total shown for other principal HSBC operating entities represents the combined position of all the other operating entities overseen directly by the Risk Management Meeting of the GMB. Market risk 51 Trading portfolios comprise positions arising from the market-making and warehousing of customer-derived positions. 52 Portfolio diversification is the market risk dispersion effect of holding a portfolio containing different risk types. It represents the reduction in unsystematic market risk that occurs when combining a number of different risk types; for example, interest rate, equity and foreign exchange, together in one portfolio. It is measured as the difference between the sum of the VaR by individual risk type and the combined total VaR. A negative number represents the benefit of portfolio diversification. As the maximum and minimum occurs on different days for different risk types, it is not meaningful to calculate a portfolio diversification benefit for these measures. 53 The total VaR is non-additive across risk types due to diversification effects. 54 Investments in private equity are primarily made through managed funds that are subject to limits on the amount of investment. Potential new commitments are subject to risk appraisal to ensure that industry and geographical concentrations remain within acceptable levels for the portfolio as a whole. Regular reviews are performed to substantiate the valuation of the investments within the portfolio. 55 Investments held to facilitate ongoing business include holdings in government-sponsored enterprises and local stock exchanges. 56 Instead of assuming that all interest rates move together, we group our interest rate exposures into currency blocs whose rates are considered likely to move together. See page 281, ‘Cautionary statement regarding forward- looking statements’. Risk management of insurance operations 57 ‘Other Contracts’ includes term assurance, credit life insurance, universal life insurance and investment contracts not included in the ‘Unit-linked’ or ‘With DPF’ columns. 58 At 31 December 2015, ‘Shareholder assets and liabilities’ included assets and liabilities classified as held for sale in respect of the disposal of operations in Brazil, which was completed on 1 July 2016. The assets, comprising mainly debt and equity securities and PVIF, were reported within ‘Other assets and investment properties’ and totalled $4.1bn. The liabilities classified as held for sale, comprising mainly liabilities under insurance contracts and liabilities under investment contracts, were reported within ‘Other liabilities’ and totalled $3.7bn. No assets and liabilities relating to insurance businesses were held for sale at 31 December 2016. 59 Financial investments held to maturity (‘HTM’) and available for sale (‘AFS’). 60 Comprise mainly loans and advances to banks, cash and inter-company balances with other non-insurance legal entities. 61 Present value of in-force long-term insurance business. 62 ‘Deferred tax’ includes the deferred tax liabilities arising on recognition of PVIF. 63 Does not include associated insurance companies SABB Takaful Company and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited. 64 HSBC has no insurance manufacturing subsidiaries in Middle East and North Africa or North America. 65 A block of contracts in France with guaranteed nominal annual returns in the range 1.25%-3.72% is reported entirely in the 2.1%-4.0% category in line with the average guaranteed return of 2.6% offered to policyholders by these contracts. 66 Real annual return guarantees provide the policyholder a guaranteed return in excess of the rate of inflation, and are supported by inflation-linked debt securities with yields that are also expressed in real terms. 67 Where a -100 basis point parallel shift in the yield curve would result in a negative interest rate, the effects on profit after tax and total equity have been calculated using a minimum rate of 0%. 126 HSBC Holdings plc Annual Report and Accounts 2016 Capital Capital overview Capital management Capital Risk-weighted assets Leverage ratio Capital highlights Page 127 127 128 129 131 • Our common equity tier 1 (‘CET1’) ratio of 13.6% was up from 11.9% at the end of 2015, mainly due to a change in the regulatory treatment of Bank of Communications Co., Limited ('BoCom'). • Our CET1 capital base reduced during the year by $14.3bn, driven by unfavourable foreign currency movements of $7.7bn, a $5.6bn reduction due to the BoCom change, and the $2.5bn share buy- back. • A decrease in RWAs in 2016 of $245.8bn from continued implementation of RWA-reduction initiatives, the BoCom change and favourable foreign currency movements, supported the increase in capital ratios. Capital overview Capital ratios CRD IV end point Common equity tier 1 ratio CRD IV transitional Common equity tier 1 ratio Tier 1 ratio Total capital ratio Footnote 1 1 At 31 Dec 2016 % 13.6 13.6 16.1 20.1 2015 % 11.9 11.9 13.9 17.2 Total regulatory capital and risk-weighted assets CRD IV end point Common equity tier 1 capital CRD IV transitional Common equity tier 1 capital Additional tier 1 capital Tier 2 capital Total regulatory capital Transitional risk-weighted assets At 31 Dec 2016 $m 2015 $m Footnote 1 1 1 115,984 130,863 116,552 130,863 21,470 34,336 22,440 36,530 172,358 189,833 857,181 1,102,995 1 Due to transitional provisions in the threshold deduction our CET1 and RWAs are different for transitional and end point. At 31 December 2016, end point RWAs were $855.8bn. RWAs by risk types Credit risk Counterparty credit risk Market risk Operational risk At 31 Dec 2016 RWAs $bn 655.7 62.0 41.5 98.0 857.2 Capital required 1 $bn 52.5 5.0 3.3 7.8 68.6 1 ‘Capital required’ represents the Pillar 1 capital charge at 8% of RWAs. Capital management (Audited) Our objective in the management of Group capital is to maintain appropriate levels of capital to support our business strategy, and meet our regulatory and stress testing related requirements. Approach and policy Our approach to capital management is driven by our strategic and organisational requirements, taking into account the regulatory, economic and commercial environment. It is our objective to maintain a strong capital base to support the risks inherent in our business and invest in accordance with our strategy, meeting both consolidated and local regulatory capital requirements at all times. Our policy on capital management is underpinned by a capital management framework and our internal capital adequacy assessment process (‘ICAAP’), which enables us to manage our capital in a consistent manner. The framework incorporates a number of different capital measures calculated on an economic capital and regulatory capital basis. The internal capital adequacy assessment process brings together regulatory and internal capital resources and requirements with HSBC’s business model, strategy, performance and planning, risks to capital, and the implications of stress testing to assess the bank’s capital position. Our assessment of capital adequacy is aligned to our assessment of risks. These include credit, market, operational, pensions, insurance, structural foreign exchange risk, residual risks and interest rate risk in the banking book. Planning and performance Capital plans and RWA plans form part of the Annual Operating Plan that is approved by the Board. Revised RWA forecasts are submitted to the GMB on a monthly basis and reported RWAs are monitored against plan. The responsibility for global capital allocation principles and decisions rests with the Group Finance Director. Through our internal governance processes, we seek to maintain discipline over our investment and capital allocation decisions, and seek to ensure that returns on investment meet the Group’s management objectives. Our strategy is to allocate capital to businesses and entities to support growth objectives where above hurdle returns have been identified and their regulatory and economic capital needs. We manage business returns by use of a return on risk- weighted assets (‘RoRWA’) measure. In 2016, we augmented this through the introduction of financial information and metrics on the consumption of, and returns on, capital by global business to support management’s assessment of business performance and the allocation of capital resources. We plan to further embed this in 2017. Risks to capital Outside the stress testing framework, other risks may be identified that have the potential to affect our RWAs and/or capital position. The downside or upside scenarios are assessed against our capital management objectives and mitigating actions are assigned as necessary. Stress testing In addition to an annual internal stress test, the Group is subject to supervisory stress testing in many jurisdictions. Supervisory stress testing requirements are increasing in frequency and in the granularity with which the results are required. These exercises include the programmes of the PRA, the FRB, the EBA, the ECB and the HKMA, as well as stress tests undertaken in other jurisdictions. We take into account the results of all such regulatory stress testing and our internal stress test when assessing our internal capital requirements. The outcome of stress testing exercises carried out by the PRA will also feed HSBC Holdings plc Annual Report and Accounts 2016 127 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Capital into a PRA buffer under the Pillar 2 requirements, where required. Capital generation HSBC Holdings is the provider of equity capital to its subsidiaries and also provides them with non-equity capital where necessary. These investments are substantially funded by HSBC Holdings’ own capital issuance and profit retention. As part of its capital management process, HSBC Holdings seeks to maintain a prudent balance between the composition of its capital and its investment in subsidiaries. Capital Transitional own funds disclosure (Audited) Ref* Common equity tier 1 (‘CET1’) capital: instruments and reserves 1 Capital instruments and the related share premium accounts – ordinary shares 2 Retained earnings1 3 Accumulated other comprehensive income (and other reserves)1 5 Minority interests (amount allowed in consolidated CET1) 5a Independently reviewed interim net profits net of any foreseeable charge or dividend1 6 Common equity tier 1 capital before regulatory adjustments Common equity tier 1 capital: regulatory adjustments 7 Additional value adjustments 8 Intangible assets (net of related deferred tax liability) 10 Deferred tax assets that rely on future profitability excluding those arising from temporary differences (net of related tax liability) 11 Fair value reserves related to gains or losses on cash flow hedges 12 Negative amounts resulting from the calculation of expected loss amounts 14 Gains or losses on liabilities at fair value resulting from changes in own credit standing 15 Defined-benefit pension fund assets 16 Direct and indirect holdings of own CET1 instruments 19 Direct, indirect and synthetic holdings by the institution of the CET1 instruments of financial sector entities where the institution has a significant investment in those entities (amount above 10% threshold and net of eligible short positions) 28 Total regulatory adjustments to common equity tier 1 29 Common equity tier 1 capital Additional tier 1 (‘AT1’) capital: instruments 30 Capital instruments and the related share premium accounts 31 – classified as equity under IFRSs 33 Amount of qualifying items and the related share premium accounts subject to phase out from AT1 34 Qualifying tier 1 capital included in consolidated AT1 capital (including minority interests not included in CET1) issued by subsidiaries and held by third parties 35 – of which: instruments issued by subsidiaries subject to phase out 36 Additional tier 1 capital before regulatory adjustments Additional tier 1 capital: regulatory adjustments 37 Direct and indirect holdings of own AT1 instruments 41b Residual amounts deducted from AT1 capital with regard to deduction from tier 2 (‘T2’) capital during the transitional period – direct and indirect holdings by the institution of the T2 instruments and subordinated loans of financial sector entities where the institution has a significant investment in those entities 43 Total regulatory adjustments to additional tier 1 capital 44 Additional tier 1 capital 45 Tier 1 capital (T1 = CET1 + AT1) Tier 2 capital: instruments and provisions 46 Capital instruments and the related share premium accounts 47 Amount of qualifying items and the related share premium accounts subject to phase out from T2 48 Qualifying own funds instruments included in consolidated T2 capital (including minority interests and AT1 instruments not included in CET1 or AT1) issued by subsidiaries and held by third parties 49 – of which: instruments issued by subsidiaries subject to phase out 51 Tier 2 capital before regulatory adjustments Tier 2 capital: regulatory adjustments 52 Direct and indirect holdings of own T2 instruments 55 Direct and indirect holdings by the institution of the T2 instruments and subordinated loans of financial sector entities where the institution has a significant investment in those entities (net of eligible short positions) 57 Total regulatory adjustments to tier 2 capital 58 Tier 2 capital 59 Total capital (TC = T1 + T2) At 31 Dec 2016 $m 21,310 21,310 2015 $m 20,858 20,858 125,442 122,304 560 3,878 (1,899) 8,832 3,519 8,670 149,291 164,183 (1,358) (15,037) (1,151) (20,650) (1,696) (52) (4,025) 1,052 (3,680) (1,573) (1,204) (52) (4,920) (495) (4,009) (839) (6,370) (32,739) 116,552 — (33,320) 130,863 11,259 11,259 7,946 2,419 1,522 21,624 (60) (94) (94) (154) 9,261 9,261 8,972 4,388 2,842 22,621 (60) (121) (121) (181) 21,470 138,022 22,440 153,303 16,732 5,695 12,323 12,283 34,750 (40) (374) (414) 15,863 6,645 14,344 14,330 36,852 (40) (282) (322) 34,336 172,358 36,530 189,833 * 1 The references identify the lines prescribed in the EBA template, which are applicable and where there is a value. In the comparative period, profits and other comprehensive income have been reallocated from row 2 into rows 5a and 3 respectively. In addition, retained earnings and profits pertaining to the deconsolidation of insurance and other entities have been reallocated from row 3 to rows 2 and 5a. 128 HSBC Holdings plc Annual Report and Accounts 2016 Throughout 2016, we complied with the Prudential Regulation Authority’s (‘PRA’) regulatory capital adequacy requirements, including those relating to stress testing. Following a clarification of policy by the PRA, at 30 September 2016 the regulatory treatment of our investment in BoCom changed from proportional consolidation of RWAs to a deduction from capital (subject to regulatory thresholds). The revised regulatory treatment is more consistent with our financial reporting treatment, aligning with the equity method of accounting, and better reflects our relationship with BoCom, including the nature of our obligations and financial commitments. CET1 capital decreased during the year by $14.3bn, primarily because of: • unfavourable foreign currency translation differences of $7.8bn; • a $5.6bn reduction from the change in treatment of BoCom; and • the $2.5bn share buy-back. These decreases were partly offset by: • $2.4bn from the sale of our operations in Brazil. Risk-weighted assets RWAs RWAs decreased in 2016 by $245.8bn, of which $38.1bn was due to foreign currency translation differences. RWA initiatives reduced RWAs by $143.2bn, partly offset by book size movements increasing RWAs by $38.7bn. The change of regulatory treatment of our investment in BoCom reduced RWAs by $120.9bn. The following comments describe RWA movements in 2016, excluding foreign currency translation differences. RWA initiatives The main drivers of these reductions were: • $69.8bn as a result of reduced exposures, refined calculations and process improvements; • $41.8bn from the sale of our activities in Brazil; and • $31.6bn through the continued reduction in Legacy Credit and US run-off portfolios. Book size Book size movements increased RWAs by $38.7bn, principally from: • increased corporate lending in GB&M and CMB, increasing RWAs by $32bn in Asia and Europe; • movements in market parameters increasing counterparty credit risk and market risk by $11.7bn; and • offset by a decrease in operational risk RWAs of $3.4bn reflecting the decrease of average income over three years. RWAs by global business Credit risk Counterparty credit risk Market risk Operational risk At 31 Dec 2016 Credit risk Counterparty credit risk Market risk Operational risk At 31 Dec 2015 RWAs by geographical region Credit risk Counterparty credit risk Market risk1 Operational risk At 31 Dec 2016 Credit risk Counterparty credit risk Market risk Operational risk At 31 Dec 2015 RBWM $bn 84.6 — — 30.5 115.1 99.7 — — 31.0 130.7 Europe $bn 205.8 30.9 30.8 30.9 298.4 231.6 31.9 30.5 33.2 327.2 CMB $bn 250.6 — — 25.3 275.9 278.1 — — 24.1 302.2 Asia $bn 260.0 16.1 21.3 36.6 334.0 373.6 17.1 21.9 47.1 459.7 GB&M $bn 170.8 59.1 38.5 32.0 300.4 189.6 64.3 40.7 35.7 330.3 GPB $bn 12.2 0.2 — 2.9 15.3 14.4 0.3 — 3.3 18.0 Corporate Centre $bn 137.5 2.7 3.0 7.3 150.5 294.1 4.6 1.8 21.3 321.8 MENA North America Latin America $bn 49.0 1.2 1.4 7.5 59.1 59.2 2.0 1.5 7.9 70.6 $bn 118.5 12.6 6.8 12.8 150.7 156.4 14.6 6.5 14.1 191.6 $bn 22.4 1.2 0.5 10.2 34.3 55.1 3.6 1.6 13.1 73.4 Total $bn 655.7 62.0 41.5 98.0 857.2 875.9 69.2 42.5 115.4 1,103.0 Total $bn 655.7 62.0 41.5 98.0 857.2 875.9 69.2 42.5 115.4 1,103.0 1 RWAs are non-additive across geographical regions due to market risk diversification effects within the Group. HSBC Holdings plc Annual Report and Accounts 2016 129 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Capital RWA movement by global business by key driver RWAs at 1 Jan 2016 RWA movements RWA initiatives Foreign exchange movement Acquisitions and disposals Book size Book quality Model updates – portfolios moving onto IRB1 approach – new/updated models Methodology and policy – internal updates – external updates – regulatory Total RWA movement RWAs at 31 Dec 2016 1 Internal ratings based. RWA movement by geographical region by key driver RWAs at 1 Jan 2016 RWA movements RWA initiatives Foreign exchange movement Acquisitions and disposals Book size Book quality Model updates – portfolios moving onto IRB1 approach – new/updated models Methodology and policy – internal updates – external updates – regulatory Total RWA movement RWAs at 31 Dec 2016 1 Internal ratings based. Credit risk, counterparty credit risk and operational risk RBWM $bn 130.8 (10.1) (4.1) — 0.7 (1.5) (0.9) — (0.9) 0.2 1.0 (0.8) (15.7) 115.1 CMB $bn 302.1 (39.0) (15.7) — 16.6 7.7 — — — 4.2 4.2 — (26.2) 275.9 GB&M $bn 289.6 (48.1) (10.1) — 22.9 8.5 (0.1) (0.1) — (0.8) (0.8) — (27.7) 261.9 GPB $bn 18.0 (0.3) (0.7) — (1.5) — — — — (0.2) (0.2) — (2.7) 15.3 Corporate Centre $bn 320.0 Market risk $bn 42.5 Total RWAs $bn 1,103.0 (39.8) (7.5) — (4.9) 0.3 — — — (120.6) (1.0) (119.6) (172.5) 147.5 (5.9) — — 4.9 — — — — — — — (1.0) 41.5 (143.2) (38.1) — 38.7 15.0 (1.0) (0.1) (0.9) (117.2) 3.2 (120.4) (245.8) 857.2 Credit risk, counterparty credit risk and operational risk Europe $bn 296.7 (28.4) (26.9) — 20.4 4.1 0.2 (0.1) 0.3 1.5 2.6 (1.1) (29.1) 267.6 Asia $bn 437.8 (19.1) (7.8) — 12.6 7.6 — — — (118.4) 0.6 (119.0) (125.1) 312.7 MENA $bn 69.1 North America $bn 185.0 Latin America Market risk Total RWAs $bn 71.9 $bn 42.5 $bn 1,103.0 (3.6) (6.5) — (1.4) 0.2 — — — (0.1) (0.1) — (11.4) 57.7 (43.6) (42.6) 0.9 — 0.2 2.8 (1.2) — (1.2) (0.2) (0.2) — (41.1) 143.9 2.2 — 2.0 0.3 — — — — 0.3 (0.3) (38.1) 33.8 (5.9) — — 4.9 — — — — — — — (1.0) 41.5 (143.2) (38.1) — 38.7 15.0 (1.0) (0.1) (0.9) (117.2) 3.2 (120.4) (245.8) 857.2 130 HSBC Holdings plc Annual Report and Accounts 2016 Leverage ratio Leverage ratio Ref* 21 Total leverage ratio exposure 20 Tier 1 capital (end point) 22 Leverage ratio At 31 Dec 2016 $bn 2,354.4 127.3 5.4% 2015 $bn 2,794.4 140.2 5.0% EU-23 Choice on transitional arrangements for the definition of the capital measure Fully phased in Fully phased in Total leverage ratio exposure – quarterly average Leverage ratio – quarterly average * The references identify the lines prescribed in the EBA template. Our leverage ratio calculated on CRR basis was 5.4% at 31 December 2016, up from 5.0% at 31 December 2015. This was mainly due to a reduction in the exposure measure resulting from the change in regulatory treatment of our investment in BoCom. The Group’s UK leverage ratio on a modified basis, excluding qualifying central bank balances, was 5.7%. This modification to the leverage ratio exposure measure was made following recommendations by the Bank of England’s Financial Policy Committee. The Financial Policy Committee has stated that it intends to recalibrate the leverage ratio in 2017 to take account of this modification. HSBC’s UK leverage ratio on a modified basis should be considered in this context. 2,438.7 5.4% 2,869.4 5.0% At 31 December 2016, our UK minimum leverage ratio requirement of 3% was supplemented by an additional leverage ratio buffer of 0.2%. This additional buffer translates to a value of $5bn. The countercyclical leverage ratio buffer results in no capital impact. We comfortably exceeded these leverage requirements. Pillar 3 disclosure requirements Pillar 3 of the Basel regulatory framework is related to market discipline and aims to make firms more transparent by requiring publication, at least annually, of wide-ranging information on their risks, capital and management. Pillar 3 Disclosures 2016 is published on our website, www.hsbc.com, under Investor Relations. HSBC Holdings plc Annual Report and Accounts 2016 131 Strategic ReportCorporate Governance Financial Statements Shareholder Information Financial Review Report of the Directors | Corporate Governance Corporate Governance Report The Board The Board aims to promote the Group’s long-term success, deliver sustainable value to shareholders and promote a culture of openness and debate. Led by the Group Chairman, the Board sets the Group’s strategy and risk appetite. It also approves capital and operating plans for achieving strategic objectives, on the recommendation of management. Powers of the Board The Board is responsible for overseeing the management of HSBC globally and, in so doing, may exercise its powers, subject to any relevant laws, regulations and HSBC Holdings’ Articles of Association (the ‘Articles of Association’). Although the Board delegates day-to-day management of the business and implementation of strategy to the Group Chief Executive, certain matters, including annual operating plans, risk appetite and performance targets, procedures for monitoring and control of operations, approval of credit or market risk limits, acquisitions, disposals, investments, capital expenditure or realisation or creation of a new venture, specified senior appointments and any substantial change in balance sheet management policy are reserved by the Board for approval. Executive Directors The Group Chairman, the Group Chief Executive, the Group Finance Director and the Group Chief Risk Officer are HSBC employees. Non-executive Directors The Board comprises a majority of independent non-executive Directors. Their role is to constructively challenge, scrutinise the performance of management and help develop proposals on strategy. They also review the performance of management in meeting agreed goals and objectives and monitor the Group’s risk profile. The Board considers all non-executive Directors to be independent of HSBC. The Board has concluded that there are no relationships or circumstances likely to affect any individual non-executive Director’s judgement. To satisfy the Rules Governing the Listing of Securities on the HKEx, all non- executive Directors have provided confirmation of their independence during the year. Sam Laidlaw has served on the Board for more than nine years and, in that respect only, does not meet the usual criteria for independence set out in the UK Corporate Governance Code and the Hong Kong Corporate Governance Code. The Board has determined Sam Laidlaw to be independent in character and judgement, notwithstanding his length of service, taking into account his continuing level of constructive challenge of management and strong contribution to Board discussions. He will, however, be retiring from the Board at the conclusion of the forthcoming AGM. Role and support of Directors The roles of Group Chairman and Group Chief Executive are separate, with a clear division of responsibilities between the running of the Board and executive responsibility for running HSBC’s business. Their respective roles are set out in writing and are available on the website at www.hsbc.com/about-hsbc/ corporate-governance/board-committees, along with the role description of the Senior Independent Director (‘SID’). Statement of compliance The Board Director and Group Managing Director biographies Appointment and induction of Directors Operation of the Board Conflicts of interest and indemnification Board performance evaluation Shareholder engagement and the AGM Board committees Internal control Going concern and viability Share capital and other disclosures Employees Page 132 132 133 138 138 138 138 139 140 145 146 147 150 Statement of compliance The statement of corporate governance practices set out on pages 132 to 182 and the information referred to therein constitutes the Corporate Governance Report of HSBC Holdings. The websites referred to do not form part of this Report. Relevant corporate governance codes UK Corporate Governance Code www.frc.org.uk Hong Kong Corporate Governance Code (set out in Appendix 14 to the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited) Descriptions of the roles and responsibilities of the: – Group Chairman – Group Chief Executive – Senior Independent Director www.hkex.com.hk www.hsbc.com/about-hsbc/corporate- governance/board-committees Board and senior management www.hsbc.com/about-hsbc/leadership Roles and responsibilities of the Board and its committees www.hsbc.com/about-hsbc/corporate- governance/board-committees Board’s policies on: – Diversity – Shareholder communication Global Internal Audit Charter www.hsbc.com/investor-relations/ governance/corporate-governance- codes www.hsbc.com/investor-relations/ governance/internal-control HSBC is subject to corporate governance requirements in both the UK and Hong Kong. During 2016, HSBC complied with the applicable provisions of the UK Corporate Governance Code, and also the requirements of the Hong Kong Corporate Governance Code. Under the Hong Kong Code the Audit Committee should be responsible for the oversight of all risk management and internal control systems. HSBC’s Group Risk Committee is responsible for oversight of internal control, other than internal control over financial reporting, and risk management systems. This is permitted under the UK Corporate Governance Code. The Board has codified obligations for transactions in HSBC Group securities in accordance with the requirements of the Market Abuse Regulation and the rules governing the listing of securities on The Stock Exchange of Hong Kong Limited (‘HKEx’), save that the HKEx has granted waivers from strict compliance with the rules that take into account accepted practices in the UK, particularly in respect of employee share plans. HSBC is in discussion with the HKEx to update these waivers to take account of the Market Abuse Regulation. Following specific enquiry, each Director has confirmed that he or she has complied with their obligations in respect of transacting in Group securities during the year. 132 HSBC Holdings plc Annual Report and Accounts 2016 Executive Directors Douglas Flint, CBE, 61 Group Chairman Appointed to the Board: December 1995 Group Chairman since December 2010 Skills and experience: Douglas has extensive board-level experience and knowledge of governance primarily having served on the boards of HSBC and BP plc, and as a partner of KPMG. He has expertise in finance and risk management in banking, multinational financial reporting, treasury and securities trading operations. He joined HSBC as Group Finance Director in 1995 and, prior to becoming Chairman in 2010, his responsibilities broadened to Chief Financial Officer, and Executive Director for Risk and Regulation. He is a member of the Institute of Chartered Accountants of Scotland and a Fellow of the Chartered Institute of Management Accountants. Current appointments include: Board member of the Institute of International Finance, member of the International Business Leaders Advisory Councils of the mayors of both Beijing and Shanghai, a UK Business Ambassador at the invitation of the UK Prime Minister, non-executive Chairman of the Just Finance Foundation, trustee of the Royal Marsden Cancer Charity Board and a member of its Investment Committee. Stuart Gulliver, 57 Group Chief Executive Appointed to the Board: May 2008 Group Chief Executive since January 2011 appointments include director of Hang Seng Bank Limited; Chief Financial Officer, HSBC Asia-Pacific. Before joining HSBC, Iain worked at General Electric (‘GE’), serving as Controller of its Global Consumer Finance Unit, Chief Financial Officer of GE Consumer Finance Americas, and Chief Financial Officer of GE Healthcare – Global Diagnostic Imaging. Iain is a member of the Institute of Chartered Accountants of Scotland. Current appointments include: Member of the Board of Trustees of the British Heart Foundation and chairman of its audit and risk committee. Marc Moses, 59 Group Chief Risk Officer Appointed to the Board: January 2014 Skills and experience: Marc joined HSBC in 2005 as Chief Financial and Risk Officer for Global Banking and Markets, and in December 2010 became Group Chief Risk Officer. He has extensive risk management and financial experience. Marc is a Fellow of the Institute of Chartered Accountants in England and Wales. He was European chief financial officer at J.P. Morgan and an audit partner at PricewaterhouseCoopers. Independent non-executive Directors Phillip Ameen, 68 Independent non-executive Director Appointed to the Board: January 2015 Skills and experience: Stuart has more than 36 years’ international banking experience, having joined HSBC in 1980. He played a leading role in developing and expanding Global Banking and Markets, and has held key roles in the Group’s operations worldwide, working in London, Hong Kong, Tokyo, Kuala Lumpur and the United Arab Emirates. Former appointments include Chairman of HSBC Bank plc, HSBC Bank Middle East Limited, HSBC Private Banking Holdings (Suisse) SA and HSBC France. He was also Deputy Chairman of HSBC Trinkaus & Burkhardt AG and a member of its supervisory board. Current appointments include: Chairman of the Group Management Board, and The Hongkong and Shanghai Banking Corporation Limited. Iain Mackay, 55 Group Finance Director Appointed to the Board: December 2010 Member of the Group Audit Committee. Skills and experience: As a Certified Public Accountant with extensive financial and accounting experience, Phillip served as Vice President, Comptroller, and Principal Accounting Officer of GE. Prior to joining General Electric, he was a partner of KPMG. He also served on the International Financial Reporting Interpretations Committee of the International Accounting Standards Board, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants and the Financial Accounting Standards Board Emerging Issues Task Force. He was also Chairman of the Committee on Corporate Reporting of Financial Executives International, Chairman of Skyonic Corporation and a trustee of the Financial Accounting Foundation. Current appointments include: A non-executive director of HSBC North America Holdings Inc., HSBC Bank USA N.A., HSBC Finance Corporation and HSBC USA Inc. Kathleen Casey, 50 Independent non-executive Director Appointed to the Board: March 2014 Skills and experience: Iain has extensive financial and international experience, having worked in London, Paris, the US, Africa and Asia. He joined HSBC in 2007 as Chief Financial Officer of HSBC North America Holdings Inc. Other former Member of the Group Audit Committee and the Financial System Vulnerabilities Committee. HSBC Holdings plc Annual Report and Accounts 2016 133 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance Skills and experience: Kathleen has extensive financial regulatory policy experience. She is a former Commissioner of the US Securities and Exchange Commission, and acted as its principal representative in multilateral and bilateral regulatory dialogues with the G-20 Financial Stability Board and the International Organisation of Securities Commissions. Other former appointments include Staff Director and Counsel to the United States Senate Committee on Banking, Housing, and Urban Affairs; Chair of the Alternative Investment Management Association; and Legislative Director and Chief of Staff for a US Senator. Current appointments include: Senior adviser to Patomak Global Partners and to a number of public bodies in the US. Laura Cha, GBS, 67 Independent non-executive Director Appointed to the Board: March 2011 Chair of the Philanthropic & Community Investment Oversight Committee, and a member of the Conduct & Values Committee and the Nomination Committee. Skills and experience: Laura has extensive regulatory and policy making experience in the finance and securities sector in Hong Kong and mainland China. She is the former Vice Chairman of the China Securities Regulatory Commission. Other former appointments include serving as a non-executive director of Bank of Communications Co., Limited; Hong Kong Exchanges and Clearing Limited; and Tata Consultancy Services Limited. She also served as chair of the University Grants Committee in Hong Kong, and was Deputy Chairman of the Securities and Futures Commission in Hong Kong. Current appointments include: A non-executive Deputy Chairman of The Hongkong and Shanghai Banking Corporation Limited, Chairman of Hong Kong’s Financial Services Development Council and a non-executive director of China Telecom Corporation Limited, Unilever PLC and Unilever N.V. Henri de Castries, 62 Independent non-executive Director Appointed to the Board: March 2016 Skills and experience: Henri has more than 25 years’ international experience in the financial services industry. He joined AXA in 1989 and his roles included responsibility for the group’s asset management, financial and real-estate businesses, the oversight of North American and UK operations, and the preparation and execution of all the group’s major mergers and acquisitions undertaken in the 1990s. Henri retired as Chairman and Chief Executive Officer of AXA SA on 1 September 2016. Other former appointments include serving as a director of AllianceBernstein Corporation. Current appointments include: Chairman of Institut Montaigne, a French think-tank; non-executive director of Nestlé S.A. and a non-executive director of the French National Foundation for Political Science. 134 HSBC Holdings plc Annual Report and Accounts 2016 Lord Evans of Weardale, 59 Independent non-executive Director Appointed to the Board: August 2013 Chairman of the Financial System Vulnerabilities Committee, and a member of the Conduct & Values Committee and the Philanthropic & Community Investment Oversight Committee. Skills and experience: Jonathan has extensive experience in national security policy and operations. He was formerly Director General of the UK’s Security Service (MI5) with responsibility for its leadership, policy and strategy, and areas including international and domestic counter-terrorism, counter- espionage and counter-proliferation activities, and cybersecurity. Jonathan held various positions during a 30-year career in the Security Service, which included responsibility for the oversight of the Joint Terrorist Analysis Centre and the Centre for the Protection of National Infrastructure, and attending the National Security Council. Current appointments include: A non-executive director of Ark Data Centres and an adviser to various cybersecurity and technology companies. Joachim Faber, 66 Independent non-executive Director Appointed to the Board: March 2012 Chairman of the Group Risk Committee. Skills and experience: Joachim has extensive international experience in banking and asset management. He is a former Chief Executive Officer of Allianz Global Investors AG and is a member of the management board of Allianz SE. He spent 14 years with Citicorp, holding positions in Trading and Project Finance, and as Head of Capital Markets for Europe, North America and Japan. He was also chairman of various Allianz subsidiaries. He was previously a member of the supervisory board and chairman of the audit and risk committee of OSRAM Licht AG. He was also a member of the German Council for Sustainable Development and a member of the advisory board of the Siemens Group Pension Board. Current appointments include: Chairman of the supervisory board of Deutsche Börse AG and the Shareholder Committee of Joh. A. Benckiser SARL, and a director of Coty Inc. and Allianz France S.A. Sam Laidlaw, 61 Independent non-executive Director Appointed to the Board: January 2008 Chairman of the Group Remuneration Committee and the Nomination Committee. Skills and experience: Sam has had responsibility for businesses in four continents and has particular experience in the energy sector. He was Chief Executive Officer of Centrica plc and lead non-executive board member of the UK Department for Transport. He was also an Executive Vice President of Chevron Corporation and a member of the UK Prime Minister’s Business Advisory Group. He is a qualified solicitor with a Master’s in business administration. Current appointments include: Chair of the National Centre for Universities and Business, Chair of the Global Leadership Council for the Saïd Business School and Executive Chairman of Neptune Oil & Gas Limited. Sam was also appointed as a non- executive director of Rio Tinto plc and Rio Tinto Limited on 10 February 2017. Skills and experience: Rachel was Deputy Governor of the Bank of England, and Permanent Secretary at the UK Government Departments for Transport and Work and Pensions, and the Welsh Office. She was a non-executive director of Reinsurance Group of America Inc. and The Scottish American Investment Company P.L.C. Current appointments include: A of Arcus European Infrastructure Fund GP LLP, Heathrow Airport Holdings Limited, SETL Development Limited and Serco Group plc, as well as Chairman of the latter’s corporate responsibility committee. director Irene Lee, 63 Independent non-executive Director Appointed to the Board: July 2015 Heidi Miller, 63 Independent non-executive Director Appointed to the Board: September 2014 Skills and experience: Irene has more than 30 years’ finance industry experience, having held senior investment banking and fund management positions in the UK, the US and Australia, including positions at Citibank and the Commonwealth Bank of Australia. Other former appointments include serving as a member of the Advisory Council of J.P. Morgan Australia and the Australian Takeovers Panel. Current appointments include: Executive Chairman of Hysan Development Company Limited and a non-executive director of The Hongkong and Shanghai Banking Corporation Limited, Hang Seng Bank Limited, Cathay Pacific Airways Limited, CLP Holdings Limited and Noble Group Limited. John Lipsky, 70 Independent non-executive Director Appointed to the Board: March 2012 Member of the Group Risk Committee, the Nomination Committee and the Group Remuneration Committee. Skills and experience: John worked for J.P. Morgan in Chile, New York, Washington and London, and interacted with financial institutions, central banks and governments in many countries. He served at the International Monetary Fund as First Deputy Managing Director, Acting Managing Director and Special Adviser. Other former appointments include serving as a trustee of the Economic Club of New York, a Global Policy Adviser for Anderson Global Macro, LLC and Chairman of the World Economic Forum’s Global Agenda Council on the International Monetary System. Current appointments include: Senior appointments and advisory positions in international economic research organisations. Rachel Lomax, 71 Senior Independent Director Appointed to the Board: December 2008 Senior Independent Director since April 2015 Chair of the Conduct & Values Committee, and a member of the Group Risk Committee and the Nomination Committee. Member of the Group Risk Committee. Skills and experience: Heidi is a former President of International at JP Morgan Chase, and was responsible for leading the global expansion and the international business strategy across its investment bank, asset management, and treasury and securities services divisions. She was also a non- executive director of Merck & Co., Inc. and Progressive Corp.; Executive Vice President and Chief Financial Officer of Bank One Corporation; Senior Executive Vice President of Priceline.com Inc.; and Executive Vice President and Chief Financial Officer of Citigroup Inc. Current appointments include: Chair of HSBC North American Holdings Inc., a non-executive director of First Data Corporation and General Mills Inc., and an advisory director of SRS Acquiom LLC. David Nish, 56 Independent non-executive Director Appointed to the Board: May 2016 Member of the Group Audit Committee. Skills and experience: David served as Chief Executive Officer of Standard Life plc between 2010 and 2015, having joined as Finance Director in 2006. David led its investment in technology, complementary acquisitions and the disposal of the group’s Canadian operations. Other former appointments include Group Finance Director of Scottish Power plc, non-executive director of HDFC Life (India) and partner of Price Waterhouse. He is a qualified chartered accountant. Current appointments include: A non-executive director of Vodafone plc, London Stock Exchange Group plc, UK Green Investment Bank plc and Zurich Insurance Group. Jonathan Symonds, CBE, 57 Independent non-executive Director Appointed to the Board: April 2014 Chairman of the Group Audit Committee and a member of the Conduct & Values Committee. HSBC Holdings plc Annual Report and Accounts 2016 135 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Paul Walsh, 61 Independent non-executive Director Appointed to the Board: January 2016 Member of the Group Remuneration Committee and the Group Nomination Committee. Skills and experience: Paul was Group Chief Executive of Diageo plc for 12 years, having originally joined the Board of its predecessor, Grand Metropolitan plc, in 1995. He was also a non-executive director of Unilever PLC, United Spirits Limited and Centrica plc. Paul is a Fellow of the Chartered Institute of Management Accountants. Current appointments include: Non-executive Chairman of Compass Group PLC, Avanti Communications Group Plc and Chime Communications Limited, and a non-executive director of FedEx Corporation and RM2 International S.A. Group Company Secretary Ben Mathews, 49 Group Company Secretary Ben joined HSBC in June 2013 and became Group Company Secretary in July 2013. He is a Fellow of the Institute of Chartered Secretaries and Administrators. Former appointments include Group Company Secretary of Rio Tinto plc and of BG Group plc. Role of the Group Company Secretary All Directors have access to the advice and services of the Group Company Secretary, who is responsible to the Board for ensuring that Board procedures and all applicable rules and regulations are complied with, and for advising the Board on corporate governance matters. Under the direction of the Group Chairman, the Group Company Secretary is responsible for ensuring good information flows within the Board and its committees and between senior management and non-executive Directors, as well as facilitating induction and assisting with professional development as required. Report of the Directors | Corporate Governance Skills and experience: Jonathan is a former Chief Financial Officer of Novartis AG and AstraZeneca plc. He was also a partner and Managing Director of Goldman Sachs, a partner of KPMG, and a non-executive director and chair of the Audit Committee of Diageo plc. He is a fellow of the Institute of Chartered Accountants in England and Wales. Current appointments include: Chairman of HSBC Bank plc, Innocoll AG and Proteus Digital Health Inc., and a non-executive director of Genomics England Limited. Jackson Tai, 66 Independent non-executive Director Appointed to the Board: September 2016 Member of the Group Risk Committee and the Financial System Vulnerabilities Committee. Skills and experience: Jackson was formerly Vice Chairman and Chief Executive of DBS Group and DBS Bank Ltd, having served the group as Chief Financial Officer and then as President and Chief Operating Officer. He previously worked at JP Morgan & Co. Incorporated as an investment banker in New York, Tokyo and San Francisco. Other former appointments include non-executive director of Bank of China Limited, Singapore Airlines, NYSE Euronext, ING Groep N.V., CapitaLand Ltd, SingTel Ltd. and Jones Lang LaSalle Inc. Jackson also served as Vice-Chairman of Islamic Bank of Asia. Current appointments include: Non-executive director of Eli Lilly and Company, Koninklijke Philips Electronics N.V., MasterCard Incorporated and the Canada Pension Plan Investment Board. Pauline van der Meer Mohr, 57 Independent non-executive Director Appointed to the Board: September 2015 Member of the Group Remuneration Committee, the Group Nomination Committee and the Conduct & Values Committee. Skills and experience: Pauline has extensive legal and human resources experience across a number of different sectors, and contributed to the Dutch Banking Code Monitoring Commission. Former appointments include President of Erasmus University Rotterdam; Senior Executive Vice President and Head of Group Human Resources at ABN AMRO Bank NV; Group Human Resources Director at TNT NV; HR Director, Information Technology, Royal Dutch Shell Group; and Senior Legal Counsel, Shell International. Current appointments include: President of the supervisory board of EY Netherlands and member of the supervisory boards of ASML Holding N.V. and Royal DSM N.V. 136 HSBC Holdings plc Annual Report and Accounts 2016 Group Managing Directors Samir Assaf, 56 Chief Executive, Global Banking and Markets Samir joined HSBC in 1994 and became a Group Managing Director in 2011. He is Chairman and a non-executive director of HSBC France; a director of HSBC Trinkaus & Burkhardt AG and The Saudi British Bank. Former appointments include: a director of HSBC Bank plc; HSBC Global Asset Management Limited and HSBC Bank Egypt S.A.E.; and Head of Global Markets for Europe, Middle East and Africa. Peter Boyles, 61 Chief Executive Officer of Global Private Banking Peter joined HSBC in 1975 and became a Group Managing Director in 2013. He is Chairman of HSBC Private Bank (Monaco) SA and a director of HSBC Global Asset Management Limited and HSBC Private Bank (UK) Limited. Former appointments include: Chief Executive of HSBC France; a director of HSBC Bank plc, HSBC Bank Malta p.l.c. and HSBC Trinkaus & Burkhardt AG. Patrick Burke, 55 President and Chief Executive Officer of HSBC USA Patrick joined HSBC in 1989 and became a Group Managing Director in 2015. He is Chairman of HSBC Bank USA, N.A., HSBC Finance Corporation, HSBC USA Inc. and HSBC Global Asset Management (USA) Inc. John Flint, 48 Chief Executive Officer, Retail Banking and Wealth Management John joined HSBC in 1989 and became a Group Managing Director in 2013. Former appointments include: a director of HSBC Private Banking Holdings (Suisse) SA, a director of HSBC Bank Canada, Chief of Staff to the Group Chief Executive and Group Head of Strategy and Planning, Chief Executive Officer HSBC Global Asset Management, Group Treasurer and Deputy Head of Global Markets. Pierre Goad, 55 Group Head of Employee Insight and Communications Pierre first joined HSBC in 2001. In 2010 he left and joined Zurich Insurance Group as Head of Communications. He rejoined HSBC in 2011 and became a Group Managing Director in 2015. He is a director of HSBC Bank Canada. Former appointments include: Global Head of Communications; and Head of Corporate Development, Europe, Middle East and Global Businesses. Pam Kaur, 53 Group Head of Internal Audit Pam joined HSBC and became a Group Managing Director in 2013. She is a co-opted member of The Institute of Chartered Accountants in England and Wales. Former appointments include: Global Head of Group Audit for Deutsche Bank AG; Chief Financial Officer and Chief Operating Officer of the Restructuring and Risk Division, Royal Bank of Scotland Group plc; Group Head of Compliance and AML, Lloyds TSB; and Global Director of Compliance, Global Consumer Group, Citigroup. Stuart Levey, 53 Chief Legal Officer Stuart joined HSBC and became a Group Managing Director in 2012. Former appointments include: Under Secretary for Terrorism and Financial Intelligence in the US Department of the Treasury; Senior Fellow for National Security and Financial Integrity at the Council on Foreign Relations; Principal Associate Deputy Attorney General at the US Department of Justice; and a Partner at Miller, Cassidy, Larroca & Lewin LLP and at Baker Botts LLP. Andy Maguire, 50 Group Chief Operating Officer Andy joined HSBC in 2014 as Group Chief Operating Officer and became a Group Managing Director in 2015. He is Chairman of HSBC Global Services (UK) Limited; a director of HSBC Global Services Limited and HSBC Group Management Services Limited. He was formerly a Managing Partner (UK and Ireland) of the Boston Consulting Group. Paulo Maia, 58 Chief Executive, Latin America Paulo joined HSBC in 1993 and became a Group Managing Director on 1 February 2016. He is Chairman of Grupo Financiero HSBC Mexico S.A. de C.V., HSBC Argentina Holdings S.A. and a Director of HSBC North America Holdings Inc. Former appointments include: Chief Executive of HSBC Bank Canada and HSBC Bank Australia Limited. Noel Quinn, 55 Chief Executive, Global Commercial Banking Noel joined HSBC in 1992 when the Group acquired Midland Bank and became a Group Managing Director on 1 September 2016. Former appointments include: Head of Specialised and Equity Finance, Director of Strategy & Development for Commercial Banking, Head of Commercial Finance Europe, Head of Commercial Banking UK and Head of Commercial Banking Asia. Antonio Simoes, 41 Chief Executive, HSBC Bank plc Antonio joined HSBC in 2007 and became a Group Managing Director on 1 February 2016. He is a director of HSBC Bank plc and HSBC France. Former appointments include: Chief Executive of HSBC UK; Head of Retail Banking and Wealth Management, Europe; and Chief of Staff to the Group Chief Executive and Group Head of Strategy and Planning. He is the Chairman of the Practitioner Panel of the FCA. He was formerly a Partner of McKinsey & Company. Peter Wong, 65 Deputy Chairman and Chief Executive, The Hongkong and Shanghai Banking Corporation Limited Peter joined HSBC in 2005 and became a Group Managing Director in 2010. He is Chairman of HSBC Bank (China) Company Limited and HSBC Bank Malaysia Berhad, and a non- executive director of Hang Seng Bank Limited. He is also non- executive Vice Chairman of Bank of Communications Co Ltd and an independent non-executive Director of Cathay Pacific Airways Limited. Former appointments include: Vice Chairman of HSBC Bank (Vietnam) Ltd; a director of HSBC Bank Australia Limited; and a director of Ping An Insurance (Group) Company of China, Ltd. HSBC Holdings plc Annual Report and Accounts 2016 137 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance Board of Directors Appointment, retirement and re-election of Directors Appointments to the Board are made on merit and candidates are considered against objective criteria, having due regard to the benefits of diversity on the Board. A rigorous selection process, overseen by the Nomination Committee and based upon agreed requirements using an external search consultancy, is followed in relation to the appointment of non- executive Directors. During the year Henri de Castries, David Nish, Jackson Tai and Paul Walsh were appointed to the Board. Their biographies can be found on pages 133 to 136. The number of Directors must not be less than five nor exceed 25. The Board may at any time appoint any person as a Director, either to fill a vacancy or as an addition to the existing Board. The Board may appoint any Director to hold any employment or executive office and may revoke or terminate any such appointment. Shareholders may, by ordinary resolution, appoint a person as a Director or remove any Director before the expiration of his or her period of office. Newly appointed Directors retire at the Annual General Meeting (‘AGM’) following appointment and are eligible for election. All Directors are nominated for annual re-election by shareholders subject to continued satisfactory performance based upon an assessment by the Group Chairman and the Nomination Committee. Non-executive Directors are appointed for an initial three-year term and, subject to re-election by shareholders at AGMs, are typically expected to serve two three-year terms. The Board may invite a Director to serve additional periods. Any term beyond six years is subject to particularly rigorous review. The terms and conditions of appointment of non-executive Directors are set out in a letter of appointment, which includes the expectations of them and the time estimated for them to meet their commitment to the Group. The current anticipated minimum time commitment, which is subject to periodic review and adjustment by the Board, is 30 days per year. Non-executive Directors are also advised that the time they need to devote to the Group may be considerably more if they serve on Board Committees or as other matters require. All non-executive Directors have confirmed they can meet this requirement, taking into account any other commitments they have at the time of appointment, and most devote considerably more time. During their term of appointment, non-executive Directors are expected to consult the Group Chairman or the Group Company Secretary if they are considering whether to accept or vary any commitments outside the Group. The agreement of the Group Chairman is required if any additional or changed commitment might affect the time that a Director is able to devote to his or her role with the Group. Letters setting out the terms of appointment of each non- executive Director are available for inspection at the registered office of HSBC Holdings. The Board diversity policy is available at www.hsbc.com/investor-relations/governance/corporate- governance-codes. Induction Formal induction programmes are arranged for newly appointed Directors, based on the individual’s needs, skills and experience. Typically, these consist of a series of meetings with other Directors and senior executives, as well as local site visits, to provide familiarity with the business. Directors also receive comprehensive guidance from the Group Company Secretary on the Group’s governance framework and associated policies, as well as their duties as Directors on the Board. During the year Henri de Castries, David Nish, Paul Walsh and Jackson Tai completed a formal induction programme. 138 HSBC Holdings plc Annual Report and Accounts 2016 Operation of the Board The Board regularly reviews reports on performance against financial and other strategic objectives, key business challenges, risk, business developments, and investor and external relations. During 2016, it also considered presentations on strategy and performance by each of the global businesses and across the principal geographical areas. All of HSBC’s activities involve the measurement, evaluation, acceptance and management of risk or combinations of risks. The Board, advised by the Group Risk Committee (‘GRC’), Conduct & Values Committee (‘CVC’) and the Financial System Vulnerabilities Committee (‘FSVC’), promotes a strong risk governance culture which shapes the Group’s attitude to risk. The Board and these committees oversee the development and maintenance of a strong risk management framework. The Group Company Secretary will ensure that agenda and supporting papers are distributed in advance of Board and Board committee meetings to allow reasonable time for review and to facilitate full discussion at the meetings. The Chairman met with the non-executive Directors without the other executive Directors in attendance. The SID also facilitated meetings of the non-executive Directors without the attendance of executive Directors, including that of the Group Chairman. The Directors are encouraged to have free and open contact with management at all levels and full access to all relevant information. When attending off-site Board meetings and when travelling for other reasons, non-executive Directors are encouraged to visit local business operations and meet local management. Directors may take independent professional advice, if necessary, at HSBC Holdings’ expense. Conflicts of interest, indemnification of Directors and contracts of significance The Board has established a policy and procedures relating to Directors’ conflicts of interest. Where conflicts of interest arise, the Board has the power to authorise them. A review of those conflicts which have been authorised, and the terms of those authorisations, is undertaken by the Board annually. The Articles of Association state that Directors are entitled to be indemnified out of the assets of HSBC Holdings against claims from third parties in respect of certain liabilities. All Directors have the benefit of directors’ and officers’ liability insurance. None of the Directors had, during the year, a material interest, directly or indirectly, in any contract of significance with any HSBC company. Each Director is routinely reminded of their obligations in respect of transacting in HSBC Group securities and has confirmed that he or she has complied with regulatory requirements. Board performance evaluation The Board is committed to regular, independent evaluation of its own effectiveness and that of its committees. For 2015/16, an independent review was undertaken by Heidrick & Struggles/ JCA Group, an independent third-party firm that has no other connection with HSBC Holdings. The process involved an extensive series of interviews and meetings with the non- executive Directors, together with input from members of the Group Management Board. Actions arising from the review were presented and discussed in detail with the Board in February 2016 and then tracked throughout the remainder of the year and reported to the Board. Given the ongoing nature of these actions, a follow-up review is to be conducted during the first half of 2017, the outcome of which will be published in the 2017 Annual Report. In the interim period, the performance evaluation of the individual Directors was conducted internally, as provided for under the UK Corporate Governance Code, by the Group Chairman and the SID. Set out below are areas of particular focus from the 2015/16 review that the Board has addressed during the year: Theme Agenda management Action taken Board agendas were revised to allow for a greater focus on business strategy and financial and operational performance. A rolling cycle of annual deep dives across each of the four global businesses and the Group’s principal geographical regions was established. A detailed presentation of the technology and digital opportunities facing the Group was also arranged with an explanation of how the Group is currently responding to them and the Group’s longer-term strategic response. Improvements were made to the process for the preparation, submission and distribution of management information and Board and Committee papers. Committee efficiency The operation of the Committees was reviewed to improve efficiency and address overlaps and any gaps in their responsibilities. Continued development of the cohesive relationship between non-executive Directors and senior management More opportunities were created for senior management to interact with non-executive Directors both inside and outside formal Board meetings, and to increase Board exposure to other high potential managers in the Group. Succession planning There has been a continued focus by the Board, through the Nomination Committee, on executive and non- executive succession planning. A committee has been established to oversee succession planning for the Group Chairman. Director performance evaluation Non-executive Directors’ individual performance evaluation is undertaken annually by the Group Chairman. This involves a discussion about a Director’s individual contribution, explores individual training and development needs, and the time commitment that is required to continue to deliver the role effectively. The Group Chairman has confirmed that all non- executive Directors continue to perform effectively, contribute positively to the governance of HSBC and are able to fully commit the time required for their roles. Executive Directors’ individual performance evaluation is undertaken as part of the performance management process for all employees. The results are considered by the Group Remuneration Committee when determining variable pay awards each year. The Group Chairman’s performance is evaluated by the non- executive Directors, led by the SID. Training and development Training and development is provided for each Director, and is regularly reviewed by the Group Chairman supported by the Group Company Secretary. All executive Directors develop and refresh their skills and knowledge through day-to-day interactions and briefings with senior management of the Group’s businesses and functions. A two-day forum for all of the Group’s non-executive Directors was held during the year. Awareness and discussion sessions were conducted by senior executives and subject matter experts on emerging technologies, financial crime compliance, regulatory initiatives and other business developments. The following Directors attended these sessions: David Nish, Joachim Faber, John Lipsky, Jonathan Symonds, Kathleen Casey and Paul Walsh. Jonathan Symonds and Joachim Faber hosted a separate forum for the Chairs of the Group’s audit and risk committees globally. In addition, all members of the Group Audit Committee (‘GAC’) received refresher training in IFRS 9 and the Committee Chairs received training in the requirements of the Senior Managers Regime. As part of their induction programme, David Nish, Henri de Castries and Paul Walsh received training on the Volcker Rule. Shareholder engagement Communication with shareholders is given high priority by the Board and a copy of its policy is available at www.hsbc.com. Extensive information about HSBC and its activities is provided to shareholders in the Annual Report and Accounts, the Strategic Report and the Interim Report as well as at www.hsbc.com. To compliment these, there is regular dialogue with institutional investors. Enquiries from individuals on matters relating to their shareholdings and HSBC’s business are welcomed. Directors are encouraged to develop an understanding of the views of major shareholders. Non-executive Directors are invited to attend analyst presentations and other meetings with institutional investors and their representative bodies. An annual governance breakfast is also held, which gives institutional investors an opportunity to engage with the non-executive Directors and senior management on governance matters. All executive Directors hold regular meetings with institutional investors and feedback from these meetings is routinely provided to the Board. As SID, Rachel Lomax is available to shareholders if they have concerns that cannot be resolved or for which the normal channels would be inappropriate. She may be contacted via the Group Company Secretary at 8 Canada Square, London E14 5HQ. The AGM and other general meetings The 2017 AGM will be held at the Queen Elizabeth II Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE on Friday 28 April at 11.00am and a live webcast will be available on www.hsbc.com. A recording of the proceedings will be available on www.hsbc.com shortly after the conclusion of the AGM until 28 May 2017. An informal meeting of shareholders will be held at 1 Queen’s Road Central, Hong Kong on Monday 24 April at 4.30pm. Shareholders are encouraged to attend these meetings. Shareholders may send enquiries to the Board in writing via the Group Company Secretary, HSBC Holdings plc, 8 Canada Square, London E14 5HQ or by sending an email to shareholderquestions@hsbc.com. Shareholders may require the Directors to call a general meeting other than an AGM as provided by the UK Companies Act 2006. Requests to call a general meeting may be made by members representing at least 5% of the paid-up capital of HSBC Holdings that carries the right of voting at its general meetings (excluding any paid-up capital held as treasury shares). A request must state the general nature of the business to be dealt with at the meeting and may include the text of a resolution that may properly be moved and is intended to be moved at the meeting. A request may be in hard copy form or in electronic form and must be authenticated by the person or persons making it. A request may be made in writing to HSBC Holdings at its UK address, referred to in the paragraph above or by sending an email to shareholderquestions@hsbc.com. At any general meeting convened on such request, no business shall be transacted except that stated by the requisition or proposed by the Board. HSBC Holdings plc Annual Report and Accounts 2016 139 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance Board Committees The Board has seven standing committees and a Chairman’s Committee. In the case of the FSVC and the Philanthropic & Community Investment Oversight Committee, membership includes co-opted non-Director members as well as non- executive Directors. The Chairs of each Committee report matters of significance to the Board after each meeting and the minutes of the meetings are made available to all Board members. The detailed roles and responsibilities of each Committee are set out in its terms of reference, which can be found on the website at www.hsbc.com/about-hsbc/corporate-governance/ board-committees. Principal subsidiaries The GRC works closely with the GAC to strengthen alignment with the major regional and global business risk and audit committees. The GAC and GRC make a number of recommendations to the Board in relation to the preparation of the financial statements which are supported by certificates from the principal subsidiaries. Whistleblowing The GAC and the CVC are responsible for reviewing the Group’s whistleblowing procedures and received regular updates on relevant concerns raised under these procedures, together with management actions taken in response. Committee interaction Committee effectiveness The Board places significant reliance on its Committees and delegates a broad range of responsibilities to them. It is therefore important that, while unnecessary duplications between each remit of the Committees should be avoided, effective links should exist between Committees and the Board where required. The effectiveness of the Committees is evaluated as part of the overall performance evaluation of the Board as referred to above. In addition, the Committees review the papers and the effectiveness of each meeting as a standing agenda item to ensure that they continue to be effective, challenging and well- managed, and review a rolling planner of proposed committee business. 2016 Board and Committee attendance AGM Board Group Audit Committee Group Risk Committee Group Remuneration Committee Nomination Committee Financial System Vulnerabilities Committee Conduct & Values Committee Philanthropic & Community Investment Oversight Committee Number of meetings Group Chairman Douglas Flint Executive Directors Stuart Gulliver Iain Mackay Marc Moses Non-executive Directors Phillip Ameen Kathleen Casey Laura Cha Henri de Castries1 Lord Evans of Weardale Joachim Faber Rona Fairhead2 Sam Laidlaw Irene Lee John Lipsky Rachel Lomax3 Heidi Miller David Nish4 Sir Simon Robertson2 Jonathan Symonds Jackson Tai5 Pauline van der Meer Mohr6 Paul Walsh7 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 — 1 1 8 8 8 8 8 8 8 8 5/5 8 8 4/4 8 8 8 8 8 4/4 4/4 8 2/2 7 7 8 — — — — 7 8 — — — — — — — — 2/2 — 3/4 — 8 — — — 9 — — — — — — — — — 9 — — — 9 8 9 — — — 2/2 — — 9 — — — — — — — — — — — 9 — 8 — — — 4/4 — — 9 8 7 — — — — — — 7 — — — 7 — — — — — 7 — — 7 — 3/4 1/2 7 — 7 7 — — — — — 3/3 3/3 — — — — — — — — 1/2 — — 6 — — — — — — 6 — 6 — — — — — 6 — — — 5 — 6 — 3 — — — — — — 3 — 3 — — — — — — — — — — — — — * Board meetings in 2016 were held in London and Hong Kong. In addition to the Board meetings listed there were also 11 Chairman’s Committee meetings held in 2016. 1 Appointed to the Board 1 March 2016. Resigned from the Board 22 April 2016. 2 Resigned from the Group Audit Committee 20 April 2016. 3 4 Appointed to the Board 1 May 2016. Attended AGM as part of his induction. 5 Appointed to the Board 12 September 2016. 6 Appointed to the Group Nomination Committee 22 April 2016. 7 Appointed to the Board 1 January 2016 and to the Group Nomination Committee 1 May 2016. 140 HSBC Holdings plc Annual Report and Accounts 2016 Group Audit Committee Members Jonathan Symonds (Chairman) Phillip Ameen Kathleen Casey David Nish (appointed on 1 May 2016) Rachel Lomax (resigned on 20 April 2016) Role and responsibilities The GAC has non-executive responsibility for matters relating to financial reporting, including Pillar 3 disclosures and internal control over financial reporting. Governance The Group Finance Director, Group Chief Accounting Officer, Group Head of Internal Audit and other members of senior management routinely attend meetings of the GAC. The external auditor, PwC, also attended all meetings. The Chairman of the GAC had regular meetings to discuss agenda planning and specific issues as they arose during the year. How the Committee discharges its responsibilities Financial reporting The GAC reviews HSBC’s financial and reporting judgements and their application to the Group’s financial reporting, including Pillar 3 disclosures. It also reviews presentations to external analysts including the key financial metrics relating to HSBC’s strategic actions. The GAC assesses the adequacy of resources of the accounting and financial reporting function. It also monitors the legal and regulatory environment. Internal controls The GAC assesses the effectiveness of the internal control system for financial reporting and any developments affecting it in support of the Board’s assessment of internal control over financial reporting in accordance with section 404 of the Sarbanes-Oxley Act. The GAC has received confirmation that executive management has taken or is taking the necessary actions to remedy any failings or weaknesses identified through the operation of the Groups framework of controls. Further detail of how the Board reviews the effectiveness of key aspects of internal control can be found on page 145. External audit The GAC meets privately with the external auditor at every Committee meeting and the GAC Chairman maintains regular contact with the audit partner throughout the year. The GAC reviews the external auditor’s approach and strategy for the annual audit. All non-audit services provided by PwC are pre-approved by the GAC in accordance with the auditor independence policy to ensure that services do not create a conflict. The auditor independence policy has been revised with effect from 1 January 2017 to take account of the UK implementation of new EU audit rules. Details of the significant engagements for non-audit services are contained in Note 6. A policy is in place and monitored by the GAC on hiring employees or former employees of the external auditor. Internal Audit The GAC approves Internal Audit’s annual plan, resource and budget, and reviews the performance of the Group Head of Internal Audit and the performance and effectiveness of its head. The Group Head of Internal Audit reports to the Chairman of the GAC and the Committee regularly meets with the Group Head of Internal Audit without other management present. Compliance with Regulatory Requirements The Board is satisfied that each member of the GAC is independent according to SEC criteria, may be regarded as audit committee financial experts for the purposes of section 407 of the Sarbanes-Oxley Act and has recent and relevant financial experience for the purposes of the UK and Hong Kong Corporate Governance Codes. The Committee has complied with the relevant parts of the Competition and Markets Authority Final Order on the statutory audit market for the year ended 31 December 2016. Principal activities and significant issues considered during 2016 External auditor The Committee assessed the effectiveness of PwC as the Group’s external auditor, using a questionnaire which focused on the overall audit process, its effectiveness and the quality of output. It concluded that PwC had performed a high-quality and effective audit in 2016. Fees payable to PwC for the year ended 31 December 2016 totalled $111.1m, of which $39.8m or 35.8% was payable in respect of non-audit services. A further breakdown of the fees paid to the auditors for each of the last three financial years can be found in Note 6 on the Financial Statements. The GAC considered PwC to be independent and PwC, in accordance with professional ethical standards, provided the GAC with written confirmation of its independence for the duration of 2016. The GAC has therefore recommended to the Board that PwC be reappointed as auditor. Resolutions concerning the reappointment of PwC and their audit fee for 2017 will be proposed to shareholders at the 2017 AGM. Internal Audit The GAC concluded that the Internal Audit function remained effective. Finance transformation project The Finance function has embarked on a large scale three-year transformation project to respond to the future needs of a changing industry facing increased regulatory demands. The project also included embedding internal controls and improving the consistency of critical financial processes across the Group. Internal control framework The GAC continued to monitor the progress being made to upgrade entity level controls and remediate issues identified in 2015. In particular, the GAC continued to monitor the remediation of controls over access management in IT and the next phase in terms of the enhancement of strategic controls. The GAC was encouraged by the progress being made. Changing regulatory landscape Given the changing legal and regulatory landscape, the GAC continued to receive detailed presentations and updates from management on the Group’s readiness to implement IFRS 9 Financial Instruments and the revised Basel framework’s Pillar 3 disclosure requirements. HSBC Holdings plc Annual Report and Accounts 2016 141 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance Significant accounting judgements considered during 2016 included: Key area Action taken Appropriateness of provisioning for legal proceedings and regulatory matters The GAC received reports from management on the recognition and amounts of provisions, the existence of contingent liabilities, and the disclosures relating to provisions and contingent liabilities for legal proceedings and regulatory matters. Specific areas addressed included provisioning arising from investigations by US regulators and law enforcement agencies relating to trading activities in the foreign exchange market and competition law investigations relating to foreign exchange activities in a number of jurisdictions; and management’s judgement regarding provisions and contingent liabilities in connection with investigations of HSBC’s Swiss Private Bank by a number of tax administration, regulatory and law enforcement authorities. The GAC also considered management’s assumptions and judgements relating to the disclosure of a contingent liability in respect of investigations into historical sales of US mortgage securitisations by The United States Attorney for the District of Colorado for potential violations of The Financial Industry Reform, Recovery and Enforcement Act of 1989, 12 U.S.C. § 1833a. Quarterly and annual reporting The GAC considered key judgements in relation to quarterly and annual reporting. In addition, it considered external analysts’ presentations and key financial metrics included in HSBC’s strategic actions. Loan impairment, allowances and charges Valuation of financial instruments Viability statement UK customer remediation The GAC considered loan impairment allowances for personal and wholesale lending. Significant judgements and estimates for personal lending included a review of loss emergence periods across the retail loan portfolios and the potential impact of the UK electorate's vote to leave the EU. For wholesale lending, the GAC considered management’s judgements and assumptions in respect of the recognition of judgemental collective impairment allowances for oil and gas exposures, and judgements relating to impairment allowances recognised for individual identified cases, as at 31 December 2016, and noted the ongoing monitoring for signs of credit deterioration that could result from the UK electorate's vote to leave the EU. The GAC considered the key valuation metrics and judgements involved in the determination of the fair value of financial instruments. The GAC considered the valuation control framework, valuation metrics, significant year-end judgements and emerging valuation topics. Under the obligations of the UK Corporate Governance Code the Directors have carried out a robust assessment of the principal risks for the Group and parent company. The GAC has considered the Directors' judgement in concluding that the Group and parent company will be able to continue in operation and meet liabilities as they fall due, and that it is appropriate that the viability statement covers a period of three years. The GAC considered the provisions for redress for mis-selling of payment protection insurance (‘PPI’) policies, in the UK, including management’s judgements regarding the effect of the proposed time-bar for claims ending June 2019. The GAC also considered provisions in relation to the implications of a 2014 UK court case (‘Plevin’) for the non-disclosure of levels of commission regarding the historical sales of PPI products, pending finalised guidance from the Financial Conduct Authority (‘FCA’). Bank of Communications Co., Limited (‘BoCom’) impairment testing During the year, the GAC considered the regular impairment reviews of HSBC’s investment in BoCom. When testing investments in associates for impairment, IFRS requires the carrying amount to be compared with the higher of fair value and value in use. The GAC reviewed a number of aspects of management’s work in this area, including the sensitivity of the result of the impairment review to estimates and assumptions of projected future cash flows and the discount rate. It was concluded that the investment was not impaired. Goodwill impairment testing The GAC noted the process and results of the 1 July 2016 annual goodwill impairment test and the review of impairment indicators at 30 June 2016 and 31 December 2016. During the year, impairment indicators were noted for GPB Europe and GBM Europe. No impairment was recognised for GBM Europe. The GAC considered management’s judgements in respect of the impairment charge of $0.8bn relating to GPB Europe goodwill in H1 2016, and the further impairment charge of $2.4bn in Q4 2016, resulting in the impairment of the entire balance of goodwill for GPB Europe in 2016. There were two main factors which led to indicators of impairment being identified: • during the year, revised forecast cash flows became available; and • management adjusted the discount rates used in the goodwill tests due to the results of the UK EU Referendum decision. Hedge accounting The GAC considered management’s judgements relating to the partial discontinuation of a hedging relationship in France in December 2016. The GAC discussed the control weaknesses, which were limited to France, and noted management’s actions to address them. Recognition of deferred tax assets In considering the recoverability of the Group’s deferred tax assets, the GAC reviewed the recognition of deferred tax assets in the US and, in the first half of 2016, in the Brazil operations which were sold in July 2016, and the associated projections of future taxable income. Operating segments The GAC considered the change in reportable segments during the year under IFRS 8, from regions to global businesses, and the introduction of a Corporate Centre segment. Group Risk Committee Members Joachim Faber (Chairman) John Lipsky Rachel Lomax Heidi Miller Jackson Tai (appointed on 12 September 2016) Role and responsibilities The GRC has non-executive responsibility for the oversight of risk-related matters and the principal risks impacting the Group, risk governance and internal control systems (other than internal financial control systems). The GRC is updated on, but is not directly responsible for, overseeing risks relating to 142 HSBC Holdings plc Annual Report and Accounts 2016 financial crime, cyber-crime and information security, anti- bribery and corruption, and culture and conduct. These risks are overseen by the FSVC and the CVC. Governance The Group Chief Risk Officer, Group Finance Director, Chief Legal Officer, Group Head of Internal Audit, Global Head of Regulatory Compliance, Global Head of Financial Crime Compliance, Group Head of Financial Crime Risk and other members of senior management attended meetings of the GRC by invitation to contribute to discussions relating to their areas of expertise. The GRC works closely with the GAC to ensure that any areas of significant overlap are appropriately addressed and to improve inter-committee communication. The GRC holds meetings with the Group Chief Risk Officer and, separately, with the Group Head of Internal Audit without management present. Further detail of how the Board reviews the effectiveness of key aspects of internal control can be found on page 145. How the Committee discharges its responsibilities Financial System Vulnerabilities Committee As a standing item on the rolling planner the GRC reviews the Group Risk Appetite Statement (‘RAS’), the risk map (which describes the Group’s risk profile by risk type across the global businesses) and a report on the top and emerging risks (together with mitigating actions for the identified risks). This also identifies any areas where management needed to assess vulnerabilities via stress testing. Page 64 provides further information on the top and emerging risks, the risk map and the risk appetite for the Group. The GRC receives presentations on a range of topics, including stress testing and briefings on developments in the regulatory environment. In addition, the GRC requests reports and updates from management on risk-related issues for in-depth consideration and receives regular reports on matters discussed at the Risk Management Meeting of the Group Management Board (‘GMB’). It has continued to invite senior management from the global businesses and functions to present their risk control frameworks, which has led to enhanced discussions of the risk environment. Any revisions to the RAS are reviewed bi-annually by GRC and any changes are recommended to the Board. The GRC regularly reviews the Group’s risk profile against the key performance metrics set out in the RAS. It reviews management’s assessment of risk and provides scrutiny of management’s proposed mitigating actions. Regular reports are received on legal and regulatory risks. Management actions to mitigate these risks are reviewed and the potential impact of future developments in this area on the Group are considered. Principal activities and significant issues considered during 2016 The Group Risk Appetite Statement (‘RAS’) and monitoring of the Group risk profile against the RAS There were no significant changes to the RAS in 2016. Stress testing The PRA and EBA stress testing exercises and the results of stress testing were closely monitored and reviewed prior to submission. Reports were received over the course of the stress testing exercise and the Committee met an additional four times during the year solely to consider stress testing related matters, including additional stress tests specific to oil and gas exposures and the UK electorate's vote to leave the EU. Execution risk Regular reports were received from the Group Chief Operating Officer, who updated each meeting on the progress and status of the Group’s highest-priority programmes and mitigating measures being introduced to manage the identified risks appropriately. Monitoring of this risk and challenging management’s assessment of execution risk and corresponding mitigating actions remains a priority for the GRC. Internal control and risk management The GRC reviewed the Group’s risk management framework and system of internal control (other than internal financial control systems, which were covered by the GAC) and the developments affecting them over the course of 2016, as part of the Board’s assessment of internal control. In 2016 the Group Risk Committee appointed an external independent expert to assess the effectiveness of the committee. Members Lord Evans of Weardale (Chairman) Kathleen Casey Jackson Tai (appointed on 12 September 2016) Rona Fairhead (resigned on 22 April 2016) Nick Fishwick, CMG (non-Director member) Dave Hartnett, CB (non-Director member) William Hughes, CBE QPM (non-Director member) Nehchal Sandhu (non-Director member) Leonard Schrank (non-Director member) The Honourable Juan Zarate (non-Director member) Sir William Patey (non-Director member appointed 1 November 2016) David Irvine (non-Director member appointed 1 November 2016) The eight non-Director members support the Committee’s work and between them have extensive experience in geopolitical risk, financial crime risk, international security, cybersecurity and law enforcement matters. Role and responsibilities The Committee has non-executive responsibility for the oversight of matters related to financial crime and system abuse, in particular anti-money laundering; sanctions; terrorist financing and proliferation financing; anti-bribery and corruption; and cybersecurity. It is also responsible for monitoring, reviewing and advising the Board on the effectiveness of the policies and procedures established by Management to ensure that HSBC meets its obligations to regulatory and law enforcement agencies. Principal activities and significant issues considered during 2016 Financial crime During the year, the Committee monitored the Group’s progress on the implementation of Global Standards and reviewed and discussed findings from country visits conducted by the Monitor. Anti-bribery and corruption The Committee reviewed the activities underway to address key bribery and corruption risks and management’s progress with the implementation of a more robust anti-bribery and corruption compliance framework. Engaging with the Monitor The Committee was responsible for liaising with the Monitor to ensure his recommendations were acted on. The information security environment and cybersecurity risk During the year, the Committee reviewed HSBC’s progress towards improving the Group’s cybersecurity and the actions being taken to mitigate exposure to cyber risk. It also monitored significant developments in the information security environment and progress delivering strategic financial crime risk management IT solutions. Further information on key activities of the Committee can be found in the ’Financial crime risk management’ section on page 81. HSBC Holdings plc Annual Report and Accounts 2016 143 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance Conduct & Values Committee Nomination Committee Members Rachel Lomax (Chair) Laura Cha Lord Evans of Weardale Jonathan Symonds Pauline van der Meer Mohr Role and responsibilities The CVC has non-executive responsibility for oversight of culture and conduct risk. It is responsible for HSBC’s policies, procedures and standards and ensuring that the Group conducts business responsibly and consistently adheres to HSBC Values. The CVC is also responsible for Group policies and procedures for capturing and responding to whistleblowing reports. Reporting to the GAC where necessary in relation to allegations relating to accounting, internal controls over financial reporting or audit matters. Principal activities and significant issues considered during 2016 Conduct During the year the Committee reviewed the implementation of the Group’s conduct approach and, in particular, how effectively global programmes were being cascaded through the organisation. Sustainability The Committee was responsible for reviewing how effectively the Group sought to satisfy itself that it was meeting its sustainability commitments. Modern Slavery Act The Committee and Board reviewed and approved the Group’s Human Rights and Modern Slavery Act statement. Further information on conduct can be found in the ‘How we do business’ section of the Strategic Report and in the Financial Review. Group Remuneration Committee Members Sam Laidlaw (Chairman) John Lipsky Pauline van der Meer Mohr Paul Walsh Sir Simon Robertson (resigned on 22 April 2016) Role and responsibilities The Committee is responsible for setting the over-arching principles, parameters and governance framework of the Group’s remuneration policy, and the remuneration of executive Directors and other senior Group employees. The Committee regularly reviews the Group’s remuneration policy in the context of consistent and effective risk management and the regulatory requirements of multiple jurisdictions. No Directors are involved in deciding their own remuneration. A full report on the role and activities of the Committee is set out on pages 153 to 172. 144 HSBC Holdings plc Annual Report and Accounts 2016 Members Sam Laidlaw (Chairman) Laura Cha John Lipsky Rachel Lomax Pauline van der Meer Mohr (appointed on 22 April 2016) Paul Walsh (appointed on 1 May 2016) Rona Fairhead (resigned on 22 April 2016) Role and responsibilities The Nomination Committee has non-executive responsibility for leading the Board appointment process and for identifying and nominating potential candidates for appointment to the Board. The Committee is responsible for succession planning for both executive and non-executive Directors and membership of Board committees. The Nomination Committee regularly reviews the Board’s structure, size and composition (including skills, knowledge, experience, independence and diversity). It recommends any changes to the Board. An external search consultancy is used in relation to the appointment of non-executive Directors. It has no additional connection with HSBC. A separate external search consultancy is primarily used for certain senior executive hires. Principal activities and significant issues considered during 2016 Succession planning A committee was established with specific responsibility for succession planning for the Group Chairman, comprising all the Nomination Committee members plus Jonathan Symonds, Jonathan Evans and Joachim Faber, being the chairs of the GAC, FSVC and GRC respectively. Diversity The Committee took responsibility for the implementation of the Board’s diversity policy against two objectives: at least 30% of candidates being women and only using external search consultants signed up to the Voluntary Code of Conduct for Executive Search Firms. Philanthropic & Community Investment Oversight Committee Members Laura Cha (Chair) Lord Evans of Weardale Sir Malcolm Grant (non-Director member) Stephen Moss (non-Director member) Lord Janvrin (non-Director member) Role and responsibilities The Philanthropic & Community Investment Oversight Committee has non-executive responsibility for HSBC’s philanthropic and community investment activities in support of the Group’s corporate sustainability objectives. The Committee was established as a committee of the Board in 2014 to oversee activity which includes both the Group’s monetary contributions and also employee volunteering. Principal activities and significant issues considered during 2016 Charitable giving The Committee was responsible for reviewing the Group’s risk appetite for charitable donations and the budget for future years and long-term committed funds. Community investment During the year, the Committee reviewed and endorsed the Group’s annual community investment budget and the proposed allocation of this budget across agreed sustainability themes. Chairman’s Committee The Chairman’s Committee acts on behalf of the Board between scheduled Board meetings to facilitate ad hoc and other business requiring Board approval. It meets when necessary, with the required number of attendees determined by the nature of the proposed business to be discussed, as set out in its terms of reference. Group Management Board The GMB is a forum chaired by the Group Chief Executive to provide him with recommendations and advice, and assist him in his day-to-day management of HSBC and its subsidiaries as delegated by the Board. There are special meetings of the GMB that provide oversight of risk matters (the Risk Management Meeting, chaired by the Group Chief Risk Officer) and of Global Standards (the Global Standards Steering Meeting, chaired by the Group Head of Financial Crime Risk). Internal control The Board is responsible for maintaining and reviewing the effectiveness of risk management and internal control systems, and for determining the aggregate level and types of risks the Group is willing to take in achieving its strategic objectives. To meet this requirement and to discharge its obligations under the FCA Handbook and the PRA Handbook, procedures have been designed for safeguarding assets against unauthorised use or disposal; for maintaining proper accounting records; and for ensuring the reliability and usefulness of financial information used within the business or for publication. These procedures can only provide reasonable assurance against material mis-statement, errors, losses or fraud. They are designed to provide effective internal control within the Group and accord with the Financial Reporting Council's guidance for directors issued in 2014, internal control and related financial and business reporting. The procedures have been in place throughout the year and up to 21 February 2017, the date of approval of this Annual Report and Accounts 2016. In 2014, the GAC endorsed the adoption of the COSO 2013 framework for the monitoring of risk management and internal control systems to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. The key risk management and internal control procedures include the following: • The Group’s Global Standards Manual (‘GSM’) outlines the core principles within which the Group must operate wherever we conduct business. The GSM overlays all other policies and procedures throughout the Group. The requirements of the GSM are mandatory, apply to and must be observed by all businesses within the Group, regardless of the nature or location of their activities. • Delegation of authority within limits set by the Board: subject to certain matters reserved for the Board, the Group Chief Executive has been delegated authority limits and powers within which to manage the day-to-day affairs of the Group, including the right to sub-delegate those limits and powers. Each relevant group managing director or executive Director has delegated authority within which to manage the day-to-day affairs of the business or function for which he or she is accountable. Delegation of authority from the Board requires those individuals to maintain a clear and appropriate apportionment of significant responsibilities and to oversee the establishment and maintenance of systems of control that are appropriate to their business or function. Authorities to enter into credit and market risk exposures are delegated with limits to line management of Group companies. The concurrence of the appropriate global function is required, however, to credit proposals with specified higher risk characteristics. Credit and market risks are measured and reported at subsidiary company level and aggregated for risk concentration analysis on a Group-wide basis. • Risk identification and monitoring: Systems and procedures are in place to identify, assess, control and monitor the material risk types facing HSBC. Our risk measurement and reporting systems are designed to help ensure that risks are comprehensively captured with all the attributes necessary to support well-founded decisions, that those attributes are accurately assessed and that information is delivered in a timely manner for those risks to be successfully managed and mitigated. • Changes in market conditions/practices: processes are in place to identify new risks arising from changes in market conditions/practices or customer behaviours, which could expose HSBC to heightened risk of loss or reputational damage. The Group employs a top and emerging risks framework at all levels of the organisation, which enables it to identify current and forward-looking risks and to take action which either prevents them materialising or limits their impact. • Responsibility for risk management: All employees are responsible for identifying and managing risk within the scope of their role as part of the three lines of defence model, which is an activity-based model to delineate management accountabilities and responsibilities for risk management and the control environment. The second line of defence sets the policy and guidelines for managing specific risk areas, provides advice and guidance in relation to the risk, and challenges the first line of defence (the risk owners) on effective risk management. • Strategic plans: strategic plans are prepared for global businesses, global functions and geographical regions within the framework of the Group’s overall strategy. Annual Operating Plans, informed by detailed analysis of risk appetite describing the types and quantum of risk that the Group is prepared to take in executing its strategy, are prepared and adopted by all major HSBC operating companies and set out the key business initiatives and the likely financial effects of those initiatives. • IT operations: centralised control is exercised over all IT developments and operations. Common systems are employed for similar business processes wherever practicable. • Subsidiary certifications to GRC: half-yearly confirmations are provided to the GRC from the risk committees of principal subsidiary companies confirming that the committees have challenged management on the quality of the information provided, reviewed the actions proposed by management to address any emerging issues or trends indicating material divergence from the Group’s risk appetite and that the risk management and internal control systems in place are operating effectively. The key risk management and internal control procedures over financial reporting include the following: • Disclosure Committee: the Disclosure Committee, which is chaired by the Group Company Secretary, supports the discharge of the Group’s obligations under relevant legislation and regulation including the UK and Hong Kong Listing Rules, the Market Abuse Regulation and SEC rules. HSBC Holdings plc Annual Report and Accounts 2016 145 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance In so doing the Committee is empowered to (i) determine whether a new event or circumstances should be disclosed, including the form and timing of such disclosure and (ii) review all material disclosures made or to be made by the Group. The membership of the Disclosure Committee includes the Group Finance Director, Group Chief Risk Officer, Chief Legal Officer, Group Chief Accounting Officer, Global Head of Public Affairs, Global Head of Investor Relations, Group Head of Strategy and Planning and Group Financial Controller. The integrity of disclosures is underpinned by structures and processes within the Global Finance and Global Risk functions that support rigorous analytical review of financial reporting and the maintenance of proper accounting records. • Financial reporting: the Group’s financial reporting process is controlled using documented accounting policies and reporting formats, supported by detailed instructions and guidance on reporting requirements, issued to all reporting entities within HSBC in advance of each reporting period end. The submission of financial information from each reporting entity is subject to certification by the responsible financial officer, and analytical review procedures at reporting entity and Group levels. • Subsidiary certifications to the GAC: half-yearly confirmations are provided to the GAC from the audit committees of principal subsidiary companies regarding whether their financial statements have been prepared in accordance with Group policies, present fairly the state of affairs of the relevant principal subsidiary and are prepared on a going concern basis. The internal control responsibilities of the GRC and GAC were complemented by the activities of the CVC and the FSVC which, respectively, oversaw internal control over conduct-related matters and financial crime compliance. Collectively, these controls are designed to provide effective internal control within the Group. The GRC and the GAC have received confirmation that executive management has taken or is taking the necessary actions to remedy any failings or weaknesses identified through the operation of the Group's framework of controls. In 2015, deficiencies in the design and operational effectiveness of a number of controls associated with IT privileged access were identified. Significant improvement in the control environment has been observed as a result of management’s progress on the execution of the IT privileged access remediation programme. Management has assessed the effectiveness of relevant IT, business, monitoring and period-end mitigating controls for 2016. The Directors, through the GRC and the GAC, have conducted an annual review of the effectiveness of the Group's system of risk management and internal control covering all material controls, including financial, operational and compliance controls, risk management systems, the adequacy of resources, qualifications and experience of staff of the accounting and financial reporting function and the Global Risk function, and their training programmes and budget. The annual review of the effectiveness of the Group’s system of risk management and internal control over financial reporting was conducted with reference to the COSO framework. The annual review of other controls was undertaken using the Group’s risk management framework, further details of which can be found on pages 68 to 71. Based on the assessment performed, the Directors concluded that for the year ended 31 December 2016, the Group’s internal controls were effective. Internal audit The Global Internal Audit function, which is centrally controlled, provides independent and objective assurance of the design and operating effectiveness of the Group’s framework of risk management, control and governance processes, focusing on 146 HSBC Holdings plc Annual Report and Accounts 2016 the areas of greatest risk. As mentioned previously, the Group Head of Internal Audit reports to the Chairman of the GAC and frequent meetings are held between them during the year. Administratively the Group Head of Internal Audit reports to the Group Chief Executive. Executive management is responsible for ensuring that issues raised by the Global Internal Audit function are addressed within an appropriate and agreed timetable. Confirmation to this effect must be provided to Global Internal Audit. Going concern and viability The Directors considered it appropriate to prepare the financial statements on the going concern basis. Under the UK Corporate Governance Code, the Directors must also provide a viability statement. They must state whether the Group will be able to continue in operation and meet its liabilities, taking into account its current position and the principal risks it faces. They must also specify the period covered by, and the appropriateness of, this statement. The Directors have specified a period of three years to 31 December 2019. They are satisfied that a forward-looking assessment of the Group for this period is sufficient to enable a reasonable statement of viability. In addition, this period is covered by the Group’s stress testing programmes, and its internal projections for profitability, key capital ratios and leverage ratios. Notwithstanding this, our stress testing programmes also cover scenarios out to five years and our assessment of risks are beyond three years where appropriate. Based upon their assessment, the Directors have a reasonable expectation that the Group will be able to continue in operation and meet liabilities as they fall due over the next three years. In making their going concern and viability assessments, the Directors have considered a wide range of detailed information relating to present and potential conditions, including projections for profitability, cash flows, capital requirements and capital resources. The Directors have carried out a robust assessment of each risk facing the Group to determine the principal risks to the long-term viability of the Group, including those that would threaten its solvency and liquidity. They have determined that the principal risks are the Group’s top and emerging risks as set out on pages 64 to 67, which includes the status of the Deferred Prosecution Agreement as described on page 66. The Directors have assessed that all of the top and emerging risks identified are considered to be material and, therefore, appropriate to be classified as the principal risks to be considered in the assessment of viability. They also appraised the impact that these principal risks could have on the Group’s risk profile, taking account of mitigating actions planned or taken for each, and compared this with the Group’s risk appetite, as approved by the Board. At 31 December 2016, there were five heightened top and emerging risks: economic outlook and capital flows, geopolitical risk, cyber threat and unauthorised access to systems, IT systems infrastructure and resilience, and enhanced model risk management expectations. In carrying out their assessment of the principal risks, the Directors considered a wide range of information including: • Details of the Group’s business and operating models, and strategy. • Details of the Group’s approach to managing risk and allocating capital. • A summary of the Group’s financial performance, and its capital position and annual operating plan. • Enterprise-wide risk management reports, including the Group’s risk appetite profile (see page 68), top and emerging risks (see page 64) and risk map (see page 70). • Reports and updates regarding regulatory and internal stress testing exercises (see page 70). In 2016, the published Bank of England ('BoE') stress test results for HSBC showed that our capital ratios after taking account of CRD IV restrictions and strategic management actions exceeded the BoE’s requirements. The results for HSBC included an assumed dividend payment in the first year of the severe stress projection period. • Reports and updates from management on risk-related issues selected for in-depth consideration. • Reports and updates on the Group’s compliance-related initiatives connected to the resolution of the investigations by US and UK regulatory and law enforcement authorities in December 2012, and also regulatory developments more generally. • Legal reports. Share capital and other disclosures Share buy-back On 4 August 2016, HSBC Holdings commenced a share buy- back of its ordinary shares of $0.50 each for up to a maximum consideration of $2.5bn which concluded on, 19 December 2016. The purpose of the buy-back was to reduce HSBC’s number of outstanding ordinary shares, and was funded from a portion of the proceeds received from the sale of the Group’s operations in Brazil in July 2016. Further information on this disposal can be found on page 241. The nominal value of shares purchased during 2016 was $162,636,704 and the aggregate consideration paid by HSBC was £1,970,091,769. The table that follows outlines details of the shares purchased on a monthly basis during 2016. At 31 December 2016, the total number of shares purchased was 325,273,407, representing 1.61% of the shares in issue and 1.64% of the shares in issue (excluding treasury shares). Number of shares Highest price paid per share Lowest price paid per share Average price paid per share Aggregate price paid Maximum value of shares that may yet be purchased 37,287,407 79,160,560 72,211,730 82,231,879 54,381,831 £ 5.6950 5.9420 6.3210 6.4560 6.7530 £ 5.1140 5.5650 5.7850 5.8840 6.2010 £ £ 5.4551 203,408,308 5.7336 453,876,095 6.1503 444,125,860 6.2433 513,399,612 6.5331 355,281,894 $ 2,233,620,166 1,636,117,416 1,085,362,266 448,362,392 58 Month Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Dividends Dividends for 2016 First, second and third interim dividends for 2016, each of $0.10 per ordinary share, were paid on 6 July 2016, 28 September 2016 and 6 December 2016, respectively. Note 8 on the Financial Statements gives more information on the dividends declared in 2016. On 21 February 2017, the Directors declared a fourth interim dividend for 2016 of $0.21 per ordinary share in lieu of a final dividend, which will be payable on 6 April 2017 in cash in US dollars, or in sterling or Hong Kong dollars at exchange rates to be determined on 27 March 2017, with a scrip dividend alternative. As the fourth interim dividend for 2016 was declared after 31 December 2016 it has not been included in the balance sheet of HSBC as a liability. The reserves available for distribution at 31 December 2016 were $42bn. A quarterly dividend of $15.50 per 6.20% non-cumulative US dollar preference share, Series A (‘Series A dollar preference share’), (equivalent to a dividend of $0.3875 per Series A American Depositary Share (‘ADS’), each of which represents one-fortieth of a Series A dollar preference share), and £0.01 per Series A sterling preference share was paid on 15 March, 15 June, 15 September and 15 December 2016. Dividends for 2017 Quarterly dividends of $15.50 per Series A dollar preference share (equivalent to a dividend of $0.3875 per Series A American Depositary Share, each of which represents one- fortieth of a Series A dollar preference share) and £0.01 per Series A sterling preference share was declared on 8 February 2017 for payment on 15 March 2017. Share capital Issued share capital The nominal value of HSBC Holdings’ issued share capital paid up at 31 December 2016 was $10,095,807,607 divided into 20,191,586,214 ordinary shares of $0.50 each, 1,450,000 non- cumulative preference shares of $0.01 each and one non- cumulative preference share of £0.01, representing approximately 99.9999%, 0.0001%, and 0%, respectively, of the nominal value of HSBC Holdings’ total issued share capital paid up at 31 December 2016. Rights, obligations and restrictions attaching to shares The rights and obligations attaching to each class of ordinary and non-cumulative preference shares in our share capital are set out in full in our Articles of Association. The Articles of Association may be amended by special resolution of the shareholders and can be found on our website at www.hsbc.com/about-hsbc/corporate-governance/corporate- governance-codes. Ordinary shares HSBC Holdings has one class of ordinary share, which carries no right to fixed income. There are no voting restrictions on the issued ordinary shares, all of which are fully paid. On a show of hands, each member present has the right to one vote at general meetings. On a poll, each member present or voting by proxy is entitled to one vote for every $0.50 nominal value of share capital held. There are no specific restrictions on transfers of ordinary shares, which are governed by the general provisions of the Articles of Association and prevailing legislation. At the 2016 AGM, shareholders gave authority to the Directors to offer a scrip dividend alternative on any dividend (including interim dividends) declared up to the conclusion of the AGM in 2019. Information on the policy adopted by the Board for paying interim dividends on the ordinary shares may be found on page 274, under the heading ‘Shareholder Information’. Dividend waivers HSBC Holdings employee benefit trusts, holding shares in HSBC Holdings in connection with the operation of its share plans, have lodged standing instructions to waive dividends on shares held by them that have not been allocated to employees. The total amount of dividends waived during 2016 was $2.9m. HSBC Holdings plc Annual Report and Accounts 2016 147 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance Preference shares The preference shares, which have preferential rights to income and capital, do not, in general, confer a right to attend and vote at general meetings. There are three classes of preference shares in the share capital of HSBC Holdings: non-cumulative preference shares of $0.01 each (‘dollar preference shares’); non-cumulative preference shares of £0.01 each (‘sterling preference shares’); and non- cumulative preference shares of €0.01 (‘euro preference Share capital changes in 2016 shares’). The dollar preference shares in issue are Series A dollar preference shares and the sterling preference share in issue is a Series A sterling preference share. There are no euro preference shares in issue. Information on dividends declared for 2016 and 2017 may be found on page 215, under the heading ‘Dividends’ and in Note 8 on the Financial Statements. Further details of the rights and obligations attaching to the HSBC Holdings’ issued share capital may be found in Note 32 on the Financial Statements. The following events occurred during the year in relation to the ordinary share capital of HSBC Holdings: HSBC Holdings ordinary shares issued Aggregate nominal value Market value per share on number $ $ £ 20 Apr 2016 63,677,983 6 Jul 2016 111,088,990 28 Sep 2016 139,914,936 6 Dec 2016 122,620,319 31,838,992 55,544,495 69,957,468 61,310,160 6.4120 6.3288 7.1015 7.6227 4.5069 4.3274 5.4468 6.2420 Scrip dividends Issued in lieu of Fourth interim dividend for 2015 First interim dividend for 2016 Second interim dividend for 2016 Third interim dividend for 2016 All-employee share plans HSBC Holdings savings-related share option plans HSBC ordinary shares issued in £ HSBC ordinary shares issued in HK$ HSBC ordinary shares issued in $ HSBC ordinary shares issued in € Options over HSBC ordinary shares lapsed 15,437,427 7,718,714 Options over HSBC ordinary shares granted in response to approximately 15,500 applications from HSBC employees in the UK on 21 Sep 2016 15,043,601 HSBC International Employee Share Purchase Plan 102,252 51,126 HSBC share plans Vesting of awards under the HSBC Share Plan and HSBC Share Plan 2011 64,730,777 32,365,389 HSBC Holdings ordinary shares issued Aggregate nominal value $ Number Aggregate nominal value $ 4,230,999 2,115,500 £ 63,091 17,053 42,880 31,546 HK$ 8,527 21,440 $ € £ Exercise price from £ 4.0472 55.4701 7.1456 5.3532 to £ 5.4738 63.9864 8.2094 6.0657 4.1750 6.6010 Market value per share from £ 4.3000 to £ 6.7380 Compliance with Hong Kong Listing Rule 13.25A(2) HSBC Holdings has been granted a waiver from strict compliance with Rule 13.25A(2) of the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong. Under this waiver, HSBC’s obligation to file a Next Day Return following the issue of new shares pursuant to the vesting of share awards granted under its share plans to persons who are not Directors, would only be triggered where it falls within one of the circumstances set out under Rule 13.25A(3). Authorities to allot and to purchase shares and rights At the AGM in 2016, shareholders renewed the general authority for the Directors to allot new shares up to 13,138,649,236 ordinary shares, 15,000,000 non-cumulative preference shares of £0.01 each, 15,000,000 non-cumulative preference shares of $0.01 each and 15,000,000 non-cumulative preference shares of €0.01 each. Within this, the Directors have authority to allot up to a maximum of 1,970,797,386 ordinary shares wholly for cash to persons other than existing shareholders. Shareholders also renewed the authority for the Directors to make market purchases of up to 1,970,797,386 ordinary shares. The Directors exercised this authority during the year and purchased 325,273,407 ordinary shares. In addition, shareholders gave authority for the Directors to grant rights to subscribe for, or to convert any security into, no more than 3,941,594,772 ordinary shares in relation to any issue by HSBC Holdings or any member of the Group of contingent convertible securities that automatically convert into or are exchanged for ordinary shares in HSBC Holdings in prescribed circumstances. Further details about the issue of contingent convertible securities may be found in Note 32 on the Financial Statements. Other than as disclosed in the tables above headed ‘Share capital changes in 2016’, the Directors did not allot any shares during 2016. Debt securities In 2016, following its capital plan, HSBC Holdings issued the equivalent of $36.0bn of debt securities in the public capital markets in a range of currencies and maturities, including $2.0bn of contingent convertible, $2.6bn of subordinated and $31.4bn of senior securities to ensure it meets the current and proposed regulatory rules, including those relating to the availability of adequate total loss-absorbing capacity. For additional information on capital instruments and bail-inable debt, refer to Notes 28 and 32 on pages 244 and 253 and to the Fixed Income Securities section in the HSBC Investor Relations website. 148 HSBC Holdings plc Annual Report and Accounts 2016 Treasury shares Sufficiency of float In compliance with the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited at least 25% of the total issued share capital has been held by the public at all times during 2016 and up to the date of this report. Dealings in HSBC Holdings listed securities HSBC Group has policies and procedures that, except where permitted by statute and regulation, prohibit specified transactions in respect of its securities listed on The Stock Exchange of Hong Kong Limited. Except for dealings as intermediaries or as trustees by subsidiaries of HSBC Holdings, neither HSBC Holdings nor any of its subsidiaries has purchased, sold or redeemed any of its securities listed on The Stock Exchange of Hong Kong Limited during the year ended 31 December 2016. Directors’ interests Pursuant to the requirements of the UK Listing Rules and according to the register of Directors’ interests maintained by HSBC Holdings pursuant to section 352 of the Securities and Futures Ordinance of Hong Kong, the Directors of HSBC Holdings at 31 December 2016 had interests, all beneficial unless otherwise stated, in the shares or debentures of HSBC Holdings and its associated corporations as shown below. Save as stated no further interests were held by Directors and no Directors or their connected persons were awarded or exercised any right to subscribe for any shares or debentures in any HSBC corporation during the year. No Directors held any short position as defined in the Securities and Futures Ordinance of Hong Kong in the shares or debentures of HSBC Holdings and its associated corporations. In accordance with the terms of a waiver granted by the Hong Kong Stock Exchange on 19 December 2005, HSBC Holdings will comply with the applicable law and regulation in the UK in relation to the holding of any shares in treasury and with the conditions of the waiver in connection with any shares it may hold in treasury. Pursuant to Chapter 6 of the UK Companies Act 2006, 325,273,407 ordinary shares are currently held in treasury. This was the maximum number of shares held at any time during 2016; representing 1.61% of the shares in issue. The nominal value of shares purchased during 2016 was $162,636,704. Notifiable interests in share capital At 31 December 2016, HSBC Holdings had received the following notification of major holdings of voting rights pursuant to the requirements of Rule 5 of the Disclosure and Transparency Rules: • BlackRock, Inc. gave notice on 25 October 2016 that on 24 October 2016 it had the following: an indirect interest in HSBC Holdings ordinary shares of 1,172,083,824; qualifying financial instruments with 1,794,677 voting rights that may be acquired if the instruments are exercised or converted; and financial instruments with similar economic effect to qualifying financial instruments which refer to 4,861,174 voting rights, each representing 5.89%, 0.00% and 0.02%, respectively, of the total voting rights at that date. At 31 December 2016, according to the register maintained by HSBC Holdings pursuant to section 336 of the Securities and Futures Ordinance of Hong Kong: • JPMorgan Chase & Co. gave notice on 27 October 2016 that on 24 October 2016 it had the following interests in HSBC Holdings ordinary shares: a long position of 924,250,502 shares; a short position of 162,867,748 shares; and a lending pool of 437,566,359 shares, each representing 4.60%, 0.81% and 2.18%, respectively, of the ordinary shares in issue at that date; and • BlackRock, Inc. gave notice on 25 October 2016 that on 21 October 2016 it had the following interests in HSBC Holdings ordinary shares: a long position of 1,305,933,089 shares and a short position of 14,892,793 shares, each representing 6.51% and 0.07%, respectively, of the ordinary shares in issue at that date. Since 31 December 2016 to date, no further such notifications had been received. HSBC Holdings plc Annual Report and Accounts 2016 149 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance Directors’ interests – shares and debentures HSBC Holdings ordinary shares Phillip Ameen Kathleen Casey Laura Cha Henri de Castries Lord Evans of Weardale Joachim Faber Douglas Flint Stuart Gulliver Sam Laidlaw Irene Lee John Lipsky Rachel Lomax Iain Mackay Heidi Miller Marc Moses David Nish Jonathan Symonds Jackson Tai Pauline van der Meer Mohr Paul Walsh Footnotes At 1 Jan 2016 Beneficial owner At 31 Dec 2016 Child under 18 or spouse Jointly with another person Trustee Total interests1 2 2 3 4 2 2 2 5,000 3,540 5,200 — 7,416 45,778 5,000 8,620 5,200 16,165 9,170 66,605 401,450 402,158 — — — — — — — 2,861,265 3,167,323 176,885 38,012 — 16,165 18,900 39,444 10,000 16,165 18,900 223,872 345,469 3,695 3,975 624,643 824,241 — — — — — — — — 21,771 — — — — 16,886 10,160 15,000 5,079 50,000 4,885 — — — — — — — — — — — — — — — — — — — — 21,445 — — — — — — — — — 5,000 8,620 5,200 16,165 9,170 66,605 402,158 — 3,344,208 1,416 — — — — — — — — — — — 40,860 10,000 16,165 18,900 345,469 3,975 824,241 50,000 21,771 31,605 15,000 5,079 1 2 3 4 Executive Directors’ other interests in HSBC Holdings ordinary shares arising from the HSBC Holdings savings-related share option plans and the HSBC Share Plan 2011 are set out in the Scheme interests in the Directors’ Remuneration Report on page 153. At 31 December 2016, the aggregate interests under the Securities and Futures Ordinance of Hong Kong in HSBC Holdings ordinary shares, including interests arising through employee share plans were: Douglas Flint – 405,077; Stuart Gulliver – 6,576,482; Iain Mackay – 1,842,063; and Marc Moses – 2,626,463. Each Director’s total interests represents less than 0.04% of the shares in issue and 0.04% of the shares in issue (excluding treasury shares). Phillip Ameen has an interest in 1,000, Kathleen Casey has an interest in 1,724, John Lipsky has an interest in 3,233, Heidi Miller has an interest in 795 and Jackson Tai has an interest in 6,321 listed ADS, which are categorised as equity derivatives under Part XV of the Securities and Futures Ordinance of Hong Kong. Each ADS represents five HSBC Holdings ordinary shares. Since the end of the year, the number of HSBC Holdings ordinary shares held by Douglas Flint has increased by 22, following an acquisition, through regular monthly contributions in the HSBC Holdings UK Share Incentive Plan. Sam Laidlaw has a non-beneficial interest in 1,416 shares that he holds as a trustee. There have been no changes in the shares or debentures of the Directors from 31 December 2016 to the date of this report excluding those disclosed in footnote 3 of the above table. Listing Rule 9.8.4 The information to be disclosed in the Annual Report and Accounts pursuant to UK Listing Rule 9.8.4 is contained within the Corporate Governance Report. Employees At 31 December 2016, HSBC had a total workforce of 241,000 full and part-time employees compared with 264,000 at the end of 2015 and 266,000 at the end of 2014. Our main centres of employment were the UK with approximately 45,000 employees, India 37,000, Hong Kong 29,000, mainland China 24,000, Mexico 16,000, the US 13,000 and France 9,000. We encourage employees to perform at their best, and create an environment to make that possible. We also encourage employees to speak up, and reflect our purpose and values in the decisions we make and how we make them, as these decisions shape the future of our customers and colleagues. Employee relations We consult with and, where appropriate, negotiate with employee representative bodies. It is our policy to maintain communications and consultation programmes with all employee representative bodies and there have been no material disruptions to our operations from labour disputes during the past five years. Diversity and inclusion HSBC is committed to building a culture where individuals are valued, respected and supported; where different ideas, backgrounds, styles and perspectives are actively sought out to create business value; and where advancement is based on objective criteria. Focus continues on the diversity profile of our workforce to help ensure it is reflective of the communities in which we operate and the customers we serve. Building a more inclusive workplace is part of everyone’s role at HSBC. Our Global Diversity Policy makes clear the responsibility of all employees and workers to treat colleagues with dignity and respect and to create an inclusive environment free from discrimination, bullying, harassment or victimisation, irrespective of their age, colour, disability, ethnic or national origin, gender, gender identity/expression, marital status, pregnancy, race, religion or belief, or sexual orientation. Our employees are expected to demonstrate openness to different ideas and cultures, and their performance in this respect is reviewed in our year-end review process. Diversity and inclusion carries the highest level of executive support at HSBC, and oversight of our diversity agenda and related activities resides with the Global Diversity and Inclusion sub-function. We also operate governance forums covering diversity and inclusion at global line, regional and country levels. Employee development The development of our employees is essential to the future strength of our business. We continue to develop and implement practices that build employee capability, and identify, develop and deploy talented employees to ensure an appropriate supply of high calibre individuals with the values, skills and experience for current and future senior management positions. 150 HSBC Holdings plc Annual Report and Accounts 2016 In 2016, we focused on developing technical skills, experiences and behaviours necessary to deliver against our Global Standards commitments, along with several Group-wide cultural programmes for employees and managers as part of our ‘At Our Best’ initiative. Employment of people with a disability We believe in providing equal opportunities for all employees. The employment of people with a disability is included in this commitment and the recruitment, training, career development and promotion of people with a disability is based on the aptitudes and abilities of the individual. Should employees become disabled during their employment with us, efforts are made to continue their employment and, if necessary, appropriate training and reasonable equipment and facilities are provided. Health and safety HSBC is committed to providing a safe physical environment for our customers and employees, as well as those who work with us. We aim always to meet the minimum health and safety standards required by law wherever we operate and, where reasonably practical, to exceed them. Everyone at HSBC has a responsibility for helping to create a safe working environment. Employees are expected to take ownership of their safety and are encouraged and empowered to report any concerns. Chief operating officers have overall responsibility for ensuring that the correct policies, procedures and safeguards are put into practice. This includes making sure that everyone in HSBC has access to appropriate information, instruction, training and supervision. In 2016, we completed three major global projects to help us understand the risks we face, educate and inform our staff, and improve the buildings in which we operate. We have: • Concluded a survey of earthquake resilience in more than 1,500 HSBC buildings located in countries at medium to high risk of earthquakes; • Conducted more than 250 asbestos surveys in countries without bans or controls on the use of the potentially harmful material; and • Completed more than 1,800 fire risk assessments of our buildings around the world. Employee health and safety Footnote 2016 2015 2014 Number of employee workplace fatalities 1 1 — 2 Accidents involving more than three days’ absence All accident rate per 100,000 employees 75 241 110 274 96 388 1 Non-HSBC staff working on HSBC-related activity. Remuneration policy The quality and commitment of our employees is fundamental to our success and accordingly the Board aims to attract, retain and motivate the very best people. As trust and relationships are vital in our business our goal is to recruit those who are committed to making a long-term career with the Group. HSBC’s reward strategy supports this objective through balancing both short-term and sustainable performance. Our remuneration strategy is designed to reward competitively the achievement of long-term sustainable performance and attract and motivate the very best people who are committed to maintaining a long-term career with the Group while performing their role in the long-term interests of our stakeholders. In order to ensure alignment between remuneration and our business strategy, individual remuneration is determined through assessment of performance delivered against both annual and long-term objectives summarised in performance scorecards, and adherence to the HSBC Values of being ’open, connected and dependable‘ and acting with ’courageous integrity’. Altogether, performance is judged, not only on what is achieved over the short and long term, but also on how it is achieved, as the latter contributes to the sustainability of the Group. The financial and non-financial measures incorporated in the annual and long-term scorecards are carefully considered to ensure alignment with the long-term strategy of the Group. Further information on the Group’s approach to remuneration is given on page 153. Employee share plans Share options and discretionary awards of shares granted under HSBC share plans align the interests of employees with the creation of shareholder value. The table below sets out the particulars of outstanding options, including those held by employees working under employment contracts that are regarded as ‘continuous contracts’ for the purposes of the Hong Kong Employment Ordinance. The options were granted at nil consideration. No options have been granted to substantial shareholders and suppliers of goods or services, nor in excess of the individual limit for each share plan. No options were cancelled by HSBC during the year. A summary for each plan of the total number of the options which were granted, exercised or lapsed during 2016 is shown in the table below. Further details required to be disclosed pursuant to Chapter 17 of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited are available on our website at http://www.hsbc.com/about-hsbc/ corporate-governance/employee-share-plans and on the website of The Stock Exchange of Hong Kong Limited at www.hkex.com.hk, or can be obtained upon request from the Group Company Secretary, 8 Canada Square, London E14 5HQ. Particulars of options held by Directors of HSBC Holdings are set out on page 165. Note 5 on the Financial Statements gives details of share-based payments, including discretionary awards of shares granted under HSBC share plans. All-employee share plans HSBC operates all-employee share option plans under which options are granted over HSBC ordinary shares. Subject to leaver provisions, options are normally exercisable after three to five years. During 2016, options were granted at the mid- market price for HSBC Holdings ordinary shares quoted on the London Stock Exchange which, as derived from the Daily Official List on 20 September 2016, the day prior to grant, was £5.83. The UK Sharesave will terminate on 23 May 2025 unless the Directors resolve to terminate the plans at an earlier date. There will be no further grants under the HSBC Holdings Savings- Related Share Option Plan: International. The HSBC International Employee Share Purchase Plan was introduced in 2013 and now includes employees based in 26 jurisdictions. HSBC Holdings plc Annual Report and Accounts 2016 151 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the Directors | Corporate Governance / Director's Remuneration Report HSBC Holdings All-employee Share Option Plans Exercise price Exercisable At Granted Exercised Lapsed At HSBC Holdings ordinary shares to (£) Dates of awards from to from Savings-Related Share Option Plan 21 Apr 2010 21 Sep 2016 (£) 4.0472 5.4738 Savings-Related Share Option Plan: International 21 Apr 2010 21 Apr 2010 21 Apr 2010 21 Apr 2010 24 Apr 2012 24 Apr 2012 24 Apr 2012 24 Apr 2012 (£) (£) 4.4621 5.4573 ($) ($) 7.1456 8.2094 (€) 5.3532 (HK$) (€) 6.0657 (HK$) 55.4701 63.9864 from to Footnotes 1 Jan 2016 during year during year during year 31 Dec 2016 1 2 1 Aug 2015 30 Apr 2022 1 Aug 2014 1 Aug 2014 1 Aug 2015 1 Aug 2015 31 Jan 2018 31 Jan 2018 31 Jan 2018 31 Jan 2018 71,709,819 15,043,601 3,834,045 14,141,959 68,777,416 1,130,991 665,445 153,610 1,114,830 — — — — 396,954 293,728 440,309 17,053 430,654 217,738 42,880 23,814 86,916 63,091 547,272 504,467 1 2 The weighted average closing price of the shares immediately before the dates on which options were exercised was £5.75. The weighted average closing price of the shares immediately before the dates on which options were exercised was £5.10. On behalf of the Board Douglas Flint Group Chairman HSBC Holdings plc Registered number 617987 21 February 2017 152 HSBC Holdings plc Annual Report and Accounts 2016 Directors’ Remuneration Report Annual Statement from the Group Remuneration Committee Chairman Directors’ remuneration policy Remuneration policy for all employees Annual report on remuneration Additional remuneration disclosures Page 153 155 156 159 170 All disclosures in the Directors’ Remuneration Report are unaudited unless otherwise stated. Disclosures marked as audited should be considered audited in the context of financial statements taken as a whole. Annual Statement from the Group Remuneration Committee Chairman Dear Shareholder, The Group Remuneration Committee (‘the Committee’) is guided by a series of principles. These are set out in the Strategic Report on page 28, but it is worth mentioning a few here to help explain our work. To attract and retain talent, remuneration at HSBC must be competitive. However, we place a strong emphasis on linking pay to performance. We particularly emphasise the need for performance that benefits the Group over the long-term, and reflects HSBC Values and the highest standards of conduct. In 2016, we introduced a new remuneration policy for our executive Directors. It reflected feedback from shareholders, especially in its introduction of a long-term incentive (‘LTI’) award with a three-year forward-looking performance period, a seven-year deferral period, and a reduction in the cash in lieu of pension allowance for the executive Directors. I believe the new policy achieves strong alignment between the interests of our executive Directors and shareholders, and the performance measures for the new LTI award will reward long-term sustainable performance. We were pleased that the new policy received strong support at our Annual General Meeting ('AGM') in April 2016, with over 96% of shareholders voting in favour. This year’s Remuneration Report shows how the Committee has applied the new policy, aligning executive pay with the Group’s performance, both for the year and against its long-term strategic objectives. Performance achieved during 2016 Reported profit before tax for the year fell 62% to $7.1bn. However, on an adjusted basis, excluding significant items and currency translation differences, profit before tax was $19.3bn, broadly in line with prior-year. The Group's cost performance improved as prior-year initiatives gained traction and substantially offset higher loan impairment charges and marginally lower revenues. The Group is now more than a year into implementing the strategic actions set out in its Investor Update in June 2015. These aim to improve returns, deliver cost savings, reduce RWAs, rebuild profitability in Mexico and the US, optimise and capture value from our international network, and complete the implementation of Global Standards programme to help combat financial crime. Measures were incorporated into the 2016 annual incentive scorecards of the executive Directors to align their pay with progress against achievement of these objectives. The Group made strong progress in a number of areas. It reduced RWAs by $143bn in 2016, taking it more than 97% of the way towards its target for the end of 2017. It achieved cost savings of $2.25bn, despite continued investment in compliance, regulatory programmes and growth. Furthermore, it is on its way to restoring profitability in Mexico. In the second half of 2016, it executed a share buy-back worth approximately $2.5bn as a way of distributing capital to shareholders. In 2016, in sterling terms, our share price increased by 23% and the total shareholder return was 32%. Group variable pay pool and risk adjustments The Group variable pay pool is used to fund performance-related pay across the Group. In determining the size of the pool for 2016, the Committee took into consideration the Group’s financial performance, fines, penalties and customer redress costs, as well as progress implementing and embedding Global Standards. The total value of the pool for 2016 was $3,035m, which was 12.3% lower than the $3,462m figure for 2015. In particular, the 2016 pool included the following reductions of: • $194m for the fines, penalties and cost of customer redress faced by the Group; and • $309m for: – financial performance in certain key areas, in particular, profit before tax, return on risk-weighted assets and adjusted jaws; – performance against certain metrics in our Group risk appetite profile; and – continued work required to address financial crime compliance issues and the embedding of Global Standards within our businesses. In addition to the pool adjustments, we reduced variable pay awards to certain individuals by $12.1m in aggregate to reflect their involvement in certain notable events and individual transgressions. Executive Directors’ remuneration for 2016 In line with the policy approved by shareholders, we have reduced the cash in lieu of pension from 50% of base salary to 30% for executive Directors. This has resulted in fixed pay, including allowances, reducing by 7% in 2016. No increases in fixed pay are proposed for 2017. The 2016 annual incentive scorecard outcome for financial measures was 35.3% for Stuart Gulliver, 30.0% for Iain Mackay and 15.0% for Marc Moses, reflecting their individual scorecards and the performance achieved in cost savings, reductions in RWAs and achievements against our strategic objectives. Since establishing the new Financial Crime Risk function in July 2016, there has been a significant focus on transition from a programme of change to business-as-usual financial crime management across all countries, regions and global businesses. But there is more to be done. The Committee exercised its discretion to reduce the Global Standards assessments for executive Directors down to 65%. This was based on feedback received from the Monitor, matters arising from risk and compliance incidents, and a number of unsatisfactory internal audits covering anti-money laundering (‘AML’) and sanctions-related issues. Details of the annual incentive scorecard outcome are provided on page 161. In line with the new policy, no Group Performance Share Plan (‘GPSP’) awards were made in respect of the year ended 31 December 2016. This has resulted in a significant decrease in the total single figure of remuneration for executive Directors when compared with the year ending 31 December 2015. The new LTI award for our executives, awarded while taking into account performance in the financial year ended 31 December 2016, is subject to a forward-looking three-year performance period (1 January 2017 to 31 December 2019) and a seven-year HSBC Holdings plc Annual Report and Accounts 2016 153 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report deferral period. This ensures a significant proportion of executive Directors’ pay continues to be deferred. This, together with the fact that the majority of compensation is awarded in shares, helps ensure it is aligned with the achievement of our long-term strategic objectives, and the long-term interests of shareholders and other stakeholders. Details of the performance measures for the LTI award to be granted in 2017 in respect of 2016, and the relevant targets for each measure, are provided on page 164. Implementation of policy for 2017 This year will be the final one for implementing the strategic actions set out in the Investor Update. The 2017 annual incentive scorecards for the executive Directors are designed to drive delivery against these objectives. Details of the performance measures for the 2017 annual incentive scorecards are on page 169. However, for reasons of commercial sensitivity, the specific targets for each measure will not be disclosed until the end of the 2017 performance period, when performance against the targets will also be disclosed. Fees for non-executive Directors were reviewed by the Committee in 2016. Recognising the growing regulatory responsibilities and time commitment required from our Directors, their fees have been increased with effect from 1 January 2017. A travel allowance has also been introduced for non-UK based non-executive Directors to reflect the additional time commitment required for travel. The details of the increases are provided on page 156. The Committee will continue to monitor the remuneration arrangements for executive Directors, and meet with our major shareholders on implementation of the policy in 2017. The Committee will also continue to monitor any reform proposed for corporate governance and executive pay, and will consider any changes that may be required to our approach on remuneration in this regard. Our annual report on remuneration The following sections of this Remuneration Report provide an overview of the policy for executive Directors, which was approved by shareholders at the 2016 AGM, and details of remuneration decisions made for executive Directors in 2016. The report also covers the application of the 2016 policy to other Group employees. As Chairman of the Committee, I hope you will support the report. Finally, I will be retiring as a non-executive Director of the Group and as chairman of this Committee at the conclusion of the 2017 AGM. I am delighted that Pauline van der Meer Mohr, who is already a member of the Committee, has agreed to succeed me as chairman at that time. Sam Laidlaw Chairman Group Remuneration Committee 21 February 2017 154 HSBC Holdings plc Annual Report and Accounts 2016 Implementation in 2017 No change from 2016. • Douglas Flint: £1,500,000 • Stuart Gulliver: £1,250,000 Iain Mackay: £700,000 • • Marc Moses: £700,000 No change from 2016. • Douglas Flint: Nil • Stuart Gulliver: £1,700,000 Iain Mackay: £950,000 • • Marc Moses: £950,000 Directors’ Remuneration policy The tables below summarise our remuneration policy for executive and non-executive Directors. The policy was approved at the AGM on 22 April 2016 and is intended to apply for three performance years until the AGM in 2019. The full remuneration policy can be found on pages 288 to 299 of our Annual Report and Accounts 2015 and in the Directors' Remuneration Policy Supplement 2016 of this Annual Report and Accounts 2016, which is available in the Investor Relations section of www.hsbc.com. Remuneration policy summary – executive Directors Elements Operation Base salary To attract and retain key talent by being market competitive and rewarding ongoing contribution to role. • Paid in cash on a monthly basis. • Base salary increases will not exceed 15% in total during the three-year term of the policy. Fixed pay allowance To deliver fixed pay required to reflect the role, skills and experience of the Directors and to maintain a competitive total remuneration package for retention of key talent. Pension To attract and retain key talent by being market competitive. • Non-pensionable and paid in shares. • Released annually on a pro rata basis over five years, starting from the March immediately following the end of the financial year in which the shares were granted. • Dividends paid on the vested shares held during the retention period. • Directors receive cash in lieu of a pension equal to 30% of No change from 2016. base salary. Benefits To provide benefits in accordance with local market practice. • Include, for example, the provision of medical insurance, income protection insurance, health assessment, life assurance, club membership, tax return assistance, car benefit and travel assistance, including any tax due on the benefit. No change from 2016. Annual incentive To drive and reward performance against annual financial, non-financial and personal objectives which are consistent with the strategy and align to shareholder interests. Long-term incentive (‘LTI’) To incentivise sustainable long-term alignment with shareholder interests. Shareholding guideline To ensure appropriate alignment with the interest of our shareholders. • Additional benefits may also be provided where an executive is relocated or spends a substantial proportion of their time in more than one jurisdiction for business purposes. • Maximum opportunity for annual incentive award is 215% of • See page 169 for details of performance base salary. measures. • Performance is measured against an annual scorecard and varies by individual. • Shares issued are subject to a retention period of up to one year after vesting. • On vesting, shares are subject to a minimum retention period of at least six months. • Maximum opportunity for LTI award is 320% of base salary. • Award is subject to a three-year forward-looking performance period. • Performance is measured against a long-term scorecard. 60% is based on financial outcomes and 40% is based on non-financial outcome, including risk and strategy-related measures. • Awards vest in five equal instalments with the first vesting on or around the third anniversary of the grant date, and the last vesting on or around the seventh anniversary of the grant date. • Awards are discretionary and subject to malus during the vesting period and claw-back for a period of seven to 10 years from the date of award. The shareholding guidelines as a percentage of base salary are: • Group Chairman: 100% • Group Chief Executive: 400% • Group Finance Director and Group Chief Risk Officer: 300% • Details of the performance measures and targets for awards to be made in 2017 (in respect of 2016) are set out on page 164. • For awards to be made in respect of 2017, the measures and targets will be determined at the end of 2017 for the performance period commencing on 1 January 2018. • On vesting, awards are subject to a retention period of up to one year. • Number of shares to be awarded can be determined using a share price discounted for dividend yield. No change from 2016. Executive Directors are also entitled to participate in all employee share plans, such as HSBC Sharesave, on the same basis as all other employees. The policy on payment for loss of office is detailed online in the Directors’ Remuneration Policy Supplement 2016. HSBC Holdings plc Annual Report and Accounts 2016 155 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report Remuneration policy summary – non-executive Directors achieved within five years from 2014 or their appointment if later. Non-executive Directors are not employees and receive a fee for their services. The policy for non-executive Directors is to pay: • base fees; and • further fees for the role of Senior Independent Director (‘SID’) and additional Board duties such as chairmanship or membership of a committee. Expenses incurred in performing their roles and any related tax due are also reimbursed. All non-executive Directors have a shareholding guideline of 15,000 shares, which has to be The Committee has reviewed the fee levels payable to non- executive Directors and decided an increase will be applied to reflect growing regulatory responsibilities and time commitment. A travel allowance of £4,000 will also be introduced for non-UK based non-executive Directors to reflect the additional time commitment required for travel. The increases in fees is within the 20% maximum increase during the three-year term of the remuneration policy. Fees for 2017 are detailed below. Category Base fee SID Audit, Risk, Remuneration, Financial System Vulnerabilities and Conduct & Values Committees Nomination Committee Philanthropic & Community Investment Oversight Committee Service contracts Executive Directors Contract date (rolling) Notice period (Director & HSBC) Douglas Flint 14 Feb 2011 Stuart Gulliver 10 Feb 2011 Iain Mackay 4 Feb 2011 Marc Moses 27 Nov 2014 12 months 12 months 12 months 12 months Letters setting out the terms of appointment of each executive Director are available for inspection at HSBC Holdings’ registered office. Consistent with the best interests of the Group, the Committee will seek to minimise termination payments. Directors may be eligible for a payment in relation to statutory rights. 2016 fees 2017 fees £ £ 95,000 45,000 50,000 30,000 40,000 25,000 25,000 15,000 110,000 54,000 60,000 30,000 40,000 25,000 25,000 15,000 Chairman Member Chairman Member Chairman Member The Directors’ biographies are set out on pages 133 to 136, and include those directorships provided for under Capital Requirement Directive IV (‘CRD IV’). Non-executive Directors Non-executive Directors are appointed for fixed terms not exceeding three years, which may be renewed subject to their re-election by shareholders at AGMs. Non-executive Directors do not have service contracts, but are bound by letters of appointment issued for and on behalf of HSBC Holdings. There are no obligations in the non-executive Director’s letters of appointment which could give rise to remuneration payments or payments for loss of office. Non-executive Directors’ current terms of appointment will expire as follows: 2017 AGM Kathleen Casey Laura Cha Lord Evans of Weardale Sam Laidlaw Jonathan Symonds 2018 AGM Phillip Ameen Joachim Faber John Lipsky Rachel Lomax Heidi Miller 2019 AGM Henri de Castries Irene Lee Pauline van der Meer Mohr Paul Walsh 2020 AGM David Nish Jackson Tai Remuneration policy for all employees The Committee oversees the Group’s remuneration policy and its application to the wider employee population. The Committee periodically reviews the adequacy and effectiveness of the policy and ensures that it: • meets the commercial requirement to remain competitive; • is affordable; • allows flexibility in response to prevailing circumstances; • is compliant with regulatory requirements; • aligns with the long-term interests of our stakeholders; and • is consistent with effective risk management. The mix of fixed and variable pay granted to an employee corresponds to the individual’s role, local market factors and regulatory requirements. The variable pay for all material risk takers (‘MRTs’) is restricted to a maximum of 200% of their fixed pay. Individuals are identified as MRTs based on the qualitative and quantitative criteria set out in the Regulatory Technical Standard EU 604/2014 and additional criteria determined by the Committee. The table provides an overview of the different remuneration elements for our employees. 156 HSBC Holdings plc Annual Report and Accounts 2016 Component of remuneration Application Fixed pay • Attract and retain employees by paying market-competitive pay for the role, skills and experience required by the business. • This may include salary, fixed pay allowance, cash in lieu of pension and other cash allowances in accordance with local market practices. • These payments are fixed and do not vary with performance. Pension and benefits • Provided in accordance with local market practice. They include, but are not limited to, the provision of pensions, medical coverage, life insurance, health assessment, tax return preparation, legal fees and relocation allowances. Annual incentive • Awards to drive and reward performance based on annual financial and non-financial measures consistent with the medium-to-long-term strategy, shareholder interests and adherence to HSBC Values. • For MRTs, awards are normally subject to a 40% or 60% deferral, delivered in cash and/or shares, subject to a minimum six-month retention period. From 2016 onwards, the deferral period could be three, five or seven years, depending on the regulatory status of the employee. Deferred awards are subject to malus. All awards are subject to claw-back and compliance with local laws. • For all other employees, awards can be in the form of cash and/or shares. Awards above a specified threshold are subject to deferral based on a deferral table. All deferred awards are subject to malus. • HSBC operates an anti-hedging policy for all employees who are required to certify each year that they have not entered into any personal hedging strategies. Link between performance and reward Under our remuneration framework, pay decisions are based on a number of factors: business results, individual performance against scorecard objectives and adherence to HSBC Values, business principles, policies, procedures and Global Standards. At the end of each performance year, assessment of performance against scorecard objectives, including non- financial and risk objectives, forms the basis of remuneration decisions. This helps ensure risk management is embedded and forms an integral part of all our activities. The performance and remuneration of individuals in control functions is assessed according to a balanced scorecard of objectives specific to the functional role they undertake, to ensure their remuneration is determined independent of the performance of the business areas they control. Key feature Application HSBC Values play a key role in ensuring the Group remains sound and sustainable. All employees are given a separate values-aligned behavioural rating, which informs their eligibility for variable pay and influences their variable pay determinations. Regular reviews are undertaken to assess instances of non- compliance with risk procedures and expected behaviours. Instances of non-compliance are escalated for consideration in variable pay decisions, using our adjustment, malus and claw-back policies (see the next section). The key features of our remuneration framework that enable us to achieve alignment between risk, reward and performance are set out below. Scorecards • Assessment of performance with reference to clear and relevant objectives set within a performance scorecard framework. • Global Standards including risk and compliance measures and conduct, set at a minimum of 25% of the scorecard for Group Management Board members. Group variable pay pool calculation Deferral of variable pay Malus/adjustment policy • Fines and penalties are automatically included in the Committee’s definition of profit. • Performance against metrics in the Group Risk Appetite Statement and Conduct Framework is taken into consideration. • Deferral of a significant proportion of variable pay into HSBC shares and/or other instruments to tie recipients to the future performance of the Group and business units. • Allows cancellation/reduction of unvested deferred variable pay awards. Longer deferral period under PRA Remuneration Rules increases the time period over which malus can be applied. • This is in addition to our in-year variable pay adjustments and other disciplinary actions that can be taken under our global consequence management policy. Claw-back policy • Subject to compliance with local labour laws, allows us to recoup/reclaim paid awards in certain circumstances as defined by the PRA for a period of up to seven-years from grant (can be extended to 10 years for individuals in PRA designated Senior Management Function roles). Retail/wealth compensation • We removed commission based sales plans globally for Wealth in 2013 and Retail in 2014. HSBC Holdings plc Annual Report and Accounts 2016 157 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report The following policies help embed values in our remuneration structure while ensuring greater global consistency in our approach to achieving alignment between risk and reward. Programmes Application Values rating for all employees Performance management • To ensure performance is judged not only on what is achieved in the short and long term but also on how it is achieved, which contributes to the sustainability of the Group. • Strong correlation is expected between performance and values. • No discretionary variable pay for an unacceptable behaviour rating. • 2016 focus on moving away from traditional cycle-based performance management towards a culture of everyday performance and development. Global consequence management policy Introduced to increase consistency in approach and actions taken. • • Clear messaging to employees on impact of breaches as part of reward communications (through pay statements, manager guidelines, etc.). Positive adjustments • To focus on positive behaviours in the context of Global Standards through in-year positive variable pay adjustments. Global recognition programme • Circa 80% of the global employee population can now access a single HSBC recognition platform to perform values-based peer-to-peer recognition. Includes communication of positive stories on our intranet (HSBC Now). • Variable pay adjustment, malus and claw-back Where there are instances of conduct breaches, the actions below can be taken. The Committee has discretion to apply malus and claw-back under the policies it has adopted, taking into consideration an individual’s proximity to, and responsibility for, the issue in question. Where possible, an adjustment will be made to current-year variable pay, before the application of malus, then claw-back. This is in line with regulatory requirements. Type of action Type of variable pay award affected Circumstances where it may apply (including, but not limited to) Adjustment • Current-year variable pay. • Detrimental conduct, including conduct which brings the business into disrepute. Involvement in events resulting in significant operational losses, or events which • have caused or have the potential to cause significant harm to HSBC. • Non-compliance with HSBC Values and other mandatory requirements or policies. Adjustment under the downward override policy • Current-year variable pay for • Downward override policy was introduced in 2014, based on the executive Directors and certain other senior executives. recommendations received from the independent Monitor as appointed by the US Deferred Prosecution Agreement (‘DPA’). • A downward adjustment can be applied where there is: – insufficient yearly progress in developing an effective AML and sanctions compliance programme; or • – non-compliance with the DPA and other relevant orders. In deciding the application and degree of any such downward override to reduce variable pay awards, the Committee considers feedback from the Financial System Vulnerabilities Committee, the Monitor in relation to cooperation with their review and Legal. • Detrimental conduct, including conduct which brings the business into disrepute. • Past performance being materially worse than originally reported. • Restatement, correction or amendment of any financial statements. • Improper or inadequate risk management. • Participation in, or responsibility for, conduct which results in significant losses. • Failing to meet appropriate standards and propriety. • Reasonable evidence of misconduct or material error that would justify, or would have justified, summary termination of a contract of employment. • HSBC or a business unit suffers a material failure of risk management in the context of Group risk-management standards, policies and procedures. Malus • Unvested deferred awards granted in prior years. Claw-back • Vested or paid awards granted to MRTs on or after 1 January 2015 for seven years. • From 2016 onwards, this period may be extended to 10 years for employees under the PRA’s Senior Manager Regime in the event of ongoing internal/regulatory investigation at the end of the seven- year period. 158 HSBC Holdings plc Annual Report and Accounts 2016 Annual report on remuneration Remuneration Committee Details of the roles, responsibility and membership of the Committee are set out on page 144. No executive Directors are involved in deciding their own remuneration. Activities The Committee met nine times during 2016. The following is a summary of the Committee’s key activities during 2016. A copy of the Committee’s terms of reference can be found on our website at www.hsbc.com/about-hsbc/corporate-governance/ board-committees. Details of the Committee’s key activities Month Activities Month Activities Jan • Reviewed and approved pay review matters and regulatory Jul filings. • Received updates on notable events. • Received updates on regulatory changes. Feb • Approved 2015 performance year pay review matters. • Considered progress update on 2015 Monitor Sept recommendations. • Approved 2015 Directors’ Remuneration Report and Strategic Report including new policy for Directors. • Received updates on notable events. • Received updates on regulatory changes. • Reviewed and approved regulatory filling for 2016. • Received updates on notable events. • Updated on high-priority programmes progress. • Reviewed 2016 performance year pay review matters. • Received updates on notable events. • Noted progress updates from 2016 Monitor recommendations. • Reviewed fixed pay framework. • Reviewed executive Directors’ scorecards. • Approved Group-wide variable pay deferral policy. Apr • Met with Monitor to discuss incentivisation workstream. • Considered matters discussed with regulators and reviewed regulatory filings. May • Approved 2016 MRT list. • Received updates on notable events. • Considered shareholder feedback received on executive remuneration policy matters. Advisers The Committee received input and advice from different advisers on specific topics during 2016. Deloitte LLP (‘Deloitte’) was appointed by the Committee in 2015 as an objective, independent adviser to support the Committee on specific remuneration matters for executive Directors. The Committee made the appointment after considering invited proposals from a number of consultancy firms. In 2016, the Committee agreed to extend Deloitte’s appointment for a further period of one year. Deloitte provided benchmarking data on remuneration policy matters and independent advice to the Committee. The Committee may request ad-hoc assistance from Deloitte. Deloitte also provided services to the Group, comprising tax compliance and other advisory services. To ensure the advice from Deloitte was objective, the Committee required the advice to be independent and distinct from any internal review and analysis on remuneration policy matters. The Committee was satisfied the advice provided by Deloitte was objective and independent in 2016. Deloitte is a founding member of the Remuneration Consultants Group and voluntarily operates under the Code of Conduct in relation to executive remuneration consulting in the UK. For 2016, total fees of £168,150 were incurred in relation to its remuneration advice provided by Deloitte. This was based on pre-agreed fees and a time and materials basis. During the year, the Group Chief Executive provided regular briefings to the Committee. In addition, the Committee received updates from the following employees as part of their roles with HSBC: Oct and Nov Dec • Committee Chairman met with shareholders. • Reviewed 2016 performance year pay review matters. • Reviewed 2016 regulatory submissions. • Received updates on notable events. • Reviewed long-term incentive scorecard. • Received updates on investor guidelines. • Approved 2016 performance year pay matters. • Approved 2016 regulatory submissions. • Reviewed executive Directors’ scorecards and pay proposals. • Approved long-term incentive scorecard measures. • Pierre Goad, Group Head of Human Resources (until August 2016); • Donna Wong, Acting Group Head of Human Resources (from September 2016); • Alexander Lowen, Group Head of Performance and Reward; • Marc Moses, Group Chief Risk Officer; • Iain Mackay, Group Finance Director; • Colin Bell, Group Head of Financial Crime Risk; • Robert Werner, Former Global Head of Financial Crime Compliance and Group Money Laundering Reporting Officer; • Ralph Nash, Global Head of Financial Crime Compliance; • John Flint, Chief Executive Retail Banking and Wealth Management; • Stuart Levey, Chief Legal Officer; and • Andy Maguire, Group Chief Operating Officer. The Committee also received feedback and input from the Group Risk Committee, the Financial System Vulnerabilities Committee and the Conduct & Values Committee on risk and compliance-related matters relevant to remuneration. This included input from the Financial System Vulnerabilities Committee on the implementation and annual assessment of progress on the AML and sanctions compliance programme for the purposes of the Committee’s determination on any adjustments to be made under the downward override policy. HSBC Holdings plc Annual Report and Accounts 2016 159 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report Single figure of remuneration The following table shows the single figure total remuneration of each executive Director for 2016, together with comparative figures for 2015. (Audited) (£000) Douglas Flint Stuart Gulliver Iain Mackay Marc Moses 2016 2015 2016 2015 2016 2015 2016 2015 Base salary 1,500 1,500 1,250 1,250 700 700 700 700 Fixed pay allowance Pension Annual incentive GPSP/LTI Sub-total Taxable benefits Non- taxable benefits Notional returns — — 1,700 1,700 950 950 950 950 450 750 375 625 210 350 210 350 — — 1,695 1,072 987 1,068 1,005 827 — — — 1,969 — 1,101 — 1,101 1,950 2,250 5,020 6,616 2,847 4,169 2,865 3,928 100 151 557 662 52 54 15 6 86 95 71 53 37 28 38 29 — — 27 9 17 5 18 5 Total 2,136 2,496 5,675 7,340 2,953 4,256 2,936 3,968 Year-on-year single figure comparison (Unaudited) The GPSP was replaced by the LTI in 2016. As such, no GPSP award was made for 2016 and the value for 2016 is nil. The first LTI award will be made in March 2017, with a performance period ending in 2019. Vesting of the first LTI award will be included in the single figure table for the financial year ending on 31 December 2019. For year-on-year comparison purposes, if target performance is achieved over the three-year performance period, LTI payout for the 2016 award would be 50% of grant value. In this case, the 2016 single figure total remuneration of the executive Directors for year-on-year comparison would be (in £000) £7,670 for Stuart Gulliver, £4,069 for Iain Mackay and £4,052 for Marc Moses. Illustration of release profile The following chart provides an illustrative release profile for executive Directors. Illustration of release profile Fixed pay allowance • Released in five equal annual instalments starting from March 2017. Annual incentive • Paid in immediately vested shares subject to minimum six- month retention period. • Subject to claw-back provisions for seven-years, which may be extended in the event of an ongoing internal/ regulatory investigation. • Award subject to three-year forward-looking performance period. Long-term incentive • Subject to satisfaction of performance conditions, awards will vest in five equal annual instalments starting from the third anniversary of the grant date. • On vesting, shares are subject to a minimum six-month retention period. Notes to the single figure of remuneration (Audited) Benefits In the single figure of remuneration table above, ‘Benefits’ refers to: • all taxable benefits (gross value before payment of tax) including provision of medical insurance, accommodation and car, club membership, tax gross-up for accommodation and car benefit; and • non-taxable benefits including the provision of life assurance and other insurance cover. The values of the significant benefits in the above table are set out below. (Audited) (£000) Douglas Flint Stuart Gulliver Iain Mackay Marc Moses 2016 2015 2016 2015 2016 2015 2016 2015 Car benefit (UK and Hong Kong)1 Hong Kong bank-owned accommodation2 Tax expense on car benefit and Hong Kong bank-owned accommodation Insurance benefit (non-taxable)1 — 69 64 87 — — — — — — 263 281 — — — — — 57 211 275 — — — — 75 80 63 — — — — — 1 2 The car benefits, tax on car benefits and insurance benefits for Iain Mackay and Marc Moses are not included in the above table as they were not significant. Based on the current market rental value of the bank-owned property in Hong Kong, as estimated by an external lease service provider, plus utility costs, rates, the taxable value of furniture and taking into account the business use of the property. The taxable value of the accommodation is considered to be 70% of the total of these amounts. 160 HSBC Holdings plc Annual Report and Accounts 2016 Notional returns In the single figure of remuneration table above, ‘Notional returns’ refers to the notional return on deferred cash. The deferred cash portion of the annual incentive also includes a right to receive notional returns for the period between grant date and vesting date, which is determined by reference to the dividend yield on HSBC shares, calculated annually. A payment of notional return is made annually in the same proportion as the vesting of the deferred awards on each vesting date. The amount is disclosed on a paid basis in the year in which the payment is made. Determining executive Directors’ annual performance (Audited) Awards made to executive Directors reflected the Committee’s assessment of the extent to which they had achieved personal and corporate objectives set within their performance scorecard as agreed at the beginning of the year, which had been set to reflect the risk appetite and strategic priorities. In accordance with the downward override policy, the Committee also consulted the Financial System Vulnerabilities Committee and took into consideration their feedback in relation to progress on enhancing AML and sanctions compliance along with progress in meeting the Group’s obligations under the US DPA and other relevant orders. The Committee also took into consideration the report of the independent Monitor in determining the scorecard outcomes. In order for any annual incentive award to be made, each executive Director must meet a required behavioural rating which is assessed with reference to the HSBC Values. For 2016, all executive Directors met the required behavioural rating. For 2016, the Committee exercised its discretion and reduced the Global Standards assessments from 75% to 65% for Stuart Gulliver, from 86% to 65% for Iain Mackay and from 74% to 65% for Marc Moses. This was based on feedback received from the Monitor, matters arising from risk and compliance incidents, and a number of unsatisfactory internal audits covering AML and sanctions-related issues. The performance achieved by executive Directors in the year is shown in the table below. Annual assessment Profit before tax1 Deliver cost savings Reduce Group RWAs Strategic growth Global Standards including risk and compliance Personal objectives Total Maximum annual incentive opportunity (£000) Annual incentive (£000) Stuart Gulliver Iain Mackay Marc Moses Weighting (%) Assessment (%) Outcome (%) Weighting (%) Assessment (%) Outcome (%) Weighting (%) Assessment (%) Outcome (%) 20.00 20.00 10.00 10.00 25.00 15.00 100.00 0.00 100.00 100.00 52.70 65.00 81.27 0.00 20.00 10.00 5.27 16.25 12.19 63.71 £2,660 £1,695 20.00 20.00 10.00 – 25.00 25.00 100.00 0.00 100.00 100.00 – 65.00 80.00 0.00 20.00 10.00 – 16.25 20.00 66.25 £1,490 £987 10.00 – 0.00 – 15.00 100.00 – – 50.00 25.00 100.00 65.00 80.00 0.00 – 15.00 – 32.50 20.00 67.50 £1,490 £1,005 1 Adjusted profit before tax, as defined for Group annual bonus pool calculation. This excludes the year-on-year effects of foreign currency translation differences, fair value movements on our own debt, business disposal gains and losses, acquisitions and goodwill, debt valuation adjustments, restructuring costs included in costs to achieve and variable pay expense. The adjusted profit before tax includes the cost of fines, penalties and costs of customer redress. Financial performance Annual assessment Measure Profit before tax Deliver cost savings1 Reduce Group RWAs Strategic growth2 Minimum (25% payout) Maximum (100% payout) Performance Assessment $19.7bn $34.0bn $100.0bn Various $20.6bn $32.9bn $110.0bn Various $18.2bn $30.7bn $143.0bn Partly met targets for seven measures and did not meet minimum targets for two measures. 0% 100% 100% 5.27% 1 Measured by reference to Group adjusted cost base. 2 Strategic growth measures on optimising global network, rebuilding NAFTA region profitability, delivering growth above GDP from international network, pivot to Asia and renminbi internationalisation. HSBC Holdings plc Annual Report and Accounts 2016 161 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report Non-financial performance The table below provides an overview of the non-financial performance achieved by each executive Director. Stuart Gulliver Global Standards including risk and compliance • Effective risk management in compliance with AML, sanctions and anti-bribery and corruption policies. • Enhancement of customer due • diligence. Implementation and embedding of global conduct programme. • Progress on embedding Global Standards. Personal objectives • Progress transactions in Brazil and Turkey. • Progress key milestones on set-up of UK ring-fenced bank. • Delivery of other high-priority projects. • People development including diversity. Iain Mackay Global Standards including risk and compliance • Strengthen governance and control around financial processes. • Delivery of controls optimisation • project. Implementation and embedding of global conduct programme. • Enhancement of operational risk management framework. • Successful delivery of stress testing in key markets. Personal objectives • Deliver cost savings. • Implementation of consistent capital management framework. • Progress key milestones on set-up of UK ring-fenced bank. • People development including diversity. Performance Assessment • Progressive implementation of the most effective Global Standards to combat financial 65.0% crime across the Group continues, including related attestations by country chief executive officers. • AML and sanctions policy outcomes strengthened with strategic deployments covering client due diligence, sanctions screening and transaction monitoring. • Empirical measurements used to assess sustainable operational effectiveness in financial crime compliance. • Conduct programme implementation progressed largely to plan. • For 2016, the Committee exercised its discretion and reduced the Global Standards assessments from 75% to 65%. This was based on feedback received from the Monitor, matters arising from risk and compliance incidents, and a number of unsatisfactory internal audits covering AML and sanctions-related issues. • Completed sale of operations in Brazil and maintained a presence to serve large corporate 81.3% clients. Restructuring of business in Turkey to make it a profitable franchise largely complete. • Overall implementation of high-priority programmes is fully met including the establishment of the ring-fenced bank in the UK which is on track for completion by 1 July 2018. • Comprehensive review of diversity and inclusion completed. Refreshed diversity and inclusion strategy and targets. • Exceeded target for female share of promotions into senior management. Assessment 65.0% Performance • Continued enhancement of the Sarbanes Oxley framework and alignment with the operational risk management framework ('ORMF'). Delivery of 2016 milestones for the controls optimisation project which is on track to be completed by April 2017. • Effective execution of operational risk management through embedding of the three lines of defence, with remediation plans in place to address any gaps identified against ORMF. • Continued progress to comply with regulatory requirements including 2016 stress tests for the PRA, European Banking Authority and US Federal Reserve Bank, and successful submission of the inaugural Group-wide individual liquidity adequacy assessment process. • Embedding of the tax risk management framework in businesses and functions continues. Significant progress achieved in embedding US Foreign Account Tax Compliance Act ('FATCA') related measures, common reporting standards and tax transparency. Implementation of global conduct programme milestones and outcomes were largely met. • • For 2016, the Committee exercised its discretion and reduced the Global Standards assessments from 86% to 65%. This was based on feedback received from the Monitor, matters arising from risk and compliance incidents, and a number of unsatisfactory internal audits covering AML and sanctions-related issues. • 2016 Global Finance function direct costs and FTE targets met via significant 80.0% restructuring (transforming the function from geographically aligned to a global operating model), accompanied by enhancements of technology, demand management, process re- engineering and off-shoring. Material progress achieved in the strengthening of the Global Finance Centre. • Activities to implement business segmentation on track and further enhancements to the capital management framework delivered. • New internal liquidity framework fully implemented. • Delivery against 2016 milestones for UK ring-fencing requirements and other high-priority programmes were fully met. • Delivery of the Global Finance function people agenda, including implementation of accelerated development programmes for targeted employees, the sponsorship and development of careers and capabilities of employees, and improvement of gender diversity in the function. 162 HSBC Holdings plc Annual Report and Accounts 2016 Marc Moses Performance Global Standards including risk and compliance • Effective risk management in compliance with AML, sanctions and anti-bribery and corruption policies. • Enhancement of customer due • diligence. Implementation and embedding of global conduct programme. • Enhancement of operational risk • management framework. Implementation of US risk management measures. • Global Financial Crime Compliance function focus progressed, although not as quickly as planned. Progress in enhancing know your customer, customer due diligence, and effective risk management in compliance with AML, sanctions, anti-bribery and corruption policies and Global Standards, were somewhat met as certain key components were not fully developed at the mid-year. • Management oversight of Global Financial Crime Risk function activities were effectively handed over to the newly appointed Group Head of Financial Crime Risk following the establishment of the new Financial Crime Risk function. • The conduct programme implementation progressed largely to plan. • Our operational risk transformation programme on track with all key milestones delivered. Embedding of the three lines of defence framework continues with the management of ‘High’ rated residual risks, mitigating actions and remediation activities largely meeting expectations. However, further work to self-identify issues is required. • Successfully completed all 2016 outcomes to enable compliance with conduct Assessment 65.0% Personal objectives • Deliver cost savings. • Successful delivery of stress testing. • Support business growth and improve RWA effectiveness/efficiency. • People development including diversity. regulation. • For 2016, the Committee exercised its discretion and reduced the Global Standards assessments from 74% to 65%. This was based on feedback received from the Monitor, matters arising from risk and compliance incidents, and a number of unsatisfactory internal audits covering AML and sanctions-related issues. • Effective cost management driven through management of business performance and Global Risk function transformation activities including process re-engineering and location optimisation. 80.0% • Satisfactorily progressed the 2016 PRA and European Banking Authority stress tests and stress testing for other key regulators. • RBWM expansion in the Pearl River Delta and creation of the risk infrastructure to launch credit cards in China fully met. Improved RWA effectiveness and efficiency within CMB and GBM to support overall reduction in Group RWAs. • Delivered Global Risk function people initiatives including performance and reward plans, mandatory and key learning initiatives, and strengthened gender diversity. HSBC Holdings plc Annual Report and Accounts 2016 163 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report Awards under the long-term incentives (Audited) Under the new policy approved by shareholders, executive Directors are eligible to receive an LTI award. For the 2016 performance year, the award will be made in March 2017 with a three-year performance period starting 1 January 2017. For 2016, all executive Directors will be awarded an LTI grant equivalent to 319% of base salary. The details of the measures that will be used to assess performance and payout are provided below. To the extent performance conditions are satisfied, the awards will vest in five equal annual instalments commencing from around the third anniversary of the grant date. On vesting, awards are subject to a minimum six-month retention period. Performance conditions Measures Average return on equity1 Cost efficiency (adjusted jaws) Relative total shareholder return2 Minimum (25% payout) 7.0% Positive At median of the peer group. Target (50% payout) 8.5% 1.5% Maximum (100% payout) 10.0% 3.0% Straight-line vesting between minimum and maximum. At upper quartile of the peer group. Global Standards including risk and compliance • Status of DPA. Not applicable Not applicable Met all commitments to achieve closure of the DPA and protect HSBC from further regulatory censure for financial crime compliance failings. • Achieve and sustain compliance with Global Financial Crime Compliance policies and procedures. Performance will be assessed by the Committee based on a number of qualitative and quantitative inputs such as feedback from the Financial System Vulnerabilities Committee, Group Financial Crime Risk assessment against Financial Crime Compliance objectives, outcome of assurance and audit reviews, and achievement of the long-term Group objectives and priorities during the performance period. Strategy • International client revenues. (Share of revenues supported by international network) • Revenue synergies. (Share of revenues supported by universal banking model) • Employee engagement. (Results of employee survey) • Customer. (Based on customer recommendation in home country markets) Total 50% 22% 65% 51% 23% 67% 52% 24% 70% Rank within top three in at least two of the four RBWM and CMB customer segments in home country markets. Rank within top three in three of the four RBWM and CMB customer segments in home country markets. Rank within top three in all four RBWM and CMB customer segments in home country markets. Weighting % 20 20 20 25 15 100 1 2 Significant items are excluded from the profit attributable to ordinary shareholders of the company for the purpose of computing adjusted return on equity. The peer group for the 2016 award is: Australia and New Zealand Banking Group, Bank of America, Barclays, BNP Paribas, Citigroup, Credit Suisse Group, DBS Group Holdings, Deutsche Bank, JPMorgan Chase & Co., Lloyds Banking Group, Standard Chartered and UBS Group. Payments to past Directors (Audited) No payments were made to or in respect of former Directors in the year in excess of the minimum threshold of £50,000 set for this purpose. Total pension entitlements (Audited) No employees who served as executive Directors during the year have a right to amounts under any HSBC final salary pension scheme for their services as executive Directors or are entitled to additional benefits in the event of early retirement. There is no retirement age set for Directors, but the normal retirement age for employees is 65. External appointments During 2016, Stuart Gulliver received S$10,000 in fees as a member of the Monetary Authority of Singapore International Advisory Panel, which was donated to charity. Exit payments made in year (Audited) No payments for loss of office were made in 2016 to any person serving as a Director in the year or any previous years. Scheme interests awarded during 2016 (Audited) The table below sets out the scheme interests awarded to Directors in 2016 (for performance in 2015) as disclosed in the 2015 Directors’ Remuneration Report. No non-executive Directors received scheme interests during the financial year. 164 HSBC Holdings plc Annual Report and Accounts 2016 Scheme awards in 2016 (Audited) Type of interest awarded Basis on which award made Date of award Stuart Gulliver Deferred cash Annual incentive 2015 29 Feb 2016 Deferred shares Annual incentive 2015 29 Feb 2016 Deferred shares GPSP 2015 29 Feb 2016 Iain Mackay Deferred cash Annual incentive 2015 29 Feb 2016 Deferred shares Annual incentive 2015 29 Feb 2016 Deferred shares GPSP 2015 29 Feb 2016 Marc Moses Deferred cash Annual incentive 2015 29 Feb 2016 Deferred shares Annual incentive 2015 29 Feb 2016 Deferred shares GPSP 2015 29 Feb 2016 Face value awarded1 £000 Percentage receivable for minimum performance1 Number of shares awarded Share price on date of grant2 End of performance period 322 322 1,969 320 320 1,101 248 248 1,101 — — — — — — — — — n/a 68,845 421,232 n/a 68,556 235,654 n/a 53,065 235,654 n/a 31 Dec 2015 £4.6735 31 Dec 2015 £4.6735 31 Dec 2015 n/a 31 Dec 2015 £4.6735 31 Dec 2015 £4.6735 31 Dec 2015 n/a 31 Dec 2015 £4.6735 31 Dec 2015 £4.6735 31 Dec 2015 1 Unvested awards determined based on performance achieved during the period to 31 December 2015. The overall award level could have been 0% of the maximum opportunity if minimum performance was achieved for the period to 31 December 2015. After grant, awards are subject to service condition and malus provisions. Share price used is the closing mid-market price on the last working day preceding the date of grant. 2 GPSP awards were made based on performance up to the financial year-end preceding the grant date with no further performance conditions after grant. Vesting occurs five years after grant date and is normally subject to the Director remaining an employee until the vesting date. The net of tax shares which the Director becomes entitled to on the vesting date are subject to a retention requirement. The above table does not include details of shares issued as part of the fixed pay allowances, as those shares vest immediately and are not subject to any service or performance conditions. Directors’ interests in shares (Audited) The shareholdings of all persons who were Directors in 2016, including the shareholdings of their connected persons, at 31 December 2016 are set out below. The table below shows the comparison of shareholdings to the company shareholding guidelines. There have been no changes in the shareholdings of the Directors from 31 December 2016 to the date of this report excluding those disclosed in footnote 8 of the below table. Shares (Audited) Executive Directors Douglas Flint8 Stuart Gulliver Iain Mackay Marc Moses Group Managing Directors9 Shareholding guidelines2 (% of salary) Current shareholding as at Dec 20163 (% of salary) 100% 400% 300% 300% 170% 1,691% 312% 744% 250,000 shares 250,000 shares Share interests4 (number of shares) 402,158 3,344,208 345,469 824,241 n/a At 31 Dec 2016 Scheme interests Shares awarded subject to deferral1 Share options5 without performance conditions4, 6 with performance conditions7 2,919 — 3,469 — n/a — 3,132,917 1,424,437 1,735,488 n/a — 99,357 68,688 66,734 n/a The gross number of shares is disclosed. A portion of these shares will be sold at vesting to cover any income tax and social security which falls due at the time of vesting. The current shareholding guideline does not count unvested share-based incentives. 1 2 3 An average of three-month closing share price as on 31 December 2016 (£6.3224) has been used to calculate current shareholding as a percentage of salary. 4 Under the annual incentive, in line with regulatory requirements, any deferred shares (net of tax) which the Director becomes entitled to are subject to a retention requirement, such that they must be held for a predefined period of time. To provide the executive Directors with appropriate flexibility, the Committee determined that, the requirement to hold these shares could be met either by (i) retaining the shares that vested from the underlying award (net of tax) or (ii) by separately retaining a number of shares equivalent to those that vested under the award. The Committee consider that such an arrangement results in the employee holding the same number of shares as per the original intention of the retention period as set out in the remuneration policy approved by shareholders in 2014. 5 All share options are unvested and unexercised. 6 Includes GPSP awards, which were made following an assessment of performance over the relevant period ending on 31 December immediately before the grant date but are subject to a five-year vesting period. 7 Awards granted in March 2013 are subject to service conditions and satisfactory completion of the DPA, as determined by the Committee. The DPA condition ends on the fifth anniversary of the award date unless the DPA is extended or otherwise continues beyond that date, in which case the awards will vest on the date on which the DPA expires and otherwise ceases to operate. This award will lapse if the Committee determines that the performance conditions are not satisfied. Since the end of the year, the number of HSBC Holdings ordinary shares held by Douglas Flint has increased by 22, following an acquisition, through regular monthly contributions in the HSBC Holdings UK Share Incentive Plan. 8 9 All Group Managing Directors are expected to meet their minimum shareholding guideline by 2019 or within five years of the date of their appointment, whichever is later. Share options (Audited) Date of award Exercise price Douglas Flint Iain Mackay 23 Sep 2014 23 Sep 2014 £ 5.1887 5.1887 Exercisable from1 1 Nov 2019 1 Nov 2017 until 30 April 2020 30 April 2018 At 1 Jan 2016 2,919 3,469 Exercised in year — — At 31 Dec 2016 2,919 3,469 1 May be advanced to an earlier date in certain circumstances, such as retirement. The above awards were made under HSBC UK Sharesave, an all-employee share plan under which eligible employees may be granted options to acquire HSBC Holdings ordinary shares. The exercise price is set at a 20% discount to the share price immediately prior to the start of the invitation period. Employees may make contributions of up to £500 each month over a period of three or five years. The market value per ordinary share at 31 December 2016 was £6.5690. Market value is the mid- HSBC Holdings plc Annual Report and Accounts 2016 165 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report market price derived from the London Stock Exchange Daily Official List on the relevant date. Under the Securities and Futures Ordinance of Hong Kong, the options are categorised as unlisted physically settled equity derivatives. Summary of shareholder return and Group Chief Executive remuneration The following graph shows the total shareholder return (‘TSR’) performance against the FTSE 100 Total Return Index for the HSBC TSR and FTSE 100 Total Return Index eight-year period that ended on 31 December 2016. The FTSE 100 Total Return Index has been chosen as this is a recognised broad equity market index of which HSBC Holdings is a member. The single figure remuneration over the past eight years together with the outcomes of the respective annual incentive and long-term incentive awards are also presented below. Group Chief Executive Total single figure £000 Annual incentive1 (% of max.) Long-term incentive2,3 (% of max.) 2009 2010 Michael Geoghegan Michael Geoghegan 2011 Stuart Gulliver 2012 Stuart Gulliver 2013 Stuart Gulliver 2014 Stuart Gulliver 2015 Stuart Gulliver 2016 Stuart Gulliver 7,580 7,932 8,047 7,532 8,033 7,619 7,340 5,675 94% 25% 82% 19% 58% 50% 52% 40% 49% 49% 54% 44% 45% 41% 64% — 1 2 3 The 2012 annual incentive figure for Stuart Gulliver used for this table includes 60% of the annual incentive disclosed in the 2012 Directors’ Remuneration Report which was deferred for five years and subject to service conditions and satisfactory completion of the DPA, as determined by the Committee. The DPA condition ends on the fifth anniversary of the award date unless the DPA is extended or otherwise continues beyond that date, in which case the awards will vest on the date on which the DPA expires and otherwise ceases to operate. This award will lapse if the Committee determines that the performance conditions are not satisfied. Long-term incentive awards are included in the single figure for the year in which the performance period is deemed to be substantially completed. For GPSP awards this is the end of the financial year preceding the date of grant (GPSP awards shown in 2011 to 2015 therefore relate to awards granted in 2012 to 2016). For performance share awards that were awarded before introduction of GPSP, the value of awards that vested subject to satisfaction of performance conditions attached to those awards are included at the end of the third financial year following the date of grant (for example, performance share awards shown in 2010 relates to awards granted in 2008). The GPSP was replaced by the LTI in 2016 and the value for GPSP is nil for 2016 as no GPSP award was made for 2016. The first LTI award will be made in March 2017, with a performance period ending in 2019. Vesting of the first LTI award will be included in the single figure table for the financial year ending on 31 December 2019. For year-on-year comparison purposes, if target performance is achieved over the three-year performance period, LTI payout for the 2016 award would be 50% of grant value. In this case, the single figure total remuneration of the executive Directors for year-on-year comparison would be (in £000) £7,670 for Stuart Gulliver. 166 HSBC Holdings plc Annual Report and Accounts 2016 Comparison of Group Chief Executive and all-employee pay The following charts compare the changes in Group Chief Executive pay to changes in employee pay between 2015 and 2016, and provide a breakdown of total staff pay relative to the amount paid out in dividends. Percentage change in remuneration between 2015 and 2016 Group Chief Executive Employee Group Base salary 1 Benefits 2, 3 Annual incentive 4 0% (12)% 58 % 4% (11)% (5)% 1 2 3 4 Employee group consists of local full-time UK employees as representative of employees from different businesses and functions across the Group. Group Chief Executive's total fixed pay has not increased since 1 January 2014. There has been no change in the benefits provided to the Group Chief Executive. The change in the value of the benefit is due to the change in the taxable value of the benefit as reported in the single figure table. Employee group consists of UK employees eligible for taxable benefits which was deemed the most appropriate comparison for the Group Chief Executive given varying local requirements. There has been no change in the benefit coverage for employees from 2015 to 2016. The reduction in the average cost of benefits per employee is reflective of the decrease in the cost of providing such benefit on average. Employee group consists of all employees globally, based on annual incentive pool as disclosed on page 29 and staff numbers (full-time equivalents at the financial year-end). The percentage change in annual incentive award of the Group Chief Executive is primarily driven by the difference in the 2015 and 2016 scorecard outcome, reflecting performance achieved in those years, and change in policy. Details of the 2016 total single figure of remuneration for the Group Chief Executive are on page 160. Relative importance of spend on pay 26% 9% Return to shareholder Employee compensation and benefits Dividends Share buy-back The chart above shows the change in: • total staff pay between 2015 and 2016; and • dividends paid out in respect of 2015 and 2016. We also executed a share buy-back worth approximately $2.5bn in the second half of 2016, and completed this early in the first quarter of 2017. HSBC Holdings plc Annual Report and Accounts 2016 167 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report Non-executive Directors The table below shows the total fees of non-executive Director for 2016, together with comparative figures for 2015. Fees and benefits (Audited) (£000) Phillip Ameen Kathleen Casey Henri de Castries (Appointed 1 Mar 2016) Laura Cha Lord Evans of Weardale Joachim Faber Rona Fairhead (Retired on 22 Apr 2016) Sam Laidlaw Irene Lee John Lipsky Rachel Lomax Heidi Miller David Nish (Appointed 1 May 2016) Sir Simon Robertson (Retired on 22 Apr 2016) Jonathan Symonds Jackson Tai (Appointed 12 Sep 2016) Pauline van der Meer Mohr Paul Walsh (Appointed 1 Jan 2016) Total Total ($000) Footnotes 2016 2015 2016 2015 2016 2015 Fees Benefits9 Total 1 2 3 4 5 6 7 8 440 155 79 247 190 152 78 185 268 180 254 536 83 49 520 48 172 142 403 155 — 238 190 151 510 174 184 180 253 175 — 195 520 — 32 — 3,778 5,097 3,360 5,135 43 24 4 23 5 12 9 13 10 21 6 35 22 2 7 4 10 6 256 345 13 29 — 14 9 14 14 13 2 49 11 31 — 12 1 — 5 — 483 179 83 270 195 164 87 198 278 201 260 571 105 51 527 52 182 148 416 184 — 252 199 165 524 187 186 229 264 206 — 207 521 — 37 — 217 332 4,034 5,442 3,577 5,467 1 2 3 4 5 Includes fees of £315,000 in 2016 (£278,000 in 2015) as a Director, Chairman of the Audit Committee and member of the Risk Committee of HSBC North America Holdings Inc. Includes fees of £72,000 for 2016 (£63,000 for 2015) as a Director, Deputy Chairman and member of the Nomination Committee of The Hongkong and Shanghai Banking Corporation Limited. Includes £7,000 (inclusive of VAT) in respect of his membership of a verwaltungsrat (advisory body) to HSBC Trinkaus & Burkhardt AG. These fees were received in respect of 2015 also, although they were not included in the disclosure. Includes fees of £31,000 for 2016 (£360,000 in 2015) as Chairman of HSBC North America Holdings Inc. Includes fees of £173,000 in 2016 as Director and member of the Audit Committee and the Risk Committee of The Hongkong and Shanghai Banking Corporation Limited and as Director, member of the Audit Committee and Chairman of the Risk Committee of Hang Seng Bank Limited. Includes a fee of £411,000 as Chairman of HSBC North America Holdings Inc. following appointment on 1 January 2016. Includes a fee of £345,000 in 2016 (£345,000 in 2015) as non-executive Chairman of HSBC Bank plc. 6 7 8 Appointed as a Director on 1 September 2015 and as a member of the Conduct & Values Committee and Group Remuneration Committee on 1 January 2016 and the 9 Nomination Committee on 22 April 2016. Benefits include accommodation and travel-related expenses relating to attendance at Board and other meetings at HSBC Holdings' registered office. Amounts disclosed have been grossed up using a tax rate of 45%, where relevant. Non-executive Directors’ interests in shares (Audited) The shareholdings of persons who were non-executive Directors in 2016, including the shareholdings of their connected persons, at 31 December 2016 are set out below. The table below shows the comparison of shareholdings to the company shareholding guidelines. Phillip Ameen Kathleen Casey Laura Cha Henri de Castries Lord Evans of Weardale Joachim Faber Sam Laidlaw Irene Lee John Lipsky Rachel Lomax Heidi Miller David Nish Jonathan Symonds Jackson Tai Pauline van der Meer Mohr Paul Walsh Shareholding guidelines (number of shares) Share interests (number of shares) 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000 5,000 8,620 5,200 16,165 9,170 66,605 40,860 10,000 16,165 18,900 3,975 50,000 21,771 31,605 15,000 5,079 168 HSBC Holdings plc Annual Report and Accounts 2016 Voting results from 2016 Annual General Meeting The table below summarises the voting results at our last AGM. Remuneration Report Remuneration Policy For 90.49% Against 9.51% Withheld 54,280,789 (8,327,033,672) (875,494,490) 96.05% 3.95% 35,165,873 (8,887,168,002) (365,908,568) Implementation of remuneration policy in 2017 for executive Directors Implementation of fixed remuneration is disclosed on page 156 along with the remuneration policy summary. Further details on performance measures and weightings for the 2017 annual incentive award are provided below. strategic and financial objectives set out in our Investor Update in June 2015. The performance targets for the annual incentive are commercially sensitive and it would be detrimental to the Group’s interests to disclose them at the start of the financial year. Subject to commercial sensitivity, we will disclose the targets after the end of a relevant financial year in that year’s remuneration report. Annual incentive scorecards The weightings and performance measures to apply to the 2017 annual incentive award for Stuart Gulliver, Iain Mackay and Marc Moses are disclosed below. These align to the Group’s 2017 annual incentive scorecards Executive Directors will be eligible for an annual incentive award of up to 213% of base salary. Measures Profit before tax1 Capital management Deliver cost savings Reduce Group RWAs Strategic growth Global Standards including risk and compliance Personal objectives Total Stuart Gulliver Iain Mackay Marc Moses % 20 — 20 10 10 25 15 100 % 10 25 10 10 — 25 20 100 % 10 — — 15 — 50 25 100 1 Adjusted profit before tax as defined for Group annual bonus pool calculation. Details of the Global Standards and personal objectives measures are provided below. Stuart Gulliver Iain Mackay Marc Moses Measures Global Standards including risk and compliance Personal objectives • Achieve and sustain compliance • Effective management of material • Ensure the Global Risk function enables and with global financial crime compliance policies and procedures, and/or have approved dispensations in place. Implement the operational risk management framework. Implementation of global conduct programme and maturity level achieved against the required conduct outcomes. • • • Effective risk management with AML, sanctions, anti-bribery and corruption policies and Global Standards. • operational risks. Implementation of the operational risk management framework. • Proactively review and challenge the first line of defence to assess the adequacy of risk management activities relating to accounting and tax. Implementation of global conduct programme and maturity level achieved against the required conduct outcomes. • • Successful delivery of regulatory and internal stress tests in 2017. • Ensure climate change is reflected • Enhanced environmental, social across the Group’s activities. • Optimise global network and reduce complexity. • Set-up UK ring-fenced bank headquartered in Birmingham and move the business to be ready for a UK departure from the EU. • Delivery of high-priority projects. • Improve customer satisfaction and employee diversity. • Complete succession and transition planning. and governance (‘ESG’) disclosures in collaboration with External Affairs function and global businesses. • Deliver Global Finance transformation. • Set-up UK ring-fenced bank headquartered in Birmingham and move the business to be ready for a UK departure from the EU. Improve employee diversity. • • Complete succession and transition planning. supports Financial Crime Risk function to achieve and sustain compliance with global financial crime compliance policies and procedures. • Effective management of material operational • risks. Implementation of the operational risk management framework. • Proactively review and challenge the first line of defence to assess the adequacy of risk management activities and fulfil risk steward responsibilities. • Manage credit and market risk, and oversee liquidity risk within the Board approved risk appetite. Implementation of global conduct programme and maturity level achieved against the required conduct outcomes. • • Successful delivery of regulatory and internal stress tests in 2017. • Develop processes to measure exposure to carbon-intensive and low-carbon-intensive activities. • Define opportunities to develop risk management policies and procedures consistent with Group risk appetite to protect the Group from climate change risk, and enable business activities supporting a transition to a low-carbon economy. • Pivot to Asia and support growth of customer lending. • Deliver Global Risk transformation. • • • Complete succession and transition planning. Improve RWA effectiveness and efficiency. Improve employee diversity. HSBC Holdings plc Annual Report and Accounts 2016 169 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report Long-term incentives Details of the performance measures and targets for LTI awards to be made in 2017, in respect of 2016, are provided on page 164. The performance measures and targets for awards to be made in respect of 2017, granted in 2018, will be provided in the Annual Reports and Accounts 2017. Implementation of remuneration policy in 2017 for non-executive Directors The Committee has reviewed the fee levels payable to the non- executive Directors and details can be found on page 155. Additional remuneration disclosures This section provides disclosures required under the Hong Kong Ordinances, Hong Kong Listing Rules, the US Securities and Exchange Commission Form 20-F and the Pillar 3 remuneration disclosures. Employee compensation and benefits Executive Directors Set out below are details of compensation paid to executive Directors for the year ended 31 December 2016. Basic salaries, allowances and benefits in kind Pension contributions Performance-related pay paid or receivable 1,2 Inducements to join paid or receivable Compensation for loss of office Notional return on deferred cash Total Total ($000) Douglas Flint Stuart Gulliver Iain Mackay Marc Moses 2016 £000 2,136 — — — — — 2015 £000 2,496 — — — — — 2016 £000 3,953 — 1,695 — — 27 2015 £000 4,290 — 3,041 — — 9 2016 £000 1,949 — 987 — — 17 2,136 2,882 2,496 3,815 5,675 7,656 7,340 11,218 2,953 3,984 2015 £000 2,082 — 2,169 — — 5 4,256 6,505 2016 £000 1,913 — 1,005 — — 18 2,936 3,961 2015 £000 2,035 — 1,928 — — 5 3,968 6,065 1 For the 2016 performance year, Stuart Gulliver, Iain Mackay and Marc Moses will receive an LTI award with a face value of £3,990,000, £2,232,000 and £2,232,000, respectively, which is not included in the amount above. Vesting of the award is subject to the performance conditions detailed on page 164. For the 2015 performance year, performance-related pay includes annual incentives and GPSP. 2 3 Deferred compensation accrued in 2016 for awards granted in prior years was £3,630,102 ($4,897,447) for Stuart Gulliver, £1,806,500 ($2,437,187) for Iain Mackay and £2,033,451 ($2,743,371) for Marc Moses. Deferred compensation accrued in 2015 for awards granted in prior years was £3,179,883 ($4,860,042) for Stuart Gulliver, £1,378,660 ($2,107,104) for Iain Mackay and £1,674,155 ($2,558,730) for Marc Moses. The aggregate amount of Directors' emoluments as defined above (including both executive Directors and non-executive Directors) for the year ended 31 December 2016 was $23,925,335. As per our policy, benefits in kind may include, but are not limited to, the provision of medical insurance, income protection insurance, health assessment, life assurance, club membership, tax assistance, Hong Kong accommodation for Stuart Gulliver, car benefit, travel assistance, and relocation costs (including any tax due on the benefit, where applicable). Medical insurance benefit of £1,605 ($2,165) was provided to a past director, Alexander Flockhart, during the year ended 31 December 2016. Amounts are converted into US dollars based on the average year-to-date exchange rates for the respective year. Emoluments of senior management and five highest paid employees Set out below are details of emoluments paid to senior management (being here, executive Directors and Group Managing Directors of HSBC Holdings) for the year ended 31 December 2016 or for the period of appointment in 2016 as a Director or Group Managing Director. Details of remuneration paid to the five highest paid employees, including three executive Directors and two Group Managing Directors of HSBC Holdings, for the year ended 31 December 2016 are also presented below. Emoluments Basic salaries, allowances and benefits in kind Pension contributions Performance-related pay paid or receivable1 Inducements to join paid or receivable Compensation for loss of office Total Total ($000) 1 Includes the face value of LTI awards at grant. Five highest paid employees Senior management £000 15,474 82 17,916 — — 33,472 45,158 £000 34,101 251 32,818 — 2,669 69,839 94,222 170 HSBC Holdings plc Annual Report and Accounts 2016 The emoluments of senior management were within the following bands: Hong Kong dollars US dollars HK$5,500,001 – 6,000,000 $708,536 – 772,948 HK$10,000,001 – 10,500,000 $1,288,246 – 1,352,658 HK$16,500,001 – 17,000,000 $2,125,606 – 2,190,018 HK$22,000,001 – 22,500,000 $2,834,142 – 2,898,554 HK$23,500,001 – 24,000,000 $3,027,379 – 3,091,791 HK$29,500,001 – 30,000,000 $3,800,326 – 3,864,738 HK$30,500,001 – 31,000,000 $3,929,151 – 3,993,563 HK$34,500,001 – 35,000,000 $4,444,449 – 4,508,862 HK$39,500,001 – 40,000,000 $5,088,572 – 5,152,985 HK$44,500,001 – 45,000,000 $5,732,695 – 5,797,108 HK$46,000,001 – 46,500,000 $5,925,932 – 5,990,345 HK$47,500,001 – 48,000,000 $6,119,169 – 6,183,581 HK$53,500,001 – 54,000,000 $6,892,117 – 6,956,529 HK$54,000,001 – 54,500,000 $6,956,529 – 7,020,941 HK$61,000,001 – 61,500,000 $7,858,302 – 7,922,714 HK$80,000,001 – 80,500,000 $10,305,969 – 10,370,381 HK$100,500,001 – 101,000,000 $12,946,874 – 13,011,286 Number of highest paid employees Number of senior management — — — — — — — — — — — — 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Pillar 3 remuneration disclosures The following tables show the remuneration awards made by HSBC to its MRTs for 2016. Individuals have been identified as MRTs based on the qualitative and quantitative criteria set out in the Regulatory Technical Standard EU 604/2014 and additional criteria determined by the Committee. Aggregate remuneration expenditure 2016 Global business aligned Retail Banking and Wealth Management Commercial Banking Global Banking and Markets Global Private Banking $m 94.2 $m 67.4 $m 756.9 $m 66.8 Corporate Centre $m 391.1 Total $m 1,376.4 Includes salary and incentives awarded in respect of the performance year 2016 (including deferred component) and any pension or benefits outside of policy. Remuneration – fixed and variable amounts – Group-wide Senior management1 MRTs (non-senior management) Number of MRTs Fixed Cash-based Shares-based Total fixed Variable2 Cash Non-deferred shares3 Deferred cash Deferred shares Total variable pay4 114 $m 116.8 13.6 130.4 20.9 25.9 29.1 40.5 116.4 1,203 $m 619.8 7.9 627.7 138.2 127.7 116.3 119.7 501.9 Total 1,317 $m 736.6 21.5 758.1 159.1 153.6 145.4 160.2 618.3 1 Definition of senior management for Pillar 3 disclosure includes our members of the Group Management Board, Group General Managers and non-executive Directors. 2 3 4 Variable pay awarded in respect of 2016. Vested shares, subject to a six-month retention period. In accordance with shareholder approval received on 23 May 2014, for each MRT the variable component of remuneration for any one year is limited to 200% of fixed component of the total remuneration of the MRT. HSBC Holdings plc Annual Report and Accounts 2016 171 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Directors’ Remuneration Report Remuneration – fixed and variable amounts – UK based Senior management1 MRTs (non-senior management) Number of MRTs Total fixed Variable2 Cash Non-deferred shares3 Deferred cash Deferred shares Total variable pay4 76 $m 80.4 11.6 16.6 16.3 27.7 72.2 522 $m 255.8 57.3 51.4 47.7 48.4 204.8 1 Definition of senior management for Pillar 3 disclosure includes our members of the Group Management Board, Group General Managers and non-executive Directors. 2 3 4 Variable pay awarded in respect of 2016. Vested shares, subject to a six-month retention period. In accordance with shareholder approval received on 23 May 2014, for each MRT the variable component of remuneration for any one year is limited to 200% of fixed component of the total remuneration of the MRT. Deferred remuneration1 Deferred remuneration at 31 Dec Outstanding, unvested Awarded during the year Paid out2 Reduced through malus Senior management MRTs (non-senior management) $m 280.3 86.2 53.2 — $m 657.1 331.1 216.8 — 1 2 This table provides details of actions taken during performance year 2016. For details of variable pay awards granted for 2016, please refer to both the ‘remuneration’ tables above. Vested shares are valued using the closing share price on the business day immediately preceding the vesting day. Sign-on and severance payments Sign-on payments1 Made during year ($m) Number of beneficiaries Severance payments2 Awarded and made during year ($m) Number of beneficiaries Highest such award to a single person ($m) Senior management MRTs (non-senior management) 1.6 1 3.2 1 3.2 11.7 18 4.0 7 1.8 1 Guaranteed variable pay awards granted to new hires and limited to their first year of service. 2 Represents non-standard termination payments made in excess of any local policies, standards or statutory amounts. Material risk takers’ remuneration by band1 Senior management MRTs (non-senior management) €0 – 1,000,000 €1,000,000 – 1,500,000 €1,500,000 – 2,000,000 €2,000,000 – 2,500,000 €2,500,000 – 3,000,000 €3,000,000 – 3,500,000 €3,500,000 – 4,000,000 €4,000,000 – 4,500,000 €4,500,000 – 5,000,000 €5,000,000 – 6,000,000 €6,000,000 – 7,000,000 €7,000,000 – 8,000,000 €8,000,000 – 9,000,000 €9,000,000 – 10,000,000 €10,000,000 – 11,000,000 37 20 13 12 10 6 3 3 1 5 2 — 1 — 1 917 180 53 29 13 3 2 5 — 1 — — — — — Total 598 $m 336.2 68.9 68.0 64.0 76.1 277.0 Total $m 937.4 417.3 270.0 — Total 13.3 19 7.2 8 5.0 Total 954 200 66 41 23 9 5 8 1 6 2 — 1 — 1 1 Table prepared in euros in accordance with Article 450 of the European Union Capital Requirements Regulation, using the rates published by the European Commission for financial programming and budget for December of the reported year as published on its website. 172 HSBC Holdings plc Annual Report and Accounts 2016 Directors’ Responsibility Statement Directors’ Responsibility Statement The Directors are responsible for preparing the Annual Report and Accounts, the Directors’ Remuneration Report and the financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the parent company (‘Company’) and Group financial statements in accordance with International Financial Reporting Standards (‘IFRSs’) as adopted by the European Union. In preparing these financial statements, the Directors have also elected to comply with IFRSs, issued by the International Accounting Standards Board (‘IASB’). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and Group and of the profit or loss of the Company and Group for that period. In preparing these financial statements, the Directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • state whether applicable IFRSs as adopted by the European Union and IFRSs issued by IASB have been followed, subject to any material departures disclosed and explained in the financial statements; and • prepare the financial statements on a going concern basis unless it is inappropriate to presume that the Company and Group will continue in business. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the financial statements and the Directors’ Remuneration Report comply with the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. The Directors are responsible for the maintenance and integrity of the Annual Report and Accounts 2016 as they appear on the Company’s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. The Directors consider that the Annual Report and Accounts 2016, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position, performance, business model and strategy. Each of the Directors, whose names and functions are listed in the ‘Report of the Directors: Corporate Governance’ section on pages 133 to 137 of the Annual Report and Accounts 2016, confirm that, to the best of their knowledge: • • the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Group; and the management report represented by the Report of the Directors includes a fair review of the development and performance of the business and the position of the Group, together with a description of the principal risks and uncertainties that it faces. In accordance with Section 418 of the Companies Act 2006, the Directors’ report includes a statement, in the case of each Director in office as at the date the Report of the Directors is approved, that: • so far as the Director is aware, there is no relevant audit information of which the Company’s auditors are unaware; and • they have taken all the steps they ought to have taken as a Director in order to make themselves aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. On behalf of the Board Douglas Flint Group Chairman 21 February 2017 HSBC Holdings plc Annual Report and Accounts 2016 173 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the independent auditors to the members of HSBC Holdings plc Report of the independent auditors to the members of HSBC Holdings plc Report on the financial statements1 Our opinion on the financial statements In our opinion HSBC Holdings plc’s (‘HSBC’) Group financial statements and parent company financial statements: • give a true and fair view of the state of the Group’s and parent company's affairs at 31 December 2016 and of the Group’s and parent company’s profit and cash flows for the year then ended; • have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union (‘IFRS’); and • have been prepared in accordance with the requirements of the Companies Act 2006, and as regards the Group financial statements, Article 4 of the IAS Regulation. Performing the audit On behalf of PricewaterhouseCoopers LLP (‘PwC’), it is my responsibility to form these opinions. This was the second year that you have appointed PwC as HSBC’s auditors, and I have therefore provided information on how PwC approached the audit, how it changed from the previous year and details of the significant discussions on key audit matters that I, and my senior colleagues, had with the Group Audit Committee (‘GAC’). How the audit approach was structured The audit approach was structured to reflect how HSBC is organised. It incorporated 4 important aspects. (1) Risk assessment and audit planning at a Group level, having regard to HSBC’s global businesses and its key legal entities: In 2015 I appointed partners to lead the audits for each global business. These partners continued in their roles and met regularly with the relevant HSBC management to understand strategy and matters which arose throughout the year that could have impacted financial reporting. The partners are specialists in the nature of the relevant businesses and were best placed to design the appropriate audit approach for that part of HSBC. They oversaw each PwC member firm involved in the audit of that global business and assisted me in my review of their work. (2) Audit work performed at global shared service centres: A significant amount of HSBC’s operational processes which are critical to financial reporting are undertaken in global shared service centres across 10 individual sites in 6 countries. Additionally, many financial reporting processes required to produce the financial statements are performed in HSBC’s Global Finance Centre based in Gurugram and Hyderabad, India. Working closely with me, a partner coordinated the audit work performed by PwC member firms in each of the global shared service locations. This work established an end-to-end picture of the key processes that supported material balances, classes of transactions and disclosures within the HSBC financial statements. We then evaluated the effectiveness of the controls over these processes and considered the implications for the remainder of our audit work. (3) Audit work executed on individual legal entities: We received opinions from PwC member firms which have been appointed as the external auditors of The Hongkong and Shanghai Banking Corporation Limited, HSBC Bank plc, HSBC North America Holdings Inc, HSBC Mexico S.A., HSBC Bank Argentina S.A., HSBC Bank Middle East Limited, HSBC Bank Canada and HSBC Private Banking Holdings (Suisse) S.A. I was in active dialogue throughout the year with the partners responsible for these audits; this included consideration of how well they planned and performed their work. My senior colleagues and I visited these subsidiaries, and attended Audit Committees meetings for most of them. We also visited businesses in a further 5 countries. I also attended meetings with management in each of these key subsidiaries at the year-end. The audits of these key subsidiaries relied upon work performed by PwC member firms in Bahrain, China, France, Germany, India, Qatar and Turkey. I considered how my subsidiary audit teams instructed and reviewed the work undertaken in these locations in order to ensure the quality and adequacy of their work. Collectively, the PwC member firms completed procedures covering 85% of assets, 85% of total operating income and 92% of profit before tax. (4) Audit procedures undertaken at a Group level and on the parent company: I ensured that appropriate further work was undertaken for the HSBC parent company. This work included auditing, for example, the consolidation of the Group’s results, the preparation of the financial statements, certain disclosures within the Directors' Remuneration Report, litigation provisions and exposures, and management’s entity level and oversight controls relevant to financial reporting. A consideration was also made of all changes to, and pending changes to, financial reporting standards and requirements. As an example, we considered the parent company’s decision to adopt the provisions of IFRS 9 ‘Financial Instruments’ relating to the fair value of its own debt, and work continues to be performed as part of wider preparations for the full implementation of the standard. In aggregate, these four areas provided me with the evidence required to form an opinion on the consolidated financial statements of HSBC. 1 HSBC Holdings plc’s financial statements comprise the consolidated and parent company balance sheets as at 31 December 2016, the consolidated and parent company income statements and the consolidated statement of comprehensive income for the year then ended, the consolidated and parent company statement of cash flows for the year then ended, the consolidated and parent company statements of changes in equity for the year then ended, and the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. Certain required disclosures have been presented elsewhere in the Annual Report and Accounts 2016, rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as audited. 174 HSBC Holdings plc Annual Report and Accounts 2016 Changes to the approach in 2016 In March, I chaired a two-day meeting in London of the partners and staff from PwC member firms who undertake audits of the most significant HSBC subsidiaries. This meeting provided an opportunity for those partners and staff to hear directly from HSBC management and the Chair of the GAC. We considered during this meeting how our view of significant audit risks had changed. In doing so, we used our experience in 2015 and considered how the strategic actions and their related targets may influence areas of significant judgement. The amount of work required to perform the audit was lower because of the audit knowledge that we had acquired during the previous 18 months, and many of the transition processes were not repeated. More detailed changes in the approach arose because of 4 areas: (1) Changes in the structure and strategy of the HSBC Group The presentation of the financial statements has been amended to reflect the new operating segments adopted by HSBC. Audit work has been completed to ensure that this change is both appropriate, and that previously reported information has been represented correctly. During the year, HSBC Bank Brazil was sold. As a consequence the audit work undertaken on this business was limited to detailed procedures on the loss on disposal and an assessment of whether it is appropriately classified in the Group’s income statement. In assessing the subsidiaries which were significant in 2016, I concluded that HSBC Insurance (Bermuda) Limited was no longer material, and therefore the scope of the audit was changed. (2) Changes to HSBC processes and controls As part of the efforts to streamline controls and reduce costs, more activities continued to be migrated to the global shared service centres. This resulted in work moving between PwC member firms. In July, a workshop was held in Paris for significant subsidiaries and service centre teams so that they could understand the impact of these changes. The other objective was to further standardise controls tested and understand the end to end process for significant classes of transaction. (3) Assessment of controls I reported to the GAC detailed observations on controls over financial reporting in relation to our work in 2015. The audit was designed to consider the work that HSBC management undertook to address these observations. For example, in my 2015 report to you I referenced the improvements management was making to controls around privileged access to systems. During 2016, my team performed extensive work on management’s actions in this area. (4) Changes in the macro environment I considered other macro factors to determine if changes in the approach were required, for example the impact of the United Kingdom’s decision to leave the European Union, the devaluation of the Mexican Peso and changes in the credit environment. I reported to the GAC in December that I did not believe that these changed my original risk assessment. The purpose and scope of the audit An audit has an important role in providing confidence in the financial statements that are provided by companies to their members. The audit opinion does not provide assurance over any particular number or disclosure, but over the financial statements taken as a whole. It is the Directors’ responsibility to prepare the financial statements and to be satisfied that they give a true and fair view. These responsibilities have been recognised on behalf of the Board of Directors on page 173. The scope of an audit is sometimes not fully understood. I believe that it is important that you understand the scope in order to understand the assurance that my opinion provides. My responsibility is to undertake my work and express my opinion in accordance with applicable law and the International Standards on Auditing (UK and Ireland) as issued by the Financial Reporting Council of the United Kingdom. These standards also require me to comply with the Auditing Practices Board’s Ethical Standards for Auditors. A description of the scope of an audit is provided on the Financial Reporting Council’s website at www.frc.org.uk/ auditscopeukprivate; I recommend that you read this description carefully. It is also important that you understand the inherent limitations of the audit which are disclosed in this description, for example the possibility that an approach based upon sampling and other audit techniques may not identify all issues. In order for me to perform my work, I had regard to the concept of materiality. I determined materiality as follows: Overall Group materiality $950m. How I determined it 5% of adjusted profit before tax excluding the debit valuation adjustment and non-qualifying hedges. Why I believe this is appropriate Given the geographically dispersed nature of HSBC and the diversity of its banking activities, I believe a standard benchmark of 5% of adjusted profit before tax is an appropriate quantitative indicator of materiality, although of course an item could also be material for qualitative reasons. I selected adjusted profit before tax, because as discussed on page 48, management believes it best reflects the performance of HSBC. I excluded the debit valuation adjustment and non-qualifying hedges as they are recurring items that in my view form part of ongoing business performance. When planning the audit, I considered if multiple errors might exist which, when aggregated, could exceed $950m. In order to reduce the risk of multiple errors that could aggregate to this amount, I used a lower level of materiality, known as performance materiality, of $710m to identify the individual balances, classes of transactions and disclosures that were subject to audit. I asked each of the partners reporting to me on the subsidiaries of HSBC to work to assigned materiality levels reflecting the size of the operations they audited. These ranged from $67m (HSBC Mexico S.A.) to $760m (The Hongkong and Shanghai Banking Corporation Limited). HSBC Holdings plc Annual Report and Accounts 2016 175 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the independent auditors to the members of HSBC Holdings plc Where the audit identified some items that were not reflected appropriately in the audited financial information, I considered these items carefully to assess if they were individually or in aggregate material. I reported any such items which exceeded $50m to the GAC. The Directors have concluded that all items which remained unadjusted were not material to the financial statements, either individually or in aggregate. I agree with their conclusion. Matters discussed with the GAC I attended each of the 8 GAC meetings held during the year. Part of each meeting involved a discussion with me without management present. I also met with members of the Committee on an ad hoc basis. During these various conversations we discussed my observations on a variety of accounting matters and observations on controls over financial reporting. During the April meeting, the audit plan was presented to the Committee. The plan included the matters which I considered presented the highest risk to the audit and other information, such as our approach to the audit of journals, interest income and financial instrument valuation, and where the latest technology would be used to obtain better quality audit evidence. Throughout the year, this plan was refreshed and revised to account for changes in the external and internal environment at HSBC. As a result of operational issues in the US we changed our view of the risks associated with the accounting for pensions. This change led to a change in our audit approach which was discussed with the GAC. In December, the GAC held a meeting with a particular focus on control matters. We also discussed their impact on our audit approach, for example we explored how our audit approach would be amended to focus more on the controls used by management over key spreadsheets and system-generated information used in financial reporting. The areas of highest audit risk, where I focused most effort and resource, were: • • IT access management; impairment of loans and advances; • goodwill; • investment in Bank of Communications Co., Ltd (BoCom); • application of hedge accounting; • • litigation and regulatory enforcement actions; impact of the deferred prosecution agreement (DPA); and • pension liabilities. To help you understand their impact on the audit, I have listed them in order of decreasing audit effort. Some of them are common to other international banks, and some are specific to HSBC. I have included at the end of this report an explanation of each item, why it was considered an area of audit focus and how the audit approach was tailored to address the risk of misstatement. Going concern The Directors have made a statement on page 146 regarding going concern. This statement is based on their belief that the Group and parent company intend to, and have sufficient resources to, remain in business for 12 months from the date of this report. I am required to review this statement, and in doing so I have considered HSBC’s budgets, cash flows, capital plan and stress tests. I have nothing to report as a result of my review. I also have nothing material to add or draw attention to in relation to the statement. Other reporting The Annual Report and Accounts 2016 also contains a considerable amount of other information that is required by various regulators or standard setters. In respect of this information, my responsibilities and my reporting are set out in the table below. 176 HSBC Holdings plc Annual Report and Accounts 2016 Area of the Annual Report and Accounts 2016 My responsibility My reporting Directors’ Remuneration Report on pages 153 to 172 Those parts of which are clearly marked as audited. Consider whether the information is properly prepared. In my opinion, this information has been properly prepared in accordance with the Companies Act 2006. Other remuneration report disclosures. Consider whether certain other disclosures specified by the Companies Act have been made. The other required disclosures have been made. Other areas Strategic Report and the Directors’ Report (as defined on page 30). Viability statement on page 146 which considers the longer term sustainability of the Group’s business model. Directors’ confirmation of their robust assessment of principal risks, and disclosures describing those risks and how they are managed or mitigated on page 146. GAC Report on page 141. Directors’ statement (on page 173) that they consider the HSBC Annual Report and Accounts 2016, taken as a whole, to be fair, balanced and understandable and provides the information necessary for you to assess HSBC’s position and performance, business model and strategy. Corporate governance report (on pages 132 to 173). All other information in the Annual Report and Accounts 2016 aside from the audited financial statements. Consider whether they are consistent with the audited financial statements. Consider whether they are prepared in accordance with applicable legal requirements. Report if I have identified any material misstatements in either report. This is based on my knowledge and understanding of the Group and parent company that was obtained during the audit, and the environment they operate in. In my opinion, the information in these reports is consistent with the audited financial statements and prepared in accordance with applicable legal requirements. I have no material misstatements to report. Review the statement in the light of the knowledge gathered during the audit. I have nothing material to draw attention to or to add to the statement. Review the confirmation and description in the light of the knowledge gathered during the audit. I have nothing material to draw attention to or to add to the confirmation or description. Consider whether it deals appropriately with those matters that I reported to the GAC. No exceptions to report. Consider whether any information found during the course of the audit would cause me to disagree. No disagreements to report. Review the remaining 10 provisions of the UK Corporate Governance Code specified for our review by the UK Listing Rules. Consider whether it is materially inconsistent or materially incorrect based on the knowledge gained in my audit, or otherwise misleading. Consider whether it is materially inconsistent with the audited financial statements. Nothing to report following our review. No exceptions to report. In addition, I am required to report to you if: • I have not received all of the information and explanations required for my audit; • adequate accounting records have not been kept by the parent company; • • returns adequate for my audit have not been received from branches not visited by PwC; and the parent company financial statements and the audited part of the Directors’ Remuneration Report do not agree with the accounting records and returns. I have no exceptions to report as a result of any of these responsibilities. Use of this report This report, including the opinions, has been prepared for and only for you, the parent company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006, and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come except where expressly agreed by our prior written consent. Richard Oldfield (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London, United Kingdom 21 February 2017 HSBC Holdings plc Annual Report and Accounts 2016 177 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the independent auditors to the members of HSBC Holdings plc Appendix: Key audit matters discussed with the Group Audit Committee (‘GAC’) Those areas which presented the greatest risk of material misstatement in the financial statements are required to be discussed with the GAC. They had the greatest effect on the audit, including the allocation of resources and effort and are discussed below together with an explanation of how the audit was tailored to address these specific areas. IT Access Management Nature of area of focus All banks are highly dependent on technology due to the significant number of transactions that are processed daily. The audit approach relies extensively on automated controls and therefore procedures are designed to test access and control over IT systems. As reported in the prior year, controls over individuals’ access rights to operating systems, applications and data used in the financial reporting process required improvement. Access rights are important as they ensure that changes to applications and data are authorised and made in an appropriate manner. Ensuring staff only have appropriate access, and that the access is monitored, are key controls to mitigate the potential for fraud or error as a result of a change to an application or underlying data. A number of enhancements to the control environment have been made by management since our last report but some controls were not fully remediated by the year end and we continued to assess the risk of a material misstatement arising from access to technology as significant for the audit. Procedures performed to support our discussions and conclusions Matters discussed with the GAC The original approach discussed with the GAC was based on the control enhancements proposed by management, and involved the testing of new and improved control processes. This was supplemented with other control and substantive procedures required for the periods of the year when the changes would not yet have been effective. As the timing of the enhancements to controls changed during the year, we reflected this in the nature and extent of testing, and our final approach was discussed with the GAC in October. At each GAC meeting, there was a discussion on the status of the control remediation programme, work performed by management and results of testing performed. Access rights were tested over the various aspects of technology relied upon for financial reporting. Specifically, the audit tested that: • new access requests for joiners were properly reviewed and authorised; • application user access rights were removed on a timely basis when an individual left or moved role; • access rights to applications were periodically monitored for appropriateness; and • highly privileged access was restricted to appropriate personnel. Other areas that were independently assessed included password policies, security configurations, controls over changes to applications and databases and that business users, developers and production support did not have access to change applications, the operating system or databases in the production environment. As a consequence of the deficiencies identified a range of other procedures were performed: • where inappropriate access was identified, we understood the nature of the access, and, where possible, obtained additional evidence on the appropriateness of the activities performed; • additional substantive testing was performed on specific year-end reconciliations (i.e. custodian, bank account and suspense account reconciliations) and confirmations with external counterparties; • testing was performed on other compensating controls such as business performance reviews; and • a list of users with access to systems was obtained and manually compared to other access lists where segregation of duties was deemed to be of higher risk, for example users having access to both core banking and payments systems. Relevant references in the Annual Report and Accounts 2016 GAC Report, page 141. Effectiveness of internal controls, page 145. Impairment of loans and advances Nature of the area of focus Impairment allowances represent management’s best estimate of the losses incurred within the loan portfolios at the balance sheet date. They are calculated on a collective basis for portfolios of loans of a similar nature and on an individual basis for significant loans. The calculation of both collective and individual impairment allowances is inherently judgemental for any bank. Collective impairment allowances are calculated using models which approximate the impact of current economic and credit conditions on large portfolios of loans. The inputs to these models are based on historical loss experience with judgement applied to determine the assumptions used to calculate impairment. Model overlays are applied where data driven parameters or calculations are not considered representative of current risks or conditions of the loan portfolios. For specific impairments, judgement is required to determine when an impairment event has occurred and then to estimate the expected future cash flows related to that loan. The audit was focused on impairment due to the materiality of the loan balances and associated impairment allowances and the subjective nature of the impairment calculation. The largest loan portfolios are in Europe and Asia with the more significant impairment allowances being in Europe, North America and Latin America. Matters discussed with the GAC At each GAC and Group Risk Committee meeting there was a discussion on changes to risk factors and other inputs within the collective allowance models as well as discussions on individually significant loan impairments. We discussed a number of specific risks that changed or emerged during the course of the year, including the impact of the UK’s decision to leave the European Union; the economic slowdown in China; volatility in the oil price which impacted individual credits; and the increased macroeconomic uncertainty in North America. In all of these cases we discussed the performance of the existing credit exposures, and the potential need for changes to modelling approaches. We also discussed any significant changes made to the inputs or models impacting the collective impairment allowance as well as changes in the control environment. These included key assumptions over the retail impairment models and improvements in the way higher risk loans were identified and escalated within the organisation. 178 HSBC Holdings plc Annual Report and Accounts 2016 Impairment of loans and advances Procedures performed to support our discussions and conclusions The controls management has established to support their collective and specific impairment calculations were tested. • For collective impairment, this included controls over the appropriateness of models used to calculate the charge, the process of determining key assumptions and the identification of loans to be included within the calculation. • For specific impairment charges on individual loans, this included controls over the monitoring of the credit watch list, credit file review processes, approval of external collateral valuation vendors and review controls over the approval of significant individual impairments. • For collective allowances, the appropriateness of the modelling policy and methodology used for material portfolios was independently assessed by reference to the accounting standards and market practices. Model calculations were tested through reperformance and code review. Specifically with respect to the collective impairment models for the retail portfolios, we reviewed the enhancements made to the models and methodology to ensure they were appropriate. • The appropriateness of management’s judgements was also independently considered in respect of calculation methodologies, segmentation, economic factors and judgemental overlays, the period of historical loss rates used, loss emergence periods, cure rates for impaired loans, and the valuation of recovery assets and collateral. • For specific allowances, the appropriateness of provisioning methodologies and policies was independently assessed for a sample of loans across the portfolio selected on the basis of risk. An independent view was formed on the levels of provisions booked based on the detailed loan and counterparty information in the credit file. Calculations within a sample of discounted cash flow models were reperformed. Relevant references in the Annual Report and Accounts 2016 Impaired loans, page 90. GAC Report, page 141. Note 1 (d): Financial instruments measured at amortised cost, page 198. Goodwill Nature of the area of focus Matters discussed with the GAC The Group had goodwill of $15.5bn from a number of historical acquisitions across cash-generating units (CGUs). An assessment is required annually to establish whether a CGU’s goodwill should continue to be recognised, or if any impairment exists. At each reporting period, management is also required to identify any potential indicators, and to perform an impairment assessment if any are identified. The impairment assessment calculation used for the tests were based on estimated future cash flows for each CGU discounted at an appropriate cost of equity rate. HSBC used its Annual Operating Plan as the basis for the first five years of cash flows and then extrapolated returns into perpetuity using a terminal growth factor. Cost of equity rates were based on the investment rates used within the global business and approved by the Board. The estimation of future cash flows and the level to which they are discounted is inherently uncertain and requires significant judgement. The extent of judgement and the size of the goodwill, resulted in this matter being identified as an area of focus. We discussed the conclusions of goodwill assessments with the GAC when they considered the annual test and at each reporting period when they considered whether indicators of impairment existed. At 30 June, indicators of impairment were identified in GPB – Europe and GB&M – Europe, which prompted a full impairment test for these two CGUs. This led to an impairment of $800m of goodwill in GPB – Europe. The annual assessment was performed in the third quarter based on 1 July data. This assessment concluded no further impairment of goodwill was required. The discussions with the GAC focused on the key assumptions, both individually and when combined together. During these discussions, management confirmed their view that the forecasts for each CGU remained appropriate. Subsequently, we discussed with the GAC the impact of changing segments on the CGUs, particularly the decision to change the CGU associated with GB&M, as disclosed on page 240. The discussion also covered the decision not to change the other CGUs. At 31 December, management identified further indicators of impairment in the GPB - Europe CGU. A retest was performed and it was concluded that all remaining goodwill for the CGU should be written off. In reaching this conclusion, a view was taken on the future performance of the business, and the risk associated with these forecasts. We discussed the approach and adjustments with the GAC. Procedures performed to support our discussions and conclusions • Goodwill was assessed immediately before and after the new reporting segments were established. Both bases of the assessment were considered in the audit. • PwC’s independent valuation experts critically assessed the discount rate and terminal growth rates used in the discounted cash flow models. The focus was on the methodology used to estimate discount rates of a CGU; and whether the use of the nominal GDP growth rates was the most appropriate in estimating the terminal growth rates into perpetuity for each CGU. • The calculations used in the model were reperformed to check accuracy and the key inputs in the model were agreed to underlying sources. • Management’s future cash flow forecasts used in the model were assessed by: – testing that the forecasts agreed to the latest Annual Operating Plan approved by management; – considering current year performance against plan and the reasons for any deviation, and key drivers or strategies underlying the plan. These were discussed with management of the Global Businesses for each sensitive CGU; – reviewing the historical achievement of the Annual Operating Plan. Given the uncertainties in forecasting, this identified that forecasts have been less accurate for prior periods, and we considered if this was appropriately factored into the valuation model; – independent sensitivity analysis was performed to identify any further CGUs with a risk of impairment. The reasonableness of management’s threshold of sensitive CGUs was assessed; and – the appropriateness of disclosures made in relation to goodwill was also considered. Relevant references in the Annual Report and Accounts 2016 GAC Report, page 141. Note 20: Goodwill and intangible assets, page 239. HSBC Holdings plc Annual Report and Accounts 2016 179 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the independent auditors to the members of HSBC Holdings plc Investment in associate – Bank of Communications Company, Limited (‘BoCom’) Nature of the area of focus Matters discussed with the GAC HSBC's investment in BoCom is accounted for as an associate, using the equity method. This is the fourth consecutive year end that the market value of BoCom has been below the carrying value. At 31 December, the market value based on the share price was $11.1bn compared with the carrying value of $15.8bn. This is considered an indicator of potential impairment under IFRS. An impairment test was performed by HSBC using a value in use model to estimate the investment’s value assuming it continues to be held in perpetuity rather than sold ($16.1bn). On this basis no impairment was recorded and the share of BoCom’s profits has been recognised in the consolidated income statement. The value in use model determines the present value of HSBC’s share of BoCom’s future cash flows. The model is dependent on many assumptions, both short-term and long-term in nature. These assumptions are derived from a combination of management estimates, analysts’ forecasts and market data, and are highly judgemental. Discussions with the GAC were focused on: • the continued appropriateness of the value in use model given the period of time that the carrying value has been in excess of market value; • the key assumptions used in the model with a particular focus on the assumptions with the highest level of uncertainty including the long-term growth rate and the long term loan loss rate; • the reasonably possible alternative assumptions that were considered to identify those assumptions to which the value in use was most sensitive and to demonstrate the impact on the value in use of a movement in those assumptions; and • the overall justifications for the divergence between the value in use and market value. During these discussions, HSBC confirmed its view that the model, assumptions and cash flow forecasts remained appropriate. Procedures performed to support our discussions and conclusions • The conclusions on the appropriateness of the model were reviewed and the discount rate used within the model was independently recalculated • with the assistance of our valuation experts. Inputs used in the determination of assumptions within the model were challenged and corroborating information was obtained with reference to external market information, third-party sources, including analyst reports, and historical publicly available BoCom information. • The controls in place over the model were tested. • The year-end meeting between management and senior BoCom executive management, held specifically to identify facts or circumstances impacting management assumptions, was observed. • The mathematical accuracy of the model was tested. • Disclosures made in the Annual Report and Accounts 2016 in relation to BoCom were reviewed. Relevant references in the Annual Report and Accounts 2016 Note 1.1(f): Critical accounting estimates and judgements, page 196. Note 17: Interests in associates and joint ventures, page 232. Application of hedge accounting Nature of the area of focus Matters discussed with the GAC To qualify for hedge accounting, certain criteria must be met including documenting the nature and purpose of the hedge and performing regular testing over its effectiveness. Due to the complex nature of the hedge accounting rules this is often an area of significant risk for banks. In our prior report to you, we noted that audit testing had identified a number of instances where hedging was applied, but the accounting rules had not been adequately met. This resulted in the remediation of existing controls and the implementation of new controls in the last quarter of 2015. In light of the prior year matters, we determined this to be an area of significant audit risk. We discussed with the GAC during the year, the progress made by management in the implementation of the new controls. During December 2016, management in France identified a further issue with an established hedging relationship, which resulted in a partial discontinuation of the hedge. A discussion was held with the GAC regarding both the root cause of the matter, the period in which the adjustment should be recognised and over which controls that had not operated effectively. As indicated by the above matter, not all of the hedge accounting controls operated effectively in the year. The exceptions noted were limited to France. Procedures performed to support our discussions and conclusions • For all significant macro cash flow hedges, documentation was examined and the relationships assessed to determine if the hedges had been appropriately designated. This included consideration of the hedge objectives and specific compliance with IFRS. • A sample of new hedging relationships was examined and the relationships assessed to determine if they had been appropriately designated. This included consideration of the hedge objectives and specific compliance with IFRS. • Management’s hedge effectiveness reviews, and the measurement and recording of hedge ineffectiveness, were tested for a sample of hedge relationships. • Understood and tested controls over the documentation and review of the hedge relationships and their initial and ongoing effectiveness. • Additional substantive audit procedures were performed over the partial discontinuation of the hedging relationship in France. Relevant references in the Annual Report and Accounts 2016 GAC Report, page 141. Note 14: Derivatives, page 227. 180 HSBC Holdings plc Annual Report and Accounts 2016 Litigation and regulatory enforcement actions Nature of the area of focus Matters discussed with the GAC HSBC, like other global banking institutions, is exposed to a significant number of open legal cases and regulatory investigations in a number of its markets. Given the business is geographically dispersed, the same matter could be subject to investigation in multiple jurisdictions. Provisions of $2.4bn have been established to account for legal settlements and regulatory fines. The most significant provisions relate to tax-related investigations and foreign exchange market manipulation. There are a number of legal and regulatory matters for which no provision has been established, as discussed on page 257. There is an inherent risk that legal exposures are not identified and considered for financial reporting purposes on a timely basis. Importantly, the decision to recognise a provision and the basis of measurement are judgemental. Procedures performed to support our discussions and conclusions Group Legal provided to each GAC meeting an update on the status of legal cases. These updates considered whether all related litigation or investigations about a specific matter had been identified. Material matters were discussed during each meeting and the need for changes to provisions considered. We participated in these discussions, including consideration of whether any constructive obligation had arisen in individual cases. • Controls designed to ensure the completeness and adequacy of current legal and regulatory provisions were tested. Regulatory correspondence from material markets was also read, and a sample of legal expenses were reviewed. • Open legal cases were discussed with Group Legal and in certain instances we obtained and reviewed the relevant regulatory and litigation documents in order to assess the facts and circumstances. • The range of reasonably possible outcomes was considered for material provisions to independently assess the appropriateness of the judgement made by HSBC. • The disclosures of legal exposures and provisions were assessed for completeness and accuracy. Relevant references in the Annual Report and Accounts 2016 GAC Report, page 141. Note 27: Provisions, page 244. Note 35: Legal proceedings and regulatory matters, page 257. Impact of the deferred prosecution agreement (‘DPA’) Nature of the area of focus Matters discussed with the GAC HSBC and HSBC Bank USA, N.A., (‘HBUS’) entered into a DPA with the US Department of Justice (DoJ), Federal Reserve Board and Financial Conduct Authority in 2012 regarding non-compliance with the US Bank Secrecy Act, anti-money laundering rules, and sanctions laws. The duration of the DPA is five years. If the DOJ were to conclude that a breach of the DPA had occurred, there are a number of potential penalties that could be imposed that could have a material adverse effect on HSBC’s business. This could include loss of business and withdrawal of funding, restrictions on US dollar clearing functions through HSBC Bank USA or revocation of bank licences. The loss of this ability could have a significant adverse impact on the going concern status of HSBC and its individual subsidiaries in the future. In considering going concern as the basis of preparation of the financial statements, a discussion was held with the GAC about the progress being made in responding to the requirements of the DPA. The conversation specifically considered the 2016 report of the Monitor. In the report, he expressed significant concerns about the pace of progress, instances of potential financial crime and systems and control deficiencies, whether HSBC is on track to meet its goal to the Monitor’s satisfaction within the five-year period and, pending further review and discussion with HSBC, did not certify as to HSBC’s implementation of, and adherence to, remedial measures specified in the DPA. Assurances were sought from the Directors that they were not aware of any information to suggest that the DoJ had concluded that the DPA had been breached. Procedures performed to support our discussions and conclusions • The likelihood of the DPA being breached and a restriction to US dollar clearing imposed was independently assessed through: – inquiry with the Monitor, whose role is explained on page 82, to understand the status of his work, the outcome of his most recent country reviews, his assessment of management’s progress against the requirements of the DPA and his reporting to the DoJ and FCA; – reading the 2016 Monitor annual report and the 11 country reports issued during the year; and – reading a sample of reports produced by the compliance function that undertook a Global Standards operational effectiveness exercise, and an assessment of the findings. • Each Group Risk Committee meeting was attended during the year. At each meeting a report was provided by Group Risk on the status of the Global Standards programme, which aims to address the DPA recommendations. The related discussion was observed. • The papers supporting the Financial System Vulnerabilities Committee meeting at the year-end were read. This meeting discussed the 2016 Monitor report and management’s response. • Compliance with the DPA was discussed with Group Legal and other members of senior management. Relevant references in the Annual Report and Accounts 2016 Top and emerging risks, page 64. Areas of special interest: the Monitor, page 82. Financial System Vulnerabilities Committee, page 143. Going concern and viability statements, page 146. Note 35: Legal proceedings and regulatory matters, page 257. HSBC Holdings plc Annual Report and Accounts 2016 181 Strategic ReportFinancial Review Financial Statements Shareholder Information Corporate Governance Report of the independent auditors to the members of HSBC Holdings plc Pension liabilities Nature of the area of focus HSBC has $39.8bn of pension liabilities as a result of defined benefit pension schemes. The calculation of these pension liabilities is complex and HSBC uses third party actuaries to provide support in the process to ensure appropriate expertise is applied to the calculation. The use of these actuaries also increases the risk of error as data is passed to third parties for analysis and calculation purposes. Considering all of these factors, our initial assessment of the risk of misstatement did not identify pension liabilities as an area of significant focus as there was no history of error and the pension funds were in surplus reducing the risk of fraud. During the year management identified errors in the transfer and use of data by third parties for one of the schemes in the US. As a result of this error, we reconsidered our assessment of the audit risk surrounding pension liability valuations and increased our scope of testing in this area. Procedures performed to support our discussions and conclusions Matters discussed with the GAC The change in the assessment of risk was discussed and agreed with the GAC in December 2016. We focused our testing response and our discussions with GAC on the largest schemes in the UK and US, which made up 84% of the overall liability balance at 31 December 2016. Our increased testing was focused on the transfer and use of data by third parties to form the calculation. • The controls over the review and approval of actuarial assumptions, the completeness and accuracy of data provided to external actuaries, and the reconciliation to data used in experts calculation were tested. • Controls over the third party vendors were tested and the third party assurance reports covering controls operated by the vendors were reviewed. • The output from external actuaries was inspected and an independent view was formed of key actuarial assumptions. • Data used by the actuary in the calculation and the system to ledger reconciliations was independently tested. Relevant references in the Annual Report and Accounts 2016 Note 5: Page 208 182 HSBC Holdings plc Annual Report and Accounts 2016 Financial Statements 12 Fair values of financial instruments not carried at fair value 13 Financial assets designated at fair value Consolidated income statement Consolidated statement of comprehensive income Consolidated balance sheet Consolidated statement of cash flows Consolidated statement of changes in equity HSBC Holdings income statement HSBC Holdings statement of comprehensive income HSBC Holdings balance sheet HSBC Holdings statement of cash flows HSBC Holdings statement of changes in equity Notes on the Financial Statements 1 Basis of preparation and significant accounting policies 2 Net income/(expense) from financial instruments designated at fair value 3 Insurance business 4 Operating profit 5 Employee compensation and benefits 6 Auditors’ remuneration 7 Tax 8 Dividends 9 Earnings per share 10 Trading assets 11 Fair values of financial instruments carried at fair value Page 184 185 186 187 188 190 190 191 192 193 194 203 204 206 206 212 213 215 216 216 217 14 Derivatives 15 Financial investments 16 Assets pledged, collateral received and assets transferred 17 Interests in associates and joint ventures 18 Investments in subsidiaries 19 Structured entities 20 Goodwill and intangible assets 21 Prepayments, accrued income and other assets 22 Assets held for sale and liabilities of disposal groups held for sale 23 Trading liabilities 24 Financial liabilities designated at fair value 25 Debt securities in issue 26 Accruals, deferred income and other liabilities 27 Provisions 28 Subordinated liabilities 29 Maturity analysis of assets, liabilities and off-balance sheet commitments 30 Offsetting of financial assets and financial liabilities 31 Non-controlling interests 32 Called up share capital and other equity instruments 33 Contingent liabilities, contractual commitments and guarantees 34 Lease commitments 35 Legal proceedings and regulatory matters 36 Related party transactions 37 Events after the balance sheet date 38 HSBC Holdings’ subsidiaries, joint ventures and associates 224 226 226 229 230 231 235 236 238 241 241 242 242 242 243 243 244 247 252 253 253 255 256 256 262 264 265 HSBC Holdings plc Annual Report and Accounts 2016 183 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Financial Statements Consolidated income statement for the year ended 31 December Net interest income – interest income – interest expense Net fee income – fee income – fee expense Net trading income – trading income excluding net interest income – net interest income on trading activities Net income/(expense) from financial instruments designated at fair value – changes in fair value of long-term debt and related derivatives – net income from other financial instruments designated at fair value Gains less losses from financial investments Dividend income Net insurance premium income Other operating income/(expense) Total operating income Net insurance claims and benefits paid and movement in liabilities to policyholders Net operating income before loan impairment charges and other credit risk provisions Loan impairment charges and other credit risk provisions Net operating income Employee compensation and benefits General and administrative expenses Depreciation and impairment of property, plant and equipment Amortisation and impairment of intangible assets Goodwill impairment of Global Private Banking – Europe Total operating expenses Operating profit Share of profit in associates and joint ventures Profit before tax Tax expense Profit for the year Attributable to: – ordinary shareholders of the parent company – preference shareholders of the parent company – other equity holders – non-controlling interests Profit for the year Basic earnings per ordinary share Diluted earnings per ordinary share Notes 2 3 3 4 5 20 4 17 7 8 8 9 9 2016 $m 29,813 42,414 (12,601) 12,777 15,669 (2,892) 9,452 8,066 1,386 (2,666) (3,975) 1,309 1,385 95 9,951 (971) 59,836 (11,870) 47,966 (3,400) 44,566 (18,089) (16,473) (1,229) (777) (3,240) (39,808) 4,758 2,354 7,112 (3,666) 3,446 1,299 90 1,090 967 3,446 $ 0.07 0.07 2015 $m 32,531 47,189 (14,658) 14,705 18,016 (3,311) 8,723 6,948 1,775 1,532 863 669 2,068 123 10,355 1,055 71,092 (11,292) 59,800 (3,721) 56,079 (19,900) (17,662) (1,269) (937) — (39,768) 16,311 2,556 18,867 (3,771) 15,096 2014 $m 34,705 50,955 (16,250) 15,957 19,545 (3,588) 6,760 4,853 1,907 2,473 508 1,965 1,335 311 11,921 1,131 74,593 (13,345) 61,248 (3,851) 57,397 (20,366) (18,565) (1,382) (936) — (41,249) 16,148 2,532 18,680 (3,975) 14,705 12,572 13,115 90 860 1,574 15,096 $ 0.65 0.64 90 483 1,017 14,705 $ 0.69 0.69 184 HSBC Holdings plc Annual Report and Accounts 2016 Consolidated statement of comprehensive income for the year ended 31 December Profit for the year Other comprehensive income/(expense) Items that will be reclassified subsequently to profit or loss when specific conditions are met: Available-for-sale investments – fair value gains/(losses) – fair value gains reclassified to the income statement – amounts reclassified to the income statement in respect of impairment losses – income taxes Cash flow hedges – fair value (losses)/gains – fair value losses/(gains) reclassified to the income statement – income taxes Share of other comprehensive income/(expense) of associates and joint ventures – share for the year – reclassified to income statement on disposal Exchange differences – foreign exchange gains reclassified to income statement on disposal of a foreign operation – other exchange differences – income tax attributable to exchange differences Items that will not be reclassified subsequently to profit or loss: Remeasurement of defined benefit asset/liability – before income taxes – income taxes Other comprehensive income for the year, net of tax Total comprehensive income for the year Attributable to: – ordinary shareholders of the parent company – preference shareholders of the parent company – other equity holders – non-controlling interests Total comprehensive income for the year 2016 $m 3,446 (299) 475 (895) 71 50 (68) (297) 195 34 54 54 — (8,092) 1,894 (9,791) (195) 7 (84) 91 (8,398) (4,952) (6,968) 90 1,090 836 (4,952) 2015 $m 15,096 (3,072) (1,231) (2,437) 127 469 (24) 704 (705) (23) (9) (9) — (10,945) — (11,112) 167 101 130 (29) (13,949) 1,147 (490) 90 860 687 1,147 2014 $m 14,705 2,972 4,794 (1,672) 374 (524) 188 1,512 (1,244) (80) 80 78 2 (8,903) (21) (8,917) 35 1,985 2,419 (434) (3,678) 11,027 8,672 90 483 1,782 11,027 HSBC Holdings plc Annual Report and Accounts 2016 185 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Financial Statements Consolidated balance sheet at 31 December Assets Cash and balances at central banks Items in the course of collection from other banks Hong Kong Government certificates of indebtedness Trading assets Financial assets designated at fair value Derivatives Loans and advances to banks Loans and advances to customers Reverse repurchase agreements – non-trading Financial investments Assets held for sale Prepayments, accrued income and other assets Current tax assets Interests in associates and joint ventures Goodwill and intangible assets Deferred tax assets Total assets at 31 Dec Liabilities and equity Liabilities Hong Kong currency notes in circulation Deposits by banks Customer accounts Repurchase agreements – non-trading Items in the course of transmission to other banks Trading liabilities Financial liabilities designated at fair value Derivatives Debt securities in issue Liabilities of disposal groups held for sale Accruals, deferred income and other liabilities Current tax liabilities Liabilities under insurance contracts Provisions Deferred tax liabilities Subordinated liabilities Total liabilities at 31 Dec Equity Called up share capital Share premium account Other equity instruments Other reserves Retained earnings Total shareholders’ equity Non-controlling interests Total equity at 31 Dec Notes 10 13 14 15 22 21 17 20 7 23 24 14 25 22 26 3 27 7 28 32 32 31 2016 $m 128,009 5,003 31,228 235,125 24,756 290,872 88,126 861,504 160,974 436,797 4,389 59,520 1,145 20,029 21,346 6,163 2015 $m 98,934 5,768 28,410 224,837 23,852 288,476 90,401 924,454 146,255 428,955 43,900 54,398 1,221 19,139 24,605 6,051 2,374,986 2,409,656 31,228 59,939 28,410 54,371 1,272,386 1,289,586 88,958 5,977 153,691 86,832 279,819 65,915 2,790 41,501 719 75,273 4,773 1,623 20,984 80,400 5,638 141,614 66,408 281,071 88,949 36,840 38,116 783 69,938 5,552 1,760 22,702 2,192,408 2,212,138 10,096 12,619 17,110 (1,234) 136,795 175,386 7,192 182,578 9,842 12,421 15,112 7,109 143,976 188,460 9,058 197,518 Total liabilities and equity at 31 Dec 2,374,986 2,409,656 The accompanying notes on pages 194 to 271, the audited sections in ‘Global businesses and regions’ on pages 44 to 60, ‘Risk’ on pages 64 to 126, ‘Capital’ on pages 127 to 131 and ‘Directors’ Remuneration Report’ on pages 153 to 170 form an integral part of these financial statements. These financial statements were approved by the Board of Directors on 21 February 2017 and signed on its behalf by: Douglas Flint Group Chairman Iain Mackay Group Finance Director 186 HSBC Holdings plc Annual Report and Accounts 2016 Consolidated statement of cash flows for the year ended 31 December Profit before tax Adjustments for non-cash items: Depreciation, amortisation and impairment Net gain from investing activities Share of profits in associates and joint ventures (Gain)/loss on disposal of subsidiaries, businesses, associates and joint ventures Loan impairment losses gross of recoveries and other credit risk provisions Provisions including pensions Share-based payment expense Other non-cash items included in profit before tax Elimination of exchange differences Changes in operating assets and liabilities Change in net trading securities and derivatives Change in loans and advances to banks and customers Change in reverse repurchase agreements – non-trading Change in financial assets designated at fair value Change in other assets Change in deposits by banks and customer accounts Change in repurchase agreements – non-trading Change in debt securities in issue Change in financial liabilities designated at fair value Change in other liabilities Dividends received from associates Contributions paid to defined benefit plans Tax paid Net cash from operating activities Purchase of financial investments Proceeds from the sale and maturity of financial investments Net cash flows from the purchase and sale of property, plant and equipment Net cash inflow/(outflow) from disposal of customer and loan portfolios Net investment in intangible assets Net cash flow on disposal of subsidiaries, businesses, associates and joint ventures Net cash from investing activities Issue of ordinary share capital and other equity instruments Net sales/(purchases) of own shares for market-making and investment purposes Purchase of treasury shares Redemption of preference shares and other equity instruments Subordinated loan capital issued Subordinated loan capital repaid Dividends paid to shareholders of the parent company and non-controlling interests Net cash from financing activities Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at 1 Jan Exchange differences in respect of cash and cash equivalents Cash and cash equivalents at 31 Dec Cash and cash equivalents comprise: – cash and balances at central banks – items in the course of collection from other banks – loans and advances to banks of one month or less – reverse repurchase agreements with banks of one month or less – treasury bills, other bills and certificates of deposit less than three months – less: items in the course of transmission to other banks Footnotes 2016 $m 7,112 5,212 (1,215) (2,354) 1,743 4,090 2,482 534 (207) 2015 $m 18,867 2,181 (1,935) (2,556) — 4,546 3,472 757 (191) 2014 $m 18,680 2,251 (1,928) (2,532) 41 5,125 3,609 732 (487) 1 15,364 18,308 24,571 4,395 52,868 (13,138) (1,235) (6,591) (8,918) 8,558 (23,034) 17,802 8,792 689 (726) (3,264) 68,959 (457,084) 430,085 (1,151) 9,194 (906) 4,802 (15,060) 2,024 523 (2,510) (1,825) 2,622 (595) (9,157) (8,918) 44,981 243,863 (14,294) 274,550 128,009 5,003 77,318 55,551 14,646 (5,977) 274,550 24,384 32,971 (3,011) 2,394 9,090 (65,907) (26,481) 960 (10,785) (4,549) 879 (664) (3,852) (1,122) (438,376) 399,636 (1,249) 2,023 (954) 8 (38,912) 3,727 331 — (463) 3,180 (2,157) (8,195) (3,577) (43,611) 301,301 (13,827) 243,863 98,934 5,768 70,985 53,971 19,843 (5,638) 243,863 (18,498) 17,813 18,900 3,269 4,393 (17,443) (56,788) (8,133) (10,734) (716) 757 (681) (3,573) (21,372) (384,199) 382,837 (1,389) (1,035) (903) (272) (4,961) 5,948 (96) — (234) 3,500 (3,163) (7,823) (1,868) (28,201) 346,281 (16,779) 301,301 129,957 4,927 89,285 68,930 14,192 (5,990) 301,301 2 3 Interest received was $42,586m (2015: $47,623m; 2014: $51,522m), interest paid was $12,027m (2015: $14,559m; 2014: $15,633m) and dividends received were $475m (2015: $914m; 2014: $1,199m). 1 Adjustment to bring changes between opening and closing balance sheet amounts to average rates. This is not done on a line-by-line basis, as details cannot be determined without unreasonable expense. In July 2016, we completed the disposal of the Brazilian operations resulting in net cash inflow of $4.8bn. 2 3 At 31 December 2016 $35,501m (2015: $33,744m) was not available for use by HSBC, of which $21,108m (2015: $21,773m) related to mandatory deposits at central banks. HSBC Holdings plc Annual Report and Accounts 2016 187 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Financial Statements Consolidated statement of changes in equity for the year ended 31 December Other reserves5 Called up share capital and share premium1 Other equity instru- ments2 Retained earnings3, 4 Available- for-sale fair value reserve Cash flow hedging reserve Foreign exchange reserve Total share- holders’ equity Non- controlling interests Merger reserve6 Total equity $m $m $m 22,263 15,112 143,976 $m $m $m $m $m (20,044) 27,308 188,460 9,058 197,518 2,538 (271) (61) (7,994) $m (189) — (271) (271) — — — — — $m 34 — (61) — (61) — — — — — (7,994) — — — — 1,894 (9,888) — — — — — — — — — — — — — — — — — — — — (17) (477) 2,143 — (2,332) (2,332) — — — — 2,479 59 — — 5 54 — — (425) 3,040 (2,510) — (11,279) 534 921 137,144 13,522 73 — — 82 (9) — — — — — — — — — — — — — — 2,479 967 3,446 (8,267) (131) (8,398) (271) (61) 5 54 (28) (7) (299) (68) 2 — 7 54 1,894 (9,888) — 1,894 (98) (9,986) (5,788) 836 (4,952) 27 3,040 (2,510) 1,998 — — — — 27 3,040 (2,510) 1,998 — (11,279) (919) (12,198) — — 534 904 — (1,783) 534 (879) (27) (28,038) 27,308 175,386 7,192 182,578 58 — (24) — (24) — — — (9,265) 27,308 190,447 — — 13,522 9,531 1,574 199,978 15,096 (10,779) — (13,062) (887) (13,949) — — — — — — — — (2,332) (24) 82 (9) (740) (3,072) — 19 — (24) 101 (9) (10,779) — (10,779) (166) (10,945) At 1 Jan 2016 Profit for the year Other comprehensive income (net of tax) – available-for-sale investments – cash flow hedges – remeasurement of defined benefit asset/liability – share of other comprehensive income of associates and joint ventures – foreign exchange reclassified to income statement on disposal of a foreign operation – exchange differences Total comprehensive income for the year Shares issued under employee remuneration and share plans Shares issued in lieu of dividends and amounts arising thereon Net increase in treasury shares Capital securities issued Dividends to shareholders Cost of share-based payment arrangements Other movements At 31 Dec 2016 At 1 Jan 2015 Profit for the year Other comprehensive income (net of tax) – available-for-sale investments – cash flow hedges – remeasurement of defined benefit asset/liability – share of other comprehensive income of associates and joint ventures – exchange differences Total comprehensive income for the year Shares issued under employee remuneration and share plans Shares issued in lieu of dividends and amounts arising thereon Capital securities issued Dividends to shareholders Cost of share-based payment arrangements Other movements At 31 Dec 2015 — — — — — — — — — 452 — — — — — — — — — — — — — — — — — — 1,998 — — — 21,527 11,532 — — — — — — — — 736 — — — — — — — — — — — — — — — 3,580 — — — 22,715 17,110 136,795 13,595 (2,332) (24) (10,779) (589) 3,162 — (10,660) 757 567 — — — — — — — — — — — — 34 — — — — — — — — — — 460 147 3,162 3,580 687 1,147 — — — 147 3,162 3,580 — (10,660) (697) (11,357) — — 757 567 — (463) 757 104 22,263 15,112 143,976 (189) (20,044) 27,308 188,460 9,058 197,518 188 HSBC Holdings plc Annual Report and Accounts 2016 Consolidated statement of changes in equity (continued) Other reserves5 Available- for-sale fair value reserve Cash flow hedging reserve Foreign exchange reserve Merger reserve6 Total share- holders’ equity Non- controlling interests Called up share capital and share premium1 Other equity instru- ments2 $m $m 20,550 5,851 — — — — — — — — 977 — — — — — — — — — — — — — — — 5,681 — — — Retained earnings3, 4 $m 128,728 13,688 2,066 — — 1,986 80 — $m 97 — 2,025 2,025 — — — — $m (121) — 189 — 189 — — — $m (542) — (8,723) — — — — (8,723) 15,754 2,025 189 (8,723) (710) 2,709 — (9,893) 732 (176) — — — — — 21 — — — — — (10) 58 — — — — — — $m $m 27,308 181,871 13,688 (4,443) 2,025 189 1,986 Total equity $m 190,459 14,705 (3,678) 2,972 188 1,985 $m 8,588 1,017 765 947 (1) (1) 80 — 80 (8,723) (180) (8,903) 9,245 1,782 11,027 267 2,709 5,681 (9,893) 732 (165) — — — 267 2,709 5,681 (712) (10,605) — (127) 732 (292) — — — — — — — — — — — — — — At 1 Jan 2014 Profit for the year Other comprehensive income (net of tax) – available-for-sale investments – cash flow hedges – remeasurement of defined benefit asset/liability – share of other comprehensive income of associates and joint ventures – exchange differences Total comprehensive income for the year Shares issued under employee remuneration and share plans Shares issued in lieu of dividends and amounts arising thereon Capital securities issued Dividends to shareholders Cost of share-based payment arrangements Other movements At 31 Dec 2014 21,527 11,532 137,144 2,143 (9,265) 27,308 190,447 9,531 199,978 For further details refer to Note 32. 1 2 During 2016, HSBC Holdings issued $2,000m of perpetual subordinated contingent convertible capital securities, after issuance costs of $6m and tax benefits of $4m. In 2015, HSBC Holdings issued $2,450m and €1,000m of perpetual subordinated contingent convertible capital securities, on which there were $12m of external issuance costs, $25m of intra-group issuance costs and $19m of tax. In 2014, HSBC Holdings issued $2,250m, $1,500m and €1,500m of perpetual subordinated contingent convertible capital securities, on which there were $13m of external issuance costs and $33m of intra-group issuance costs. Under IFRSs these issuance costs and tax benefits are classified as equity. 3 At 31 December 2016, retained earnings included 353,356,251 treasury shares (2015: 81,580,180; 2014: 85,337,430). The increase principally reflects the share buy-back initiative, with the purchase of 325,273,407 ordinary shares to reduce outstanding ordinary shares. In addition, treasury shares are also held within HSBC’s Insurance business retirement funds for the benefit of policyholders or beneficiaries within employee trusts for the settlement of shares expected to be delivered under employee share schemes or bonus plans, and the market-making activities in Markets. Cumulative goodwill amounting to $5,138m has been charged against reserves in respect of acquisitions of subsidiaries prior to 1 January 1998, including $3,469m charged against the merger reserve arising on the acquisition of HSBC Bank plc. The balance of $1,669m has been charged against retained earnings. 4 5 At 31 December 2015, our operations in Brazil were classified as held for sale (see Note 22). The cumulative amount of other reserves attributable to these operations were as 6 follows: available-for-sale fair value reserve debit of $176m, cash flow hedging reserve credit of $34m and foreign exchange reserve debit of $2.6bn. Statutory share premium relief under Section 131 of the Companies Act 1985 (the ‘Act’) was taken in respect of the acquisition of HSBC Bank plc in 1992, HSBC France in 2000 and HSBC Finance Corporation in 2003, and the shares issued were recorded at their nominal value only. In HSBC’s consolidated financial statements the fair value differences of $8,290m in respect of HSBC France and $12,768m in respect of HSBC Finance Corporation were recognised in the merger reserve. The merger reserve created on the acquisition of HSBC Finance Corporation subsequently became attached to HSBC Overseas Holdings (UK) Limited (‘HOHU’), following a number of intra-group reorganisations. During 2009, pursuant to Section 131 of the Companies Act 1985, statutory share premium relief was taken in respect of the rights issue and $15,796m was recognised in the merger reserve. The merger reserve includes a deduction of $614m in respect of costs relating to the rights issue, of which $149m was subsequently transferred to the income statement. Of this $149m, $121m was a loss arising from accounting for the agreement with the underwriters as a contingent forward contract. The merger reserve excludes the loss of $344m on a forward foreign exchange contract associated with hedging the proceeds of the rights issue. HSBC Holdings plc Annual Report and Accounts 2016 189 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Financial Statements HSBC Holdings income statement for the year ended 31 December Net interest expense – interest income – interest expense Fee (expense)/income Net trading income/(expense) Net (expense)/income from financial instruments designated at fair value Dividend income from subsidiaries Other operating income Total operating income Employee compensation and benefits General and administrative expenses Impairment of subsidiaries Total operating expenses Profit before tax Tax credit Profit for the year Notes 2 5 HSBC Holdings statement of comprehensive income for the year ended 31 December Profit for the year Other comprehensive income/(expense) Items that will be reclassified subsequently to profit or loss when specific conditions are met: Available-for-sale investments – fair value gains/(losses) – income taxes Items that will not be reclassified subsequently to profit or loss: Changes in fair value of financial liabilities designated at fair value due to movement in own credit risk – before income taxes – income taxes Other comprehensive income for the year, net of tax Total comprehensive income for the year 2016 $m (424) 1,380 (1,804) (1) 119 (49) 10,436 696 10,777 (570) (4,014) — (4,584) 6,193 402 6,595 2016 $m 6,595 (72) (83) 11 (896) (1,030) 134 (968) 5,627 2015 $m (438) 866 (1,304) 39 (349) 276 8,469 654 8,651 (908) (3,434) (26) (4,368) 4,283 570 4,853 2015 $m 4,853 (57) (77) 20 — — — (57) 4,796 2014 $m (486) 944 (1,430) 47 (215) 438 9,077 608 9,469 (681) (2,522) (38) (3,241) 6,228 299 6,527 2014 $m 6,527 116 152 (36) — — — 116 6,643 190 HSBC Holdings plc Annual Report and Accounts 2016 HSBC Holdings balance sheet at 31 December Assets Cash and balances with HSBC undertakings Derivatives Loans and advances to HSBC undertakings Financial investments in HSBC undertakings Prepayments, accrued income and other assets Current tax assets Investments in subsidiaries Intangible assets Deferred tax assets Total assets at 31 Dec Liabilities and equity Liabilities Amounts owed to HSBC undertakings Financial liabilities designated at fair value Derivatives Debt securities in issue Accruals, deferred income and other liabilities Deferred tax liabilities Subordinated liabilities Total liabilities Equity Called up share capital Share premium account Other equity instruments Other reserves Retained earnings Total equity Total liabilities and equity at 31 Dec Notes 14 18 24 14 25 28 32 2016 $m 247 2,148 77,421 3,590 503 631 2015 $m 242 2,467 44,350 4,285 265 723 95,850 97,770 176 232 75 17 180,798 150,194 2,157 30,113 5,025 21,805 1,651 — 15,189 75,940 10,096 12,619 17,004 37,483 27,656 104,858 180,798 2,152 19,853 2,278 960 1,642 — 15,895 42,780 9,842 12,421 15,020 37,907 32,224 107,414 150,194 The accompanying notes on pages 194 to 271 and the audited sections in ‘Global businesses and regions’ on pages 44 to 60, ‘Risk’ on pages 64 to 126, ‘Capital’ on pages 127 to 131 and ‘Directors’ Remuneration Report’ on pages 153 to 170 form an integral part of these financial statements. These financial statements were approved by the Board of Directors on 21 February 2017 and signed on its behalf by: Douglas Flint Group Chairman Iain Mackay Group Finance Director HSBC Holdings plc Annual Report and Accounts 2016 191 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Financial Statements HSBC Holdings statement of cash flows for the year ended 31 December Profit before tax Adjustments for non-cash items: – depreciation, amortisation and impairment – charge for share-based payment – other non-cash items included in profit before tax Changes in operating assets and liabilities Change in loans to HSBC undertakings Change in net trading securities and net derivatives Change in other assets Change in debt securities in issue Change in financial liabilities designated at fair value Change in other liabilities Tax received Net cash from operating activities Purchase of financial investments in HSBC undertakings Proceeds from the sale and maturity of financial investments in HSBC undertakings Net cash outflow from acquisition of or increase in stake of subsidiaries Repayment of capital from subsidiaries Net investment in intangible assets Net cash from investing activities Issue of ordinary share capital and other equity instruments Purchase of treasury shares Subordinated loan capital issued Subordinated loan capital repaid Debt securities issued Debt securities repaid Dividends paid on ordinary shares Dividends paid to holders of other equity instruments Net cash from financing activities Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at 1 January Cash and cash equivalents at 31 Dec Cash and cash equivalents comprise Cash at bank with HSBC undertakings 2016 $m 6,193 48 10 34 4 (33,069) 3,066 (239) (1,633) (1,229) (693) 646 (26,910) — 610 (2,073) 3,920 (109) 2,348 2,381 (2,510) 2,636 (1,781) 32,080 — (7,059) (1,180) 24,567 5 242 247 247 2015 $m 4,283 114 30 86 (2) (454) 1,413 (141) (49) (1,228) (1,065) 470 3,343 (276) — (2,118) 790 (79) (1,683) 4,216 — 3,180 (1,565) 0 — (6,548) (950) (1,667) (7) 249 242 242 2014 $m 6,228 52 39 74 (61) 3,474 483 7 (149) (694) (9,071) 133 463 (2,410) 300 (1,603) 3,505 — (208) 6,559 — 3,500 (1,654) — (1,634) (6,611) (573) (413) (158) 407 249 249 Interest received was $2,605m (2015: $2,026m), interest paid was $2,910m (2015: $2,309m) and dividends received were $10,412m (2015: $8,469m). 192 HSBC Holdings plc Annual Report and Accounts 2016 HSBC Holdings statement of changes in equity for the year ended 31 December Other reserves Called up share capital Share premium Other equity instruments Retained earnings1 Available- for-sale fair value reserve $m $m $m $m 9,842 12,421 15,020 32,224 At 1 Jan 2016 Profit for the year Other comprehensive income (net of tax) – available-for-sale investments – changes in fair value of financial liabilities designated at fair value due to movement in own credit risk Total comprehensive income for the year Shares issued under employee share plans Shares issued in lieu of dividends and amounts arising thereon 219 (219) 10,096 12,619 17,004 27,656 112 2,244 35,127 104,858 9,609 11,918 11,476 — — — — — 35 — — — — — 417 — — — — — — — — — — — — — 45 — — — — 691 — — — — — — — — — — — — 60 — — — — 917 — — — — — — — — — — — — — — — — 1,984 — — — 6,595 (896) — (896) 5,699 (51) 3,040 (2,510) — (11,279) 34 499 — — — — — — 3,544 — — — — — — — — — 5,648 — — — 34,986 4,853 — — 4,853 (59) 3,162 — (10,660) 86 (144) 35,406 6,527 — — 6,527 (53) 2,709 — (9,893) 74 216 9,842 12,421 15,020 32,224 9,415 11,135 5,828 Other paid-in capital2 Merger and other reserves Total share- holders’ equity $m $m $m 2,597 35,127 107,414 — — — — — — — — — — — (353) — — — — — — — — — — — — 6,595 (968) (72) (896) 5,627 401 3,040 (2,510) 1,984 (11,279) 34 147 $m 183 — (72) (72) — (72) — — — — — — 1 240 — (57) (57) (57) — — — — — — 183 124 — 116 116 116 — — — — — — 2,089 35,127 105,445 — — — — — — — — — 508 2,597 — — — — — — — — — — 4,853 (57) (57) 4,796 677 3,162 3,544 (10,660) 86 364 35,127 107,414 2,052 35,127 — — — — — — — — — 37 — — — — — — — — — — 99,087 6,527 116 116 6,643 924 2,709 5,648 (9,893) 74 253 Shares issued in lieu of dividends and amounts arising thereon 188 (188) Net increase in treasury shares Capital securities issued Dividends to shareholders Cost of share-based payment arrangements Other movements At 31 Dec 2016 At 1 Jan 2015 Profit for the year Other comprehensive income (net of tax) – available-for-sale investments Total comprehensive income for the year Shares issued under employee share plans Capital securities issued Dividends to shareholders Cost of share-based payment arrangements Other movements At 31 Dec 2015 At 1 Jan 2014 Profit for the year Other comprehensive income (net of tax) – available-for-sale investments Total comprehensive income for the year Shares issued under employee share plans Capital securities issued Dividends to shareholders Cost of share-based payment arrangements Other movements At 31 Dec 2014 Shares issued in lieu of dividends and amounts arising thereon 134 (134) 9,609 11,918 11,476 34,986 240 2,089 35,127 105,445 Dividends per ordinary share at 31 December 2016 were $0.51 (2015: $0.50; 2014:$0.49). 1 At 31 December 2016, retained earnings included 325,499,152 ($2,499m) of treasury shares (2015: 67,881 ($1m); 2014: 179,419 ($3m)). The increase principally reflects the share buy-back initiative, with the purchase of 325,273,407 ordinary shares ($2,497m) to reduce outstanding ordinary shares. In addition, treasury shares are held to fund employee share plans. 2 Other paid-in capital arises from the exercise and lapse of share options granted to employees of HSBC Holdings subsidiaries. HSBC Holdings plc Annual Report and Accounts 2016 193 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 1 Basis of preparation and significant accounting policies 1.1 Basis of preparation (a) Compliance with International Financial Reporting Standards The consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings have been prepared in accordance with IFRSs as issued by the IASB, including interpretations (‘IFRICS’) issued by the IFRS Interpretations Committee, and as endorsed by the European Union (‘EU’). At 31 December 2016, there were no unendorsed standards effective for the year ended 31 December 2016 affecting these consolidated and separate financial statements, and HSBC’s application of IFRSs results in no differences between IFRSs as issued by the IASB and IFRSs as endorsed by the EU. Standards adopted during the year ended 31 December 2016 There were no new standards applied during the year ended 31 December 2016 by HSBC. The requirements of IFRS 9 ‘Financial Instruments’ relating to the presentation of gains and losses on financial liabilities designated at fair value were adopted in the separate financial statements of HSBC Holdings. As a result, the effects of changes in those liabilities’ credit risk is presented in other comprehensive income with the remaining effect presented in profit or loss. In accordance with the transitional requirements of IFRS 9, comparatives have not been restated. Adoption increased profit before tax by $896m with the opposite effect on other comprehensive income, with no effect on net assets. During 2016, HSBC adopted a number of interpretations and amendments to standards which had an insignificant effect on the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings. (b) Differences between IFRSs and Hong Kong Financial Reporting Standards There are no significant differences between IFRSs and Hong Kong Financial Reporting Standards in terms of their application to HSBC and consequently there would be no significant differences had the financial statements been prepared in accordance with Hong Kong Financial Reporting Standards. The Notes on the Financial Statements, taken together with the Report of the Directors, include the aggregate of all disclosures necessary to satisfy IFRSs and Hong Kong reporting requirements. (c) Future accounting developments Minor amendments to IFRSs The IASB has published a number of minor amendments to IFRSs in the ‘Annual Improvements to IFRSs 2012-2014’ and in a series of stand-alone amendments, one of which has not yet been endorsed for use in the EU. HSBC has not early adopted any of the amendments effective after 31 December 2016 and it expects they will have an insignificant effect, when adopted, on the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings. Major new IFRSs The IASB has published IFRS 9 ‘Financial Instruments’, IFRS 15 ‘Revenue from Contracts with Customers’ and IFRS 16 ‘Leases’. IFRS 9 and IFRS 15 have been endorsed for use in the EU and IFRS 16 has not yet been endorsed. IFRS 9 ‘Financial Instruments’ In July 2014, the IASB issued IFRS 9 ‘Financial Instruments’, which is the comprehensive standard to replace IAS 39 ‘Financial Instruments: Recognition and Measurement’, and includes requirements for classification and measurement of financial assets and liabilities, impairment of financial assets and hedge accounting. Classification and measurement The classification and measurement of financial assets will depend on how these are managed (the entity’s business model) and their contractual cash flow characteristics. These factors determine whether the financial assets are measured at amortised cost, fair value through other comprehensive income (‘FVOCI’) or fair value through profit or loss (‘FVPL’). The combined effect of the application of the business model and the contractual cash flow characteristics tests may result in some differences in the population of financial assets measured at amortised cost or fair value compared with IAS 39. However, based on an assessment of financial assets performed to date and expectations around changes to balance sheet composition, HSBC expects that the overall impact of any change will not be significant. For financial liabilities designated to be measured at fair value, gains or losses relating to changes in the entity’s own credit risk are to be included in other comprehensive income. Impairment The impairment requirements apply to financial assets measured at amortised cost and FVOCI, and lease receivables and certain loan commitments and financial guarantee contracts. At initial recognition, an impairment allowance (or provision in the case of commitments and guarantees) is required for expected credit losses (‘ECL’) resulting from default events that are possible within the next 12 months (’12-month ECL’). In the event of a significant increase in credit risk, an allowance (or provision) is required for ECL resulting from all possible default events over the expected life of the financial instrument (‘lifetime ECL’). Financial assets where ECL is recognised are in ‘stage 1’; financial assets that are considered to have experienced a significant increase in credit risk are in ‘stage 2’; and financial assets for which there is objective evidence of impairment, so are considered to be in default or otherwise credit impaired, are in ‘stage 3’. The assessment of credit risk and the estimation of ECL are required to be unbiased and probability-weighted, and should incorporate all available information relevant to the assessment, including information about past events, current conditions and reasonable and supportable forecasts of economic conditions at the reporting date. In addition, the estimation of ECL should take into account the time value of money. As a result, the recognition and measurement of impairment is intended to be more forward- looking than under IAS 39, and the resulting impairment charge will tend to be more volatile. IFRS 9 will also tend to result in an increase in the total level of impairment allowances, since all financial assets will be assessed for at least 12-month ECL and the population of financial assets to which lifetime ECL applies is likely to be larger than the population for which there is objective evidence of impairment in accordance with IAS 39. 194 HSBC Holdings plc Annual Report and Accounts 2016 Hedge accounting The general hedge accounting requirements aim to simplify hedge accounting, creating a stronger link with risk management strategy and permitting hedge accounting to be applied to a greater variety of hedging instruments and risks. However they do not explicitly address macro hedge accounting strategies, which are particularly important for banks. As a result, IFRS 9 includes an accounting policy choice to remain with IAS 39 hedge accounting. Based on the analysis performed to date, HSBC expects to exercise the accounting policy choice to continue IAS 39 hedge accounting and therefore is not currently planning to change hedge accounting, although it will implement the revised hedge accounting disclosures required by the related amendments to IFRS 7 ‘Financial Instruments: Disclosures’. Transition The classification and measurement and impairment requirements are applied retrospectively by adjusting the opening balance sheet at the date of initial application, with no requirement to restate comparative periods. HSBC does not intend to restate comparatives. The mandatory application date for the standard as a whole is 1 January 2018, but it is possible to apply the revised presentation for certain liabilities measured at fair value from an earlier date. HSBC has early adopted the revised presentation of fair value gains and losses relating to an entity’s own credit risk on certain liabilities in the separate financial statements of HSBC Holdings from 1 January 2016, and since interim financial statements have been issued during 2016 without adoption, will adopt new requirements in the consolidated financial statements from 1 January 2017. If this presentation was applied in the consolidated financial statements at 31 December 2016, the effect would be to increase profit before tax with the opposite effect on other comprehensive income based on the change in fair value attributable to changes in HSBC’s credit risk for the year, with no effect on net assets. Further information on the change in fair value attributable to changes in credit risk, including HSBC’s credit risk, is disclosed in Note 24. HSBC is assessing the impact that the impairment requirements will have on the financial statements. The joint Global Risk and Global Finance IFRS 9 Implementation Programme continues to progress with the documentation of Group accounting policy, the development of operating and system target operating models and the development, build and testing of risk modelling methodologies for the calculation of impairment nearing completion. HSBC intends to perform a parallel run during the second half of 2017 to gain a better understanding of the potential effect of the new standard and for the governance framework to gain experience. HSBC intends to quantify the potential impact of IFRS 9 once it is practicable to provide reliable estimates, which will be no later than in the Annual Report and Accounts 2017. Until reliable estimates of the impact are available, particularly on the interaction with the regulatory capital requirements, further information on the expected impact on the financial position and on capital planning cannot be provided. Further information about the application of IFRS 9 by HSBC is available on pages 347 to 352 of the Annual Report and Accounts 2015. IFRS 15 ‘Revenue from Contracts with Customers’ In May 2014, the IASB issued IFRS 15 ‘Revenue from Contracts with Customers’. The original effective date of IFRS 15 has been delayed by one year and the standard is now effective for annual periods beginning on or after 1 January 2018 with early application permitted. IFRS 15 provides a principles-based approach for revenue recognition, and introduces the concept of recognising revenue for performance obligations as they are satisfied. The standard should be applied retrospectively, with certain practical expedients available. HSBC has assessed the impact of IFRS 15 and expects that the standard will have no significant effect, when applied, on the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings. IFRS 16 ‘Leases’ In January 2016, the IASB issued IFRS 16 ‘Leases’ with an effective date for annual periods beginning on or after 1 January 2019. IFRS 16 results in lessees accounting for most leases within the scope of the standard in a manner similar to the way in which finance leases are currently accounted for under IAS 17 ‘Leases’. Lessees will recognise a ‘right of use’ asset and a corresponding financial liability on the balance sheet. The asset will be amortised over the length of the lease and the financial liability measured at amortised cost. Lessor accounting remains substantially the same as under IAS 17. HSBC is currently assessing the impact of IFRS 16, and it is not practicable to quantify the effect at the date of the publication of these financial statements. Existing operating lease commitments are set out in Note 34. (d) Foreign currencies HSBC’s consolidated financial statements are presented in US dollars because the US dollar and currencies linked to it form the major currency bloc in which HSBC transacts and funds its business. The US dollar is also HSBC Holdings’ functional currency because the US dollar and currencies linked to it are the most significant currencies relevant to the underlying transactions, events and conditions of its subsidiaries, as well as representing a significant proportion of its funds generated from financing activities. Transactions in foreign currencies are recorded at the rate of exchange on the date of the transaction. Assets and liabilities denominated in foreign currencies are translated at the rate of exchange at the balance sheet date except non-monetary assets and liabilities measured at historical cost that are translated using the rate of exchange at the initial transaction date. Exchange differences are included in other comprehensive income or in the income statement depending on where the gain or loss on the underlying item is recognised. In the consolidated financial statements, the assets, liabilities and results of foreign operations whose functional currency is not US dollars are translated into the Group’s presentation currency at the reporting date. Exchange differences arising are recognised in other comprehensive income. On disposal of a foreign operation, exchange differences previously recognised in other comprehensive income are reclassified to the income statement. (e) Presentation of information Certain disclosures required by IFRSs have been included in the audited sections of this Annual Report and Accounts as follows: • segmental disclosures are included in the ‘Report of the Directors: Financial Review’ on pages 30 to 63; • disclosures concerning the nature and extent of risks relating to insurance contracts and financial instruments are included in the ‘Report of the Directors: Risk’ on pages 64 to 126; • capital disclosures are included in the ‘Report of the Directors: Capital’ on pages 127 to 131; and HSBC Holdings plc Annual Report and Accounts 2016 195 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements • disclosures relating to HSBC’s securitisation activities and structured products are included in the ‘Report of the Directors: Risk’ on pages 64 to 126. In accordance with HSBC’s policy to provide disclosures that help investors and other stakeholders understand the Group’s performance, financial position and changes to them, the information provided in the Notes on the Financial Statements and the Report of the Directors goes beyond the minimum levels required by accounting standards, statutory and regulatory requirements and listing rules. In addition, HSBC follows the British Bankers’ Association Code for Financial Reporting Disclosure (‘the BBA Code’). The BBA Code aims to increase the quality and comparability of UK banks’ disclosures and sets out five disclosure principles together with supporting guidance. In line with the principles of the BBA Code, HSBC assesses good practice recommendations issued from time to time by relevant regulators and standard setters and will assess the applicability and relevance of such guidance, enhancing disclosures where appropriate. (f) Critical accounting estimates and judgements The preparation of financial information requires the use of estimates and judgements about future conditions. In view of the inherent uncertainties and the high level of subjectivity involved in the recognition or measurement of items highlighted as the critical accounting estimates and judgements in section 1.2 below, it is possible that the outcomes in the next financial year could differ from those on which management’s estimates are based, resulting in materially different conclusions from those reached by management for the purposes of these Financial Statements. Management’s selection of HSBC’s accounting policies which contain critical estimates and judgements reflects the materiality of the items to which the policies are applied and the high degree of judgement and estimation uncertainty involved. (g) Segmental analysis HSBC’s chief operating decision-maker is the Group Chief Executive, supported by the Group Management Board (‘GMB’), which operates as a general management committee under the direct authority of the Board, and operating segments are reported in a manner consistent with the internal reporting provided to the Group Chief Executive and the GMB. Measurement of segmental assets, liabilities, income and expenses is in accordance with the Group’s accounting policies. Segmental income and expenses include transfers between segments, and these transfers are conducted at arm’s length. Shared costs are included in segments on the basis of the actual recharges made. (h) Going concern The financial statements are prepared on a going concern basis, as the Directors are satisfied that the Group and parent company have the resources to continue in business for the foreseeable future. In making this assessment, the Directors have considered a wide range of information relating to present and future conditions, including future projections of profitability, cash flows and capital resources. 1.2 Summary of significant accounting policies (a) Consolidation and related policies Investments in subsidiaries Where an entity is governed by voting rights, HSBC consolidates when it holds, directly or indirectly, the necessary voting rights to pass resolutions by the governing body. In all other cases, the assessment of control is more complex and requires judgement of other factors, including having exposure to variability of returns, power to direct relevant activities and whether power is held as agent or principal. Business combinations are accounted for using the acquisition method. The amount of non-controlling interest is measured either at fair value or at the non-controlling interest’s proportionate share of the acquiree’s identifiable net assets. This election is made for each business combination. HSBC Holdings’ investments in subsidiaries are stated at cost less impairment losses. Goodwill Goodwill is allocated to cash-generating units (‘CGUs’) for the purpose of impairment testing, which is undertaken at the lowest level at which goodwill is monitored for internal management purposes. HSBC’s CGUs are based on geographical regions subdivided by global business, except for Global Banking and Markets, for which goodwill is monitored on a global basis. Impairment testing is performed at least once a year, or whenever there is an indication of impairment, by comparing the recoverable amount of a CGU with its carrying amount. 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 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. • 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. The accuracy of forecast cash flows is subject to a high degree of uncertainty in volatile market conditions. In such circumstances, management retests goodwill for impairment more frequently than once a year when indicators of impairment exist 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. 196 HSBC Holdings plc Annual Report and Accounts 2016 HSBC sponsored structured entities HSBC is considered to sponsor another entity if, in addition to ongoing involvement with the entity, it had a key role in establishing that entity or in bringing together relevant counterparties so the transaction that is the purpose of the entity could occur. HSBC is generally not considered a sponsor if the only involvement with the entity is merely administrative. Interests in associates and joint arrangements Joint arrangements are investments in which HSBC, together with one or more parties, has joint control. Depending on HSBC’s rights and obligations, the joint arrangement is classified as either a joint operation or a joint venture. HSBC classifies investments in entities over which it has significant influence, and that are neither subsidiaries nor joint arrangements, as associates. HSBC recognises its share of the assets, liabilities and results in a joint operation. Investments in associates and interests in joint ventures are recognised using the equity method. The attributable share of the results and reserves of joint ventures and associates are included in the consolidated financial statements of HSBC based on either financial statements made up to 31 December or pro- rated amounts adjusted for any material transactions or events occurring between the date the financial statements are available and 31 December. Investments in associates and joint ventures are assessed at each reporting date and tested for impairment when there is an indication that the investment may be impaired. Goodwill on acquisitions of interests in joint ventures and associates is not tested separately for impairment but is assessed as part of the carrying amount of the investment. Critical accounting estimates and judgements Impairment testing of investments in associates involves significant judgement in determining the value in use, and in particular estimating the present values of cash flows expected to arise from continuing to hold the investment. The most significant judgements relate to the impairment testing of our investment in Bank of Communications Co., Limited (‘BoCom’). Key assumptions used in estimating BoCom’s value in use, the sensitivity of the value in use calculation to different assumptions and a sensitivity analysis that shows the changes in key assumptions that would reduce the excess of value in use over the carrying amount (the ‘headroom’) to nil are described in Note 17. (b) Income and expense Operating income Interest income and expense Interest income and expense for all financial instruments, excluding those classified as held for trading or designated at fair value are recognised in ‘Interest income’ and ‘Interest expense’ in the income statement using the effective interest method. However, as an exception to this, interest on debt securities issued by HSBC that are designated under the fair value option and derivatives managed in conjunction with those debt securities are included in interest expense. Interest on impaired financial assets is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. Non-interest income and expense Fee income is earned from a diverse range of services provided by HSBC to its customers. Fee income is accounted for as follows: • • income earned on the execution of a significant act is recognised as revenue when the act is completed (for example, fees arising from negotiating a transaction, such as the acquisition of shares, for a third party); and income earned from the provision of services is recognised as revenue as the services are provided (for example, asset management services). Net trading income comprises all gains and losses from changes in the fair value of financial assets and financial liabilities held for trading, together with the related interest income, expense and dividends. Dividend income is recognised when the right to receive payment is established. This is the ex-dividend date for listed equity securities, and usually the date when shareholders approve the dividend for unlisted equity securities. Net income/(expense) from financial instruments designated at fair value includes all gains and losses from changes in the fair value of financial assets and liabilities designated at fair value through profit or loss, including derivatives that are managed in conjunction with those financial assets and liabilities, and liabilities under investment contracts. Interest income, interest expense and dividend income in respect of those financial instruments are also included, except for interest arising from debt securities issued by HSBC and derivatives managed in conjunction with those debt securities, which is recognised in ‘Interest expense’. The accounting policies for insurance premium income are disclosed in Note 1.2(f). (c) Valuation of financial instruments All financial instruments are initially recognised at fair value. Fair value is the price that would be received to sell an asset or paid 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, if there is a difference between the transaction price and the fair value of financial instruments whose fair value is based on a quoted price in an active market or a valuation technique that uses only data from observable markets, HSBC recognises the difference as a trading gain or loss at inception (‘day 1 gain or loss’). In all other cases, the entire day 1 gain or loss is deferred and recognised in the income statement over the life of the transaction until the transaction matures or is closed out, the valuation inputs become observable or 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, the fair value of the group of financial instruments is measured on a net basis but the underlying financial assets and liabilities are presented separately in the financial statements, unless they satisfy the IFRS offsetting criteria. HSBC Holdings plc Annual Report and Accounts 2016 197 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Critical accounting estimates and judgements The majority of valuation techniques employ only observable market data. However, certain financial instruments are valued on the basis of valuation techniques that feature one or more significant market inputs that are unobservable, 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). (d) Financial instruments measured at amortised cost Loans and advances to banks and customers, held-to-maturity investments and most financial liabilities are measured at amortised cost. The carrying value of these financial assets at initial recognition includes any directly attributable transactions costs. If the initial fair value is lower than the cash amount advanced, such as in the case of some leveraged finance and syndicated lending activities, the difference is deferred and recognised over the life of the loan (as described in paragraph (c) above) through the recognition of interest income, unless the loan becomes impaired. HSBC may commit to underwriting loans on fixed contractual terms for specified periods of time. When the loan arising from the lending commitment is expected to be held for trading, the commitment to lend is recorded as a derivative. When HSBC intends to hold the loan, a provision on the loan commitment is only recorded where it is probable that HSBC will incur a loss. Impairment of loans and advances Losses for impaired loans are recognised when there is objective evidence that impairment of a loan or portfolio of loans has occurred. Losses which may arise from future events are not recognised. Individually assessed loans and advances The factors considered in determining whether a loan is individually significant for the purposes of assessing impairment include the size of the loan, the number of loans in the portfolio, the importance of the individual loan relationship and how this is managed. Loans that are determined to be individually significant will be individually assessed for impairment, except when volumes of defaults and losses are sufficient to justify treatment under a collective methodology. Loans considered as individually significant are typically to corporate and commercial customers, are for larger amounts and are managed on an individual basis. For these loans, HSBC considers on a case-by-case basis at each balance sheet date whether there is any objective evidence that a loan is impaired. The determination of the realisable value of security is based on the most recently updated market value at the time the impairment assessment is performed. The value is not adjusted for expected future changes in market prices, though adjustments are made to reflect local conditions such as forced sale discounts. Impairment losses are calculated by discounting the expected future cash flows of a loan, which include expected future receipts of contractual interest, at the loan’s original effective interest rate or an approximation thereof, and comparing the resultant present value with the loan’s current carrying amount. Collectively assessed loans and advances Impairment is assessed collectively to cover losses which have been incurred but have not yet been identified on loans subject to individual assessment or for homogeneous groups of loans that are not considered individually significant, generally retail lending portfolios. Incurred but not yet identified impairment Individually assessed loans for which no evidence of impairment has been specifically identified on an individual basis are grouped together according to their credit risk characteristics for a collective impairment assessment. This assessment captures impairment losses that HSBC has incurred as a result of events occurring before the balance sheet date which HSBC is not able to identify on an individual loan basis, and that can be reliably estimated. When information becomes available which identifies losses on individual loans within a group, those loans are removed from the group and assessed individually. Homogeneous groups of loans and advances Statistical methods are used to determine collective impairment losses for homogeneous groups of loans not considered individually significant. The methods used to calculate collective allowances are set out below: • When appropriate empirical information is available, HSBC utilises roll-rate methodology, which employs statistical analyses of historical data and experience of delinquency and default to reliably estimate the amount of the loans that will eventually be written off as a result of the events occurring before the balance sheet date. Individual loans are grouped using ranges of past due days, and statistical estimates are made of the likelihood that loans in each range will progress through the various stages of delinquency and become irrecoverable. Additionally, individual loans are segmented based on their credit characteristics, such as industry sector, loan grade or product. In applying this methodology, adjustments are made to estimate the periods of time between a loss event occurring, for example because of a missed payment, and its confirmation through write-off (known as the loss identification period). Current economic conditions are also evaluated when calculating the appropriate level of allowance required to cover inherent loss. In certain highly developed markets, models also take into account behavioural and account management trends as revealed in, for example, bankruptcy and rescheduling statistics. • When the portfolio size is small or when information is insufficient or not reliable enough to adopt a roll-rate methodology, HSBC adopts a basic formulaic approach based on historical loss rate experience, or a discounted cash flow model. Where a basic formulaic approach is undertaken, the period between a loss event occurring and its identification is estimated by local management, and is typically between six and 12 months. 198 HSBC Holdings plc Annual Report and Accounts 2016 Write-off of loans and advances Loans (and the related impairment allowance accounts) are normally written off, either partially or in full, when there is no realistic prospect of recovery. Where loans are secured, this is generally after receipt of any proceeds from the realisation of security. In circumstances where the net realisable value of any collateral has been determined and there is no reasonable expectation of further recovery, write-off may be earlier. Reversals of impairment If the amount of an impairment loss decreases in a subsequent period, and the decrease can be related objectively to an event occurring after the impairment was recognised, the excess is written back by reducing the loan impairment allowance account accordingly. The write-back is recognised in the income statement. Assets acquired in exchange for loans When non-financial assets acquired in exchange for loans as part of an orderly realisation are held for sale, these assets are recorded as ‘Assets held for sale.’ Renegotiated loans Loans subject to collective impairment assessment whose terms have been renegotiated are no longer considered past due, but are treated as up-to-date loans for measurement purposes once a minimum number of payments required has been received. Where collectively assessed loan portfolios include significant levels of renegotiated loans, these loans are segregated from other parts of the loan portfolio for the purposes of collective impairment assessment to reflect their risk profile. Loans subject to individual impairment assessment, whose terms have been renegotiated, are subject to ongoing review to determine whether they remain impaired. The carrying amounts of loans that have been classified as renegotiated retain this classification until maturity or derecognition. A loan that is renegotiated is derecognised if the existing agreement is cancelled and a new agreement made on substantially different terms or if the terms of an existing agreement are modified such that the renegotiated loan is substantially a different financial instrument. Any new loans that arise following derecognition events will continue to be disclosed as renegotiated loans and are assessed for impairment as above. Critical accounting estimates and judgements Loan impairment allowances represent management’s best estimate of losses incurred in the loan portfolios at the balance sheet date. Management is required to exercise judgement in making assumptions and estimates when calculating loan impairment allowances on both individually and collectively assessed loans and advances. Collective impairment allowances are subject to estimation uncertainty, in part because it is not practicable to identify losses on an individual loan basis due to the large number of individually insignificant loans in the portfolio. The estimation methods include the use of statistical analyses of historical information, supplemented with significant management judgement, to assess whether current economic and credit conditions are such that the actual level of incurred losses is likely to be greater or less than historical experience. Where changes in economic, regulatory or behavioural conditions result in the most recent trends in portfolio risk factors being not fully reflected in the statistical models, risk factors are taken into account by adjusting the impairment allowances derived solely from historical loss experience. Risk factors include loan portfolio growth, product mix, unemployment rates, bankruptcy trends, geographical concentrations, loan product features, economic conditions such as national and local trends in housing markets, the level of interest rates, portfolio seasoning, account management policies and practices, changes in laws and regulations, and other influences on customer payment patterns. Different factors are applied in different regions and countries to reflect local economic conditions, laws and regulations. The methodology and the assumptions used in calculating impairment losses are reviewed regularly in the light of differences between loss estimates and actual loss experience. For example, roll rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual outcomes to ensure they remain appropriate. For individually assessed loans, judgement is required in determining whether there is objective evidence that a loss event has occurred and, if so, the measurement of the impairment allowance. In determining whether there is objective evidence that a loss event has occurred, judgement is exercised in evaluating all relevant information on indicators of impairment, including the consideration of whether payments are contractually past due and the consideration of other factors indicating deterioration in the financial condition and outlook of borrowers affecting their ability to pay. A higher level of judgement is required for loans to borrowers showing signs of financial difficulty in market sectors experiencing economic stress, particularly where the likelihood of repayment is affected by the prospects for refinancing or the sale of a specified asset. For those loans where objective evidence of impairment exists, management determines the size of the allowance required based on a range of factors such as the realisable value of security, the likely dividend available on liquidation or bankruptcy, the viability of the customer’s business model and the capacity to trade successfully out of financial difficulties and generate sufficient cash flow to service debt obligations. HSBC might provide loan forbearance to borrowers experiencing financial difficulties by agreeing to modify the contractual payment terms of loans in order to improve the management of customer relationships, maximise collection opportunities or avoid default or repossession. Where forbearance activities are significant, higher levels of judgement and estimation uncertainty are involved in determining their effects on loan impairment allowances. Judgements are involved in differentiating the credit risk characteristics of forbearance cases, including those which return to performing status following renegotiation. Where collectively assessed loan portfolios include significant levels of loan forbearance, portfolios are segmented to reflect the different credit risk characteristics of forbearance cases, and estimates are made of the incurred losses inherent within each forbearance portfolio segment. Forbearance activities take place in both retail and wholesale loan portfolios, but our largest concentration is in the US, in HSBC Finance’s CML run-off portfolio. The exercise of judgement requires the use of assumptions which are highly subjective and very sensitive to the risk factors, in particular to changes in economic and credit conditions across a large number of geographical areas. Many of the factors have a high degree of interdependency and there is no single factor to which our loan impairment allowances as a whole are sensitive. Non-trading reverse repurchase and repurchase agreements 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. HSBC Holdings plc Annual Report and Accounts 2016 199 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements (e) Financial instruments measured at fair value Available-for-sale financial assets Available-for-sale financial assets are recognised on the trade date when HSBC enters into contractual arrangements to purchase those instruments, and are normally derecognised when the securities are either sold or redeemed. They are subsequently remeasured at fair value, and changes therein are recognised in other comprehensive income until the assets are either sold or become impaired. Upon disposal, the cumulative gains or losses in other comprehensive income are recognised in the income statement as ‘Gains less losses from financial investments’. Impairment of available-for-sale financial assets Available-for-sale financial assets are assessed at each balance sheet date for objective evidence of impairment. Impairment losses are recognised in the income statement within ‘Loan impairment charges and other credit risk provisions’ for debt instruments and within ‘Gains less losses from financial investments’ for equities. Available-for-sale debt securities In assessing objective evidence of impairment at the reporting date, HSBC considers all available evidence, including observable data or information about events specifically relating to the securities which may result in a shortfall in the recovery of future cash flows. A subsequent decline in the fair value of the instrument is recognised in the income statement when there is objective evidence of impairment as a result of decreases in the estimated future cash flows. Where there is no further objective evidence of impairment, the decline in the fair value of the financial asset is recognised in other comprehensive income. If the fair value of a debt security increases in a subsequent period, and the increase can be objectively related to an event occurring after the impairment loss was recognised in the income statement, or the instrument is no longer impaired, the impairment loss is reversed through the income statement. Available-for-sale equity securities A significant or prolonged decline in the fair value of the equity below its cost is objective evidence of impairment. In assessing whether it is significant, the decline in fair value is evaluated against the original cost of the asset at initial recognition. In assessing whether it is prolonged, the decline is evaluated against the continuous period in which the fair value of the asset has been below its original cost at initial recognition. All subsequent increases in the fair value of the instrument are treated as a revaluation and are recognised in other comprehensive income. Subsequent decreases in the fair value of the available-for-sale equity security are recognised in the income statement to the extent that further cumulative impairment losses have been incurred. Impairment losses recognised on the equity security are not reversed through the income statement. Financial instruments designated at fair value Financial instruments, other than those held for trading, are classified in this category if they meet one or more of the criteria set out below, and are so designated irrevocably at inception: • the use of the designation removes or significantly reduces an accounting mismatch; • when a group of financial assets, liabilities or both is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy; and • where financial instruments contain one or more non-closely related embedded derivatives. Designated financial assets are recognised when HSBC enters into contracts with counterparties, which is generally on trade date, and are normally derecognised when the rights to the cash flows expire or are transferred. Designated financial liabilities are recognised when HSBC enters into contracts with counterparties, which is generally on settlement date, and are normally derecognised when extinguished. Subsequent changes in fair values are recognised in the income statement in ‘Net income/ (expense) from financial instruments designated at fair value’. Under this criterion, the main classes of financial instruments designated by HSBC are: Long-term debt issues The interest and/or foreign exchange exposure on certain fixed rate debt securities issued has been matched with the interest and/ or foreign exchange exposure on certain swaps as part of a documented risk management strategy. Financial assets and financial liabilities under unit-linked and non-linked investment contracts A contract under which HSBC does not accept significant insurance risk from another party is not classified as an insurance contract, other than investment contracts with discretionary participation features ('DPF'), but is accounted for as a financial liability. See Note 1.2(f) for investment contracts with DPF and contracts where HSBC accepts significant insurance risk. Customer liabilities under linked and certain non-linked investment contracts issued by insurance subsidiaries and the corresponding financial assets are designated at fair value. Liabilities are at least equivalent to the surrender or transfer value which is calculated by reference to the value of the relevant underlying funds or indices. Premiums receivable and amounts withdrawn are accounted for as increases or decreases in the liability recorded in respect of investment contracts. The incremental costs directly related to the acquisition of new investment contracts or renewing existing investment contracts are deferred and amortised over the period during which the investment management services are provided. Derivatives Derivatives are financial instruments that derive their value from the price of underlying items such as equities, interest rates or other indices. Derivatives are recognised initially and are subsequently measured at fair value. Derivatives are classified as assets when their fair value is positive or as liabilities when their fair value is negative; this includes embedded derivatives which are bifurcated from the host contract when they meet the definition of a derivative on a stand-alone basis. Gains and losses from changes in the fair value of derivatives that do not qualify for hedge accounting are reported in ‘Net trading income’. Gains and losses on derivatives managed in conjunction with financial instruments designated at fair value are reported in ‘Net income/(expense) from financial instruments designated at fair value’ together with the gains and losses on the economically 200 HSBC Holdings plc Annual Report and Accounts 2016 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 held for risk management purposes they are designated in hedge relationships where the required criteria for documentation and hedge effectiveness are met. HSBC enters into fair value hedges, cash flow hedges or hedges of net investments in foreign operations as appropriate to the risk being hedged. Fair value hedge Changes in the fair value of derivatives are recorded in the income statement, along with changes in the fair value of the hedged assets or liabilities attributable to the hedged risk. If a hedge relationship no longer meets the criteria for hedge accounting, hedge accounting is discontinued; the cumulative adjustment to the carrying amount of the hedged item is amortised to the income statement on 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 is recognised in other comprehensive income; the ineffective portion of the change in fair value is recognised immediately in the income statement within ‘Net trading income’. The accumulated gains and losses recognised in other comprehensive income are reclassified to the income statement in the same periods in which the hedged item affects profit or loss. In hedges of forecast transactions that result in recognition of a non-financial asset or liability, previous gains and losses recognised in other comprehensive income are included in the initial measurement of the asset or liability. When a hedge relationship is discontinued, or partially discontinued, any cumulative gain or loss recognised in 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. 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. (f) Insurance contracts A contract is classified as an insurance contract where HSBC accepts significant insurance risk from another party by agreeing to compensate that party on the occurrence of a specified uncertain future event. An insurance contract may also transfer financial risk, but is accounted for as an insurance contract if the insurance risk is significant. In addition, HSBC issues investment contracts with DPF which are also accounted for as insurance contracts as required by IFRS 4 ‘Insurance Contracts’. Net insurance premium income Premiums for life insurance contracts are accounted for when receivable, except in unit-linked insurance contracts where premiums are accounted for when liabilities are established. Reinsurance premiums are accounted for in the same accounting period as the premiums for the direct insurance contracts to which they relate. Net insurance claims and benefits paid and movements in liabilities to policyholders Gross insurance claims for life insurance contracts reflect the total cost of claims arising during the year, including claim handling costs and any policyholder bonuses allocated in anticipation of a bonus declaration. Maturity claims are recognised when due for payment. Surrenders are recognised when paid or at an earlier date on which, following notification, the policy ceases to be included within the calculation of the related insurance liabilities. Death claims are recognised when notified. Reinsurance recoveries are accounted for in the same period as the related claim. Liabilities under insurance contracts Liabilities under non-linked life insurance contracts are calculated by each life insurance operation based on local actuarial principles. Liabilities under unit-linked life insurance contracts are at least equivalent to the surrender or transfer value, which is calculated by reference to the value of the relevant underlying funds or indices. Future profit participation on insurance contracts with DPF Where contracts provide discretionary profit participation benefits to policyholders, liabilities for these contracts include provisions for the future discretionary benefits to policyholders. These provisions reflect the actual performance of the investment portfolio to date and management’s expectation of the future performance of the assets backing the contracts, as well as other experience factors such as mortality, lapses and operational efficiency, where appropriate. The benefits to policyholders may be determined by the contractual terms, regulation, or past distribution policy. Investment contracts with DPF While investment contracts with DPF are financial instruments, they continue to be treated as insurance contracts as required by IFRS 4. The Group therefore recognises the premiums for these contracts as revenue and recognises as an expense the resulting increase in the carrying amount of the liability. HSBC Holdings plc Annual Report and Accounts 2016 201 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements In the case of net unrealised investment gains on these contracts, whose discretionary benefits principally reflect the actual performance of the investment portfolio, the corresponding increase in the liabilities is recognised in either the income statement or other comprehensive income, following the treatment of the unrealised gains on the relevant assets. In the case of net unrealised losses, a deferred participating asset is recognised only to the extent that its recoverability is highly probable. Movements in the liabilities arising from realised gains and losses on relevant assets are recognised in the income statement. Present value of in-force long-term insurance business HSBC recognises the value placed on insurance contracts and investment contracts with DPF, which are classified as long-term and in-force at the balance sheet date, 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 present value of in- force business (‘PVIF’) is determined by discounting those expected future profits using appropriate assumptions in assessing factors such as future mortality, lapse rates and levels of expenses, and a risk discount rate that reflects the risk premium attributable to the respective contracts. The PVIF incorporates allowances for both non-market risk and the value of financial options and guarantees. The PVIF asset 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. (g) Employee compensation and benefits Share-based payments HSBC enters into both equity-settled and cash-settled share-based payment arrangements with its employees as compensation for services provided by employees. The vesting period for these schemes may commence before the grant date if the employees have started to render services in respect of the award before the grant date. Expenses are recognised when the employee starts to render service to which the award relates. Cancellations result from the failure to meet a non-vesting condition during the vesting period, and are treated as an acceleration of vesting recognised immediately in the income statement. Failure to meet a vesting condition by the employee is not treated as a cancellation, and the amount of expense recognised for the award is adjusted to reflect the number of awards expected to vest. Post-employment benefit plans HSBC operates a number of pension schemes (including defined benefit and defined contribution) and post-employment benefit schemes. Payments to defined contribution plans are charged as an expense as the employees render service. Defined benefit pension obligations are calculated using the projected unit credit method. The net charge to the income statement mainly comprises the service cost and the net interest on the net defined benefit asset or liability, and is presented in operating expenses. Re-measurements of the net defined benefit asset or liability, which comprise actuarial gains and losses, return on plan assets (excluding interest) and the effect of the asset ceiling (if any, excluding interest), are recognised immediately in other comprehensive income. The net defined benefit asset or liability represents the present value of defined benefit obligations reduced by the fair value of plan assets, after applying the asset ceiling test, where the net defined benefit surplus is limited to the present value of available refunds and reductions in future contributions to the plan. The cost of obligations arising from other post-employment plans are accounted for on the same basis as defined benefit pension plans. (h) Tax Income tax comprises current tax and deferred tax. Income tax is recognised in the income statement except to the extent that it relates to items recognised in other comprehensive income or directly in equity, in which case the tax is recognised in the same statement as the related item appears. Current tax is the tax expected to be payable on the taxable profit for the year and any adjustment to tax payable in respect of previous years. HSBC provides for potential current tax liabilities that may arise on the basis of the amounts expected to be paid to the tax authorities. Deferred tax is recognised on temporary differences between the carrying amounts of assets and liabilities in the balance sheet, and the amounts attributed to such assets and liabilities for tax purposes. Deferred tax is calculated using the tax rates expected to apply in the periods in which the assets will be realised or the liabilities settled. Current and deferred tax is calculated based on tax rates and laws enacted, or substantively enacted, by the balance sheet date. Critical accounting estimates and judgements The recognition of a deferred tax asset relies on an assessment of the probability and sufficiency of future taxable profits, future reversals of existing taxable temporary differences and ongoing tax planning strategies. In the absence of a history of taxable profits, the most significant judgements relate to expected future profitability and to the applicability of tax planning strategies, including corporate reorganisations. (i) Provisions, contingent liabilities and guarantees Provisions Provisions are recognised when it is probable that an outflow of economic benefits will be required to settle a present legal or constructive obligation that has arisen as a result of past events and for which a reliable estimate can be made. 202 HSBC Holdings plc Annual Report and Accounts 2016 Critical accounting estimates and judgements Judgement is involved in determining whether a present obligation exists and in estimating the probability, timing and amount of any outflows. Professional expert advice is taken on the assessment of litigation, property (including onerous contracts) and similar obligations. Provisions for legal proceedings and regulatory matters typically require a higher degree of judgement than other types of provisions. When matters are at an early stage, accounting judgements can be difficult because of the high degree of uncertainty associated with determining whether a present obligation exists, and estimating the probability and amount of any outflows that may arise. As matters progress, management and legal advisers evaluate on an ongoing basis whether provisions should be recognised, revising previous judgements and estimates as appropriate. At more advanced stages, it is typically easier to make judgements and estimates around a better defined set of possible outcomes. However, the amount provisioned can remain very sensitive to the assumptions used. There could be a wide range of possible outcomes for any pending legal proceedings, investigations or inquiries. As a result, it is often not practicable to quantify a range of possible outcomes for individual matters. It is also not practicable to meaningfully quantify ranges of potential outcomes in aggregate for these types of provisions because of the diverse nature and circumstances of such matters and the wide range of uncertainties involved. Provisions for customer remediation also require significant levels of estimation and judgement. The amounts of provisions recognised depend on a number of different assumptions, such as, the volume of inbound complaints, the projected period of inbound complaint volumes, the decay rate of complaint volumes, the population identified as systemically mis-sold and the number of policies per customer complaint. Contingent liabilities, contractual commitments and guarantees Contingent liabilities Contingent liabilities, which include certain guarantees and letters of credit pledged as collateral security, and contingent liabilities related to legal proceedings or regulatory matters, are not recognised in the financial statements but are disclosed unless the probability of settlement is remote. Financial guarantee contracts Liabilities under financial guarantee contracts which are not classified as insurance contracts are recorded initially at their fair value, which is generally the fee received or present value of the fee receivable. HSBC Holdings has issued financial guarantees and similar contracts to other Group entities. HSBC elects to account for certain guarantees as insurance contracts in HSBC Holdings’ financial statements, in which case they are measured and recognised as insurance liabilities. This election is made on a contract by contract basis, and is irrevocable. 2 Net income/(expense) from financial instruments designated at fair value Net income/(expense) arising on: Financial assets Financial assets held to meet liabilities under insurance and investment contracts Other financial assets designated at fair value Derivatives managed with other financial assets designated at fair value Financial liabilities Liabilities to customers under investment contracts HSBC’s long-term debt issued and related derivatives – changes in own credit spread on long-term debt – derivatives managed in conjunction with HSBC’s issued debt securities – other changes in fair value Other financial liabilities designated at fair value Derivatives managed with other financial liabilities designated at fair value Year ended 31 Dec HSBC Holdings Net income/(expense) arising on HSBC Holdings’ long-term debt issued and related derivatives Net income/(expense) arising on: – changes in own credit spread on long-term debt – derivatives managed in conjunction with HSBC Holdings’ issued debt securities – other changes in fair value Year ended 31 Dec Footnotes 1 2016 $m 1,480 90 (43) 1,527 (218) (3,975) (1,792) (1,367) (816) (6) 6 (4,193) (2,666) 2016 $m — (642) 593 (49) 2015 $m 531 89 13 633 34 863 1,002 (1,997) 1,858 3 (1) 899 1,532 2015 $m 348 (927) 855 276 2014 $m 2,300 131 (19) 2,412 (435) 508 417 333 (242) (23) 11 61 2,473 2014 $m 339 126 (27) 438 1 From 1 January 2016, HSBC Holdings adopted, in its separate financial statements, the requirements of IFRS 9 'Financial Instruments' relating to the presentation of gains and losses on financial liabilities designated at fair value. As a result, the effects of changes in those liabilities' credit risk is presented in other comprehensive income with the remaining effect presented in profit or loss. HSBC Holdings plc Annual Report and Accounts 2016 203 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 3 Insurance business Net insurance premium income Gross insurance premium income Reinsurers’ share of gross insurance premium income Year ended 31 Dec 2016 Gross insurance premium income Reinsurers’ share of gross insurance premium income Year ended 31 Dec 2015 Gross insurance premium income Reinsurers’ share of gross insurance premium income Year ended 31 Dec 2014 1 Discretionary participation features. Non-linked insurance Linked life insurance Investment contracts with DPF1 $m 8,036 (629) 7,407 7,506 (648) 6,858 7,705 (441) 7,264 $m 675 (8) 667 1,409 (9) 1,400 2,195 (8) 2,187 $m 1,877 — 1,877 2,097 — 2,097 2,470 — 2,470 Net insurance claims and benefits paid and movement in liabilities to policyholders Non-linked insurance Linked life insurance Investment contracts with DPF1 Gross claims and benefits paid and movement in liabilities – claims, benefits and surrenders paid – movement in liabilities Reinsurers’ share of claims and benefits paid and movement in liabilities – claims, benefits and surrenders paid – movement in liabilities Year ended 31 Dec 2016 Gross claims and benefits paid and movement in liabilities – claims, benefits and surrenders paid – movement in liabilities Reinsurers’ share of claims and benefits paid and movement in liabilities – claims, benefits and surrenders paid – movement in liabilities Year ended 31 Dec 2015 Gross claims and benefits paid and movement in liabilities – claims, benefits and surrenders paid – movement in liabilities Reinsurers’ share of claims and benefits paid and movement in liabilities – claims, benefits and surrenders paid – movement in liabilities Year ended 31 Dec 2014 1 Discretionary participation features. $m 8,778 2,828 5,950 (560) (112) (448) 8,218 7,746 3,200 4,546 (575) (153) (422) 7,171 7,770 3,575 4,195 (411) (176) (235) 7,359 204 HSBC Holdings plc Annual Report and Accounts 2016 Total $m 10,588 (637) 9,951 11,012 (657) 10,355 12,370 (449) 11,921 Total $m 12,508 5,594 6,914 (638) (126) (512) $m 1,321 749 572 (78) (14) (64) $m 2,409 2,017 392 — — — 1,243 2,409 11,870 1,398 1,869 (471) (5) (64) 59 1,393 2,765 1,499 1,266 33 (88) 121 2,798 2,728 2,101 627 — — — 2,728 3,188 2,215 973 — — — 11,872 7,170 4,702 (580) (217) (363) 11,292 13,723 7,289 6,434 (378) (264) (114) 3,188 13,345 Liabilities under insurance contracts Gross liabilities under insurance contracts at 1 Jan 2016 Claims and benefits paid Increase in liabilities to policyholders Disposals/transfers to held-for-sale Exchange differences and other movements Gross liabilities under insurance contracts at 31 Dec 2016 Reinsurers’ share of liabilities under insurance contracts Net liabilities under insurance contracts at 31 Dec 2016 Gross liabilities under insurance contracts at 1 Jan 2015 Claims and benefits paid Increase in liabilities to policyholders Disposals/transfers to held-for-sale Exchange differences and other movements Gross liabilities under insurance contracts at 31 Dec 2015 Reinsurers’ share of liabilities under insurance contracts Net liabilities under insurance contracts at 31 Dec 2015 Footnotes 2 2 Non-linked insurance Linked life insurance Investment contracts with DPF1 $m 40,538 (2,828) 8,778 — (445) 46,043 (1,500) 44,543 36,973 (3,200) 7,746 (443) (538) 40,538 (1,115) 39,423 $m 6,791 (749) 1,321 — (414) 6,949 (320) 6,629 11,820 (1,869) 1,398 (4,594) 36 6,791 (263) 6,528 $m 22,609 (2,017) 2,409 — (720) 22,281 — 22,281 25,068 (2,101) 2,728 — (3,086) 22,609 — 22,609 Total $m 69,938 (5,594) 12,508 — (1,579) 75,273 (1,820) 73,453 73,861 (7,170) 11,872 (5,037) (3,588) 69,938 (1,378) 68,560 1 Discretionary participation features. 2 ‘Exchange differences and other movements’ includes movements in liabilities arising from net unrealised investment gains recognised in other comprehensive income. The key factors contributing to the movement in liabilities to policyholders included death claims, surrenders, lapses, liabilities to policyholders created at the initial inception of the policies, the declaration of bonuses and other amounts attributable to policyholders. HSBC Holdings plc Annual Report and Accounts 2016 205 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 4 Operating profit Operating profit is stated after the following items: Income Interest recognised on impaired financial assets Fees earned on financial assets that are not at fair value through profit or loss (other than amounts included in determining the effective interest rate) Fees earned on trust and other fiduciary activities Expense 2016 $m 574 7,732 2,543 2015 $m 934 8,736 3,052 2014 $m 1,137 9,438 3,253 Interest on financial instruments, excluding interest on financial liabilities held for trading or designated at fair value (11,858) (13,680) (15,322) Fees payable on financial liabilities that are not at fair value through profit or loss (other than amounts included in determining the effective interest rate) Fees payable relating to trust and other fiduciary activities Payments under lease and sublease agreements – minimum lease payments – contingent rents and sublease payments UK bank levy Restructuring provisions Gains/(losses) Impairment of available-for-sale equity securities Gains/(losses) recognised on assets held for sale Gains on the partial sale of shareholding in Industrial Bank Loss on disposal of Brazilian operations Loan impairment charges and other credit risk provisions – net impairment charge on loans and advances – release of impairment on available-for-sale debt securities – other credit risk provisions (1,214) (129) (969) (945) (24) (922) (415) (36) (206) — (1,743) (3,400) (3,350) 63 (113) (1,251) (166) (1,190) (1,058) (132) (1,421) (430) (111) (244) 1,372 — (3,721) (3,592) 17 (146) (1,427) (185) (1,548) (1,199) (349) (1,066) (147) (373) 220 — — (3,851) (4,055) 319 (115) External net operating income is attributed to countries on the basis of the location of the branch responsible for reporting the results or advancing the funds: External net operating income by country Footnote 1 – UK – Hong Kong – US – France – other countries – of which: Brazil 1 Net operating income before loan impairment charges and other credit risk provisions, also referred to as revenue. 5 Employee compensation and benefits Wages and salaries Social security costs Post-employment benefits Year ended 31 Dec Average number of persons employed by HSBC during the year by global business Retail Banking and Wealth Management Commercial Banking Global Banking and Markets Global Private Banking Corporate Centre Year ended 31 Dec 2016 $m 47,966 9,495 12,864 5,094 2,571 17,942 (204) 2016 $m 15,735 1,312 1,042 18,089 2016 137,234 45,912 47,623 8,322 7,842 2015 $m 59,800 14,132 14,447 5,541 2,706 22,974 3,546 2015 $m 17,245 1,600 1,055 19,900 2015 155,859 51,007 49,912 8,934 2,721 2014 $m 61,248 14,392 12,656 5,736 2,538 25,926 4,817 2014 $m 17,477 1,666 1,223 20,366 2014 156,397 50,519 47,219 8,799 1,833 246,933 268,433 264,767 206 HSBC Holdings plc Annual Report and Accounts 2016 Average number of persons employed by HSBC during the year by geographical region Europe Asia Middle East and North Africa North America Latin America Year ended 31 Dec 1 2015 and 2014 figures are restated for the changes explained on page 44. Reconciliation of total incentive awards granted to income statement charge Total incentive awards approved and granted for the current year Less: deferred bonuses awarded, expected to be recognised in future periods Total incentives awarded and recognised in the current year Add: current year charges for deferred bonuses from previous years Other Income statement charge for incentive awards Year in which income statement is expected to reflect deferred bonuses Footnote 1 1 2016 71,196 122,282 12,021 20,353 21,081 2015 68,408 121,438 14,467 21,506 42,614 2014 68,163 116,492 14,477 21,983 43,652 246,933 268,433 264,767 2016 $m 3,035 (323) 2,712 371 (128) 2,955 2015 $m 3,462 (387) 3,075 483 (40) 3,518 2014 $m 3,660 (359) 3,301 425 (114) 3,612 Variable compensation from 2016 bonus pool Variable compensation from 2015 bonus pool Variable compensation from 2014 bonus pool and earlier Total Cash awards Equity awards Share-based payments Charge recognised Expected charge 2016 2015 $m 152 168 203 523 163 360 $m — 253 483 736 168 568 2014 $m — — 670 670 150 520 2017 $m 137 128 88 353 102 251 2018 and beyond $m 186 76 28 290 98 192 ‘Wages and salaries’ includes the effect of share-based payments arrangements, of which $534m were equity settled (2015: $757m; 2014: $732m), as follows: Restricted share awards Savings-related and other share award option plans Year ended 31 Dec HSBC share awards Award Policy 2016 $m 591 33 624 2015 $m 748 43 791 2014 $m 738 36 774 Restricted share awards (including annual incentive awards delivered in shares) and GPSP International Employee Share Purchase Plan (‘ShareMatch’) • An assessment of performance over the relevant period ending on 31 December is used to determine the amount of the award to be granted. • Deferred awards generally require employees to remain in employment over the vesting period and are not subject to performance conditions after the grant date. • Deferred share awards generally vest over a period of three years and GPSP awards vest after five years. • Vested shares may be subject to a retention requirement post-vesting. GPSP awards are retained until cessation of employment. • Awards granted from 2010 onwards are subject to a malus provision prior to vesting. • Awards granted to Material Risk Takers from 2015 onwards are subject to clawback post vesting. • The plan was first introduced in Hong Kong in 2013 and now includes employees based in 25 jurisdictions. • Shares are purchased in the market each quarter up to a maximum value of £750, or the equivalent in local currency. • Matching awards are added at a ratio of one free share for every three purchased. • Matching awards vest subject to continued employment and the retention of the purchased shares for a maximum period of two years and nine months. HSBC Holdings plc Annual Report and Accounts 2016 207 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Movement on HSBC share awards Restricted share awards outstanding at 1 Jan Additions during the year Released in the year Forfeited in the year Restricted share awards outstanding at 31 Dec Weighted average fair value of awards granted ($) HSBC share option plans Main plans Policy 2016 Number (000s) 118,665 94,981 (76,552) (13,928) 123,166 7.25 2015 Number (000s) 116,483 80,749 (75,235) (3,332) 118,665 9.67 Savings-related share option plans (‘Sharesave’) • Two plans: the UK Plan and the International Plan. The last grant of options under the International Plan was in 2012. • From 2014, eligible employees can save up to £500 per month with the option to use the savings to acquire shares. • Exercisable within six months following either the third or fifth anniversaries of the commencement of a three-year or five-year contract, respectively. • The exercise price is set at a 20% (2015: 20%) discount to the market value immediately preceding the date of invitation. HSBC Holdings Group share option plan • Plan ceased in May 2005. • Exercisable between the third and 10th anniversaries of the date of grant. Calculation of fair values The fair values of share options are calculated using a Black-Scholes model. The fair value of a share award is based on the share price at the date of the grant. Movement on HSBC share option plans Outstanding at 1 Jan 2016 Granted during the year Exercised during the year Expired during the year Outstanding at 31 Dec 2016 Weighted average remaining contractual life (years) Outstanding at 1 Jan 2015 Granted during the year Exercised during the year Expired during the year Outstanding at 31 Dec 2015 Weighted average remaining contractual life (years) Footnotes 2 3 2 3 Savings-related share option plans HSBC Holdings Group share option plan Number (000s) 74,775 15,044 (4,354) (15,438) 70,027 2.91 66,366 52,629 (21,120) (23,100) 74,775 3.92 WAEP1 £ 4.36 4.40 5.02 4.47 4.30 4.89 4.05 4.45 5.11 4.36 Number (000s) — — — — — — 6,374 — — (6,374) — — WAEP1 £ — — — — — 7.29 — — 7.29 — 1 Weighted average exercise price. 2 3 The weighted average fair value of options granted during the year was $1.28 (2015: $1.09). The weighted average share price at the date the options were exercised was $6.98 (2015: $8.50) and $0 (2015: $0) for the savings-related share option plans and HSBC Holdings Group share option plan, respectively. Post-employment benefit plans The Group operates pension plans throughout the world for its employees. ‘Pension risk management’ on page 84 contains details of the policies and practices associated with these pension plans. Some are defined benefit plans, of which the largest is the HSBC Bank (UK) Pension Scheme (‘the principal plan’). The principal plan The principal plan has a defined benefit section and a defined contribution section. The defined benefit section was closed to future benefit accrual in 2015, with defined benefits earned by employees at that date continuing to be linked to their salary while they remain employed by HSBC Bank. The plan is overseen by an independent corporate trustee, who has a fiduciary responsibility for the operation of the plan. Its assets are held separately from the assets of the Group. The investment strategy of the plan is to hold the majority of assets in bonds, with the remainder in a diverse range of investments. It also includes some interest rate swaps to reduce interest rate risk and inflation swaps to reduce inflation risk. 208 HSBC Holdings plc Annual Report and Accounts 2016 The latest funding valuation of the plan at 31 December 2014 was carried out by Colin G Singer, of Willis Towers Watson Limited, who is a Fellow of the UK Institute and Faculty of Actuaries, using the projected unit credit method. At that date, the market value of the plan’s assets was £24.6bn ($30.3bn) and this exceeded the value placed on its liabilities on an ongoing basis by £520m ($641m), giving a funding level of 102%. The main differences between the assumptions used for assessing the liabilities for this funding valuation and those used for IAS 19 (see ‘Key actuarial assumptions’ section below) are more prudent discount rate, inflation and longevity assumptions. Although the plan was in surplus at the valuation date, HSBC agreed to make further contributions to the plan to support a lower-risk investment strategy over the longer term. These contributions amounted to £128m ($158m) in 2016 and are expected to amount to £64m ($79m) in each of 2017, 2018 and 2019, and £160m ($197m) in each of 2020 and 2021. The chart below shows the expected profile of future benefits payable from the plan. Future benefit payments ($bn) The actuary also assessed the value of the liabilities if the plan were to be stopped and an insurance company asked to secure all future pension payments. This is generally larger than the amount needed on the ongoing basis described above because an insurance company would use more prudent assumptions and include an explicit allowance for the future administrative expenses of the plan. Under this approach, the amount of assets needed was estimated to be £31bn ($38bn) at 31 December 2014. Income statement charge Defined benefit pension plans Defined contribution pension plans Pension plans Defined benefit and contribution healthcare plans Year ended 31 Dec 2016 $m 218 783 1,001 41 1,042 2015 $m 256 793 1,049 6 1,055 Net assets/(liabilities) recognised on the balance sheet in respect of defined benefit plans Defined benefit pension plans Defined benefit healthcare plans At 31 Dec 2016 Total employee benefit liabilities (within ‘Accruals, deferred income and other liabilities’) Total employee benefit assets (within ‘Prepayments, accrued income and other assets’) Defined benefit pension plans Defined benefit healthcare plans At 31 Dec 2015 Total employee benefit liabilities (within ‘Accruals, deferred income and other liabilities’) Total employee benefit assets (within ‘Prepayments, accrued income and other assets’) Fair value of plan assets Present value of defined benefit obligations Effect of limit on plan surpluses $m 42,397 118 42,515 $m (39,747) (711) (40,458) 41,424 141 41,565 (38,326) (762) (39,088) $m (24) — (24) (14) — (14) 2014 $m 469 687 1,156 67 1,223 Total $m 2,626 (593) 2,033 (2,681) 4,714 3,084 (621) 2,463 (2,809) 5,272 HSBC Holdings plc Annual Report and Accounts 2016 209 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Defined benefit pension plans Net asset/(liability) under defined benefit pension plans Fair value of plan assets Present value of defined benefit obligations Effect of the asset ceiling Net defined benefit asset/(liability) Principal plan $m Other plans $m Principal plan $m Other plans $m Principal plan $m At 1 Jan 2016 Current service cost Past service cost and gains/(losses) from settlements Service cost Net interest income/(cost) on the net defined benefit asset/(liability) Re-measurement effects recognised in other comprehensive income – return on plan assets (excluding interest income) – actuarial gains/(losses) – other changes Exchange differences Contributions by HSBC – normal – special Contributions by employees Benefits paid Administrative costs and taxes paid by plan 32,670 8,754 (27,675) (10,651) — — — — (1) (1) (70) — (70) (235) (39) (274) 1,085 294 (914) (337) 6,449 6,449 — — 671 671 — — (6,097) (534) 347 64 283 — (970) (42) 379 207 172 30 (623) (15) (6,886) — (7,029) 143 5,254 — — — — 970 42 (299) — (152) (147) 410 — — — (30) 698 15 At 31 Dec 2016 33,442 8,955 (29,279) (10,468) Present value of defined benefit obligation relating to: – actives – deferreds – pensioners At 1 Jan 2015 Current service cost Past service cost and gains/(losses) from settlements Service cost Net interest income/(cost) on the net defined benefit asset/(liability) Re-measurement effects recognised in other comprehensive income – return on plan assets (excluding interest income) – actuarial gains/(losses) – other changes Exchange differences Contributions by HSBC – normal – special Contributions by employees Benefits paid Administrative costs and taxes paid by plan (7,066) (9,219) (12,994) (5,066) (2,306) (3,096) 35,244 9,580 (30,480) (11,582) — — — — (3) (3) (129) (53) (182) (268) 71 (197) 1,265 322 (1,088) (371) (1,521) (1,521) — — (394) (394) — — (1,704) (458) 376 159 217 17 (970) (37) 279 227 52 35 (590) (17) 1,642 — 1,392 250 1,443 — — — (17) 970 37 339 — 339 — 529 — — — (35) 649 17 At 31 Dec 2015 32,670 8,754 (27,675) (10,651) Present value of defined benefit obligation relating to: – actives – deferreds – pensioners (6,310) (7,919) (13,446) (5,350) (2,239) (3,062) — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — Other plans Principal plan $m Other plans $m $m (14) — — — (1) (8) — (8) — (1) — — — — — — 4,995 (1,911) (70) — (70) (235) (40) (275) 171 (44) (437) 6,449 (7,029) 143 (843) 347 64 283 — — — 364 671 (160) (147) (125) 379 207 172 — 75 — (24) 4,163 (1,537) (17) 4,764 (2,019) — — — (2) (30) — (30) — 35 — — — — — — (129) (53) (182) 177 121 (1,521) 1,392 250 (261) 376 159 217 — — — (268) 68 (200) (51) (85) (394) 309 — 106 279 227 52 — 59 — (14) 4,995 (1,911) HSBC expects to make $425m of contributions to defined benefit pension plans during 2017. Benefits expected to be paid from the plans to retirees over each of the next five years, and in aggregate for the five years thereafter, are as follows: Benefits expected to be paid from plans The principal plan Other plans Footnote 1 1 2017 $m 917 427 2018 $m 948 468 2019 $m 979 489 2020 $m 1,012 505 2021 $m 1,045 536 2022-2026 $m 5,533 2,492 1 The duration of the defined benefit obligation is 19.0 years for the principal plan under the disclosure assumptions adopted (2015: 17.0 years) and 13.9 years for all other plans combined (2015: 13.9 years). 210 HSBC Holdings plc Annual Report and Accounts 2016 Fair value of plan assets by asset classes The principal plan Fair value of plan assets – equities – bonds – derivatives – other Other plans Fair value of plan assets – equities – bonds – derivatives – other 31 Dec 2016 Quoted market price in active market No quoted market price in active market Thereof HSBC1 $m $m $m 29,379 4,722 23,426 — 1,231 7,631 1,502 5,592 44 493 4,063 664 — 2,107 1,292 1,324 753 219 (133) 485 878 — — 878 — 239 — 5 (85) 319 Value $m 33,442 5,386 23,426 2,107 2,523 8,955 2,255 5,811 (89) 978 31 Dec 2015 Quoted market price in active market No quoted market price in active market $m $m 29,370 4,990 22,704 — 1,676 7,882 1,900 5,458 — 524 3,300 740 — 1,011 1,549 872 534 261 7 70 Value $m 32,670 5,730 22,704 1,011 3,225 8,754 2,434 5,719 7 594 Thereof HSBC1 $m 513 — — 513 — 148 1 2 1 144 1 The fair value of plan assets includes derivatives entered into with HSBC Bank plc as detailed in Note 36. Post-employment defined benefit plans’ principal actuarial financial assumptions HSBC determines the discount rates to be applied to its obligations in consultation with the plans’ local actuaries, on the basis of current average yields of high quality (AA-rated or equivalent) debt instruments with maturities consistent with those of the defined benefit obligations. Key actuarial assumptions for the principal plan UK At 31 Dec 2016 At 31 Dec 2015 At 31 Dec 2014 Discount rate Inflation rate Rate of increase for pensions Rate of pay increase % 2.50 3.70 3.70 % 3.50 3.20 3.20 % 3.20 3.00 3.00 % 4.00 3.70 3.70 Mortality tables and average life expectancy at age 65 for the principal plan UK At 31 Dec 2016 At 31 Dec 2015 Mortality table Life expectancy at age 65 for a male member currently: Life expectancy at age 65 for a female member currently: Aged 65 Aged 45 Aged 65 Aged 45 SAPS S21 SAPS S12 22.4 23.6 24.1 25.0 24.7 24.9 26.6 26.7 1 2 Self-administered Pension Scheme (‘SAPS’) S2 table (Males: 'All Pensioners' version, Females: 'Normal Pensions' version) with a multiplier of 0.98 for both male and female pensioners. Improvements are projected in accordance with the Continuous Mortality Investigation ('CMI) core projection model 2015 with a long-term rate of improvement of 1.25% per annum. Separate tables assuming lighter mortality have been applied to higher paid pensioners. Self-administered Pension Scheme (‘SAPS’) Light table with a multiplier of 1.01 for male pensioners and 1.02 for female pensioners. Improvements are projected in accordance with the Continuous Mortality Investigation (‘CMI’) core projection model 2015 with a long-term rate of improvement of 1.25% per annum. The effect of changes in key assumptions on the principal plan Discount rate – increase/decrease of 0.25% Inflation rate – increase/decrease of 0.25% Pension payments and deferred pensions – increase/decrease of 0.25% Pay – increase/decrease of 0.25% Change in mortality – increase of 1 year Impact on HSBC Bank (UK) Pension Scheme Obligation Financial impact of increase Financial impact of decrease 2016 $m (1,322) 735 1,305 143 1,326 2015 $m (1,107) 747 990 119 670 2016 $m 1,419 (1,048) (1,255) (139) n/a 2015 $m 1,180 (855) (937) (119) n/a HSBC Holdings plc Annual Report and Accounts 2016 211 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements HSBC Holdings Employee compensation and benefit expense in respect of HSBC Holdings’ employees in 2016 amounted to $571m (2015: $908m). The average number of persons employed during 2016 was 1,660 (2015: 2,656). Employees who are members of defined benefit pension plans are principally members of either the HSBC Bank (UK) Pension Scheme or the HSBC International Staff Retirement Benefits Scheme. HSBC Holdings pays contributions to such plans for its own employees in accordance with the schedules of contributions determined by the trustees of the plans and recognises these contributions as an expense as they fall due. From 1 July 2016 employment costs of most employees are recognised by the ServCo group and the ServCo group has started providing services to HSBC Holdings. HSBC Holdings recognised a management charge of $406m for these services which is included under ‘General and administrative expenses’. Directors’ emoluments Details of directors’ emoluments, pensions and their interests are disclosed in the Directors’ Remuneration Report on page 153. 6 Auditors’ remuneration Audit fees payable to PwC/KPMG Other audit fees payable Year ended 31 Dec Fees payable by HSBC to PwC/KPMG2 Fees for HSBC Holdings’ statutory audit Fees for other services provided to HSBC – audit of HSBC’s subsidiaries – audit-related assurance services – taxation-related services: taxation compliance services taxation advisory services – other assurance services – other non-audit services Year ended 31 Dec Footnotes 1, 2 Footnotes 3 4 5 6 6 2016 $m 65.7 1.6 67.3 2016 $m 14.0 97.1 51.7 20.6 1.9 0.4 4.5 18.0 111.1 2015 $m 62.0 1.2 63.2 2015 $m 13.1 85.1 48.9 16.6 1.0 0.9 2.8 14.9 98.2 2014 $m 40.6 1.2 41.8 2014 $m 13.4 62.5 27.2 22.6 1.5 0.8 0.7 9.7 75.9 No fees were payable by HSBC to PwC or KPMG as principal auditor for the following types of services: internal audit services and services related to litigation, recruitment and remuneration. Fees payable by HSBC’s associated pension schemes to PwC/KPMG2 Audit of HSBC’s associated pension schemes Audit related assurance services Year ended 31 Dec 2016 $000 208 4 212 2015 $000 352 5 357 2014 $000 322 5 327 1 2 3 4 5 6 Included within the 2016 audit fees payable is a final fee adjustment of $4.2m related to the prior year audit in respect of overruns. PwC became the Group’s principal auditor in 2015. KPMG was the principal auditor during 2014. Fees payable to PwC and KPMG for the statutory audit of the consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings. They include amounts payable for services relating to the consolidation returns of HSBC Holdings’ subsidiaries which are clearly identifiable as being in support of the Group audit opinion. Fees payable for the statutory audit of the financial statements of HSBC’s subsidiaries, including the 2016 changes in scope and additional procedures performed due to the technology systems and data access controls matter as described on page 174. Including services for assurance and other services that relate to statutory and regulatory filings, including comfort letters and interim reviews and work performed related to the implementation of IFRS 9. Including other permitted services relating to advisory, corporate finance transactions, etc. No fees were payable by HSBC’s associated pension schemes to PwC or KPMG as principal auditor for the following types of services: audit-related assurance services, internal audit services, other assurance services, services related to corporate finance transactions, valuation and actuarial services, litigation, recruitment and remuneration, and information technology. In addition to the above, the estimated fees paid to PwC by third parties other than HSBC amount to $4.3m (PwC 2015: $2.4m; KPMG 2014: $3.6m). In these cases, HSBC is connected with the contracting party and may therefore be involved in appointing PwC. These fees arise from services such as auditing mutual funds managed by HSBC and reviewing the financial position of corporate concerns which borrow from HSBC. Fees payable for non-audit services for HSBC Holdings are not disclosed separately because such fees are disclosed on a consolidated basis for the HSBC Group. 212 HSBC Holdings plc Annual Report and Accounts 2016 7 Tax Tax expense Current tax – for this year – adjustments in respect of prior years Deferred tax – origination and reversal of temporary differences – effect of changes in tax rates – adjustments in respect of prior years Year ended 31 Dec Footnotes 1 2016 $m 3,669 3,525 144 (3) (111) (4) 112 2015 $m 3,797 3,882 (85) (26) (153) 110 17 2014 $m 3,950 4,477 (527) 25 (477) 83 419 3,666 3,771 3,975 1 Current tax included Hong Kong profits tax of $1,118m (2015: $1,294m; 2014: $1,135m). The Hong Kong tax rate applying to the profits of subsidiaries assessable in Hong Kong was 16.5% (2015: 16.5%; 2014: 16.5%). Tax reconciliation The tax charged to the income statement differs from the tax charge that would apply if all profits had been taxed at the UK corporation tax rate as follows: Profit before tax Tax expense Taxation at UK corporation tax rate of 20.0% (2015: 20.25%; 2014: 21.5%) Impact of differently taxed overseas profits in overseas locations Items increasing tax charge in 2016 not in 2015: – non-deductible goodwill write-down – non-deductible loss and taxes suffered on Brazil disposal – UK tax losses not recognised – adjustments in respect of prior period liabilities – UK Banking Surcharge – non-UK tax losses not recognised Other items increasing tax charge in 2016: – local taxes and overseas withholding taxes – other permanent disallowables – bank levy – non-deductible UK customer compensation – other items – non-deductible regulatory settlements Items reducing tax charge in 2016: – non-taxable income and gains – effect of profits in associates and joint ventures – change in tax rates Non-taxable income and gains - Industrial Bank US deferred tax temporary differences previously not recognised Other deferred tax temporary differences previously not recognised 2016 $m 7,112 1,422 43 648 464 305 256 199 147 434 438 170 162 — 20 (577) (461) (4) — — — % 20.0 0.6 9.1 6.5 4.3 3.6 2.8 2.1 6.1 6.2 2.4 2.3 — 0.3 (8.1) (6.5) (0.1) — — — 2015 $m 18,867 3,821 71 — — — (68) — — 416 421 286 87 (116) 184 (501) (508) 110 (227) (184) (21) Year ended 31 Dec 3,666 51.6 3,771 % 20.25 0.4 — — — (0.4) — — 2.2 2.2 1.5 0.5 (0.6) 1.0 (2.7) (2.7) 0.6 (1.2) (1.0) (0.1) 20.0 2014 $m 18,680 4,016 33 — — — (108) — — 434 476 229 — (22) 264 (668) (547) 22 — (154) — 3,975 % 21.50 0.2 — — — (0.6) — — 2.3 2.5 1.2 — (0.1) 1.4 (3.5) (2.9) 0.1 — (0.8) — 21.3 The Group’s profits are taxed at different rates depending on the country in which the profits arise. The key applicable tax rates include Hong Kong (16.5%), USA (35%) and UK (20%). If the Group’s profits were taxed at the statutory rates of the countries in which the profits arise then the tax rate for the year would have been 20.6% (2015: 20.65%). The effective tax rate for the year was 51.6% (2015: 20%) and was significantly higher than 2015 due to the non-deductible goodwill write-down and loss on disposal of Brazil, tax losses not recognised, adjustments in respect of prior periods and the 8% UK banking surcharge, which became applicable from 1 January 2016. Accounting for taxes involves some estimation because the tax law is uncertain and its application requires a degree of judgement, which authorities may dispute. Liabilities are recognised based on best estimates of the probable outcome, taking into account external advice where appropriate. We do not expect significant liabilities to arise in excess of the amounts provided. HSBC only recognises current and deferred tax assets where recovery is probable. HSBC Holdings plc Annual Report and Accounts 2016 213 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Movement of deferred tax assets and liabilities Assets Liabilities At 1 Jan 2016 Income statement Other comprehensive income Equity Foreign exchange and other adjustments At 31 Dec 2016 Assets Liabilities Assets Liabilities At 1 Jan 2015 Income statement Other comprehensive income Reclassification to 'Assets held for sale' Equity Foreign exchange and other adjustments At 31 Dec 2015 Assets Liabilities Footnotes 3 2 2 2 2 Loan impairment provisions Unused tax losses and tax credits Derivatives, FVOD1 and other investments Insurance business Expense provisions $m 1,351 — 1,351 (279) — — (122) 950 950 — 2,264 — 2,264 45 — (673) — (285) 1,351 1,351 — $m 1,388 — 1,388 876 — — (52) 2,212 2,212 — 1,332 — 1,332 379 — (186) — (137) 1,388 1,388 — $m 1,400 (230) 1,170 18 28 — (49) 1,167 1,441 (274) 1,764 (233) 1,531 (557) 22 76 — 98 1,170 1,400 (230) $m — (1,056) (1,056) (123) — — 9 (1,170) — (1,170) — (861) (861) (143) — 87 — (139) (1,056) — (1,056) $m 1,271 — 1,271 (370) — — (8) 893 893 — 1,244 — 1,244 418 156 (386) — (161) 1,271 1,271 — Other $m 1,050 (883) 167 (314) 259 20 356 488 1,857 (1,369) 836 (759) 77 (116) 321 (136) 4 17 167 1,050 (883) Total $m 6,460 (2,169) 4,291 (192) 287 20 134 4,540 7,353 (2,813) 7,440 (1,853) 5,587 26 499 (1,218) 4 (607) 4,291 6,460 (2,169) Fair value of own debt. 1 2 After netting off balances within countries, the balances as disclosed in the accounts are as follows: deferred tax assets $6,163m (2015: $6,051m); and deferred tax liabilities $1,623m (2015: $1,760m). Excludes a tax credit of $195m relating to deferred tax balances in Brazil, which were included within 'Assets held for sale' prior to disposal. 3 In applying judgement in recognising deferred tax assets, management has critically assessed all available information, including future business profit projections and the track record of meeting forecasts. The net deferred tax asset of $4.5bn (2015: $4.3bn) includes $4.8bn (2015: $4.5bn) deferred tax assets relating to the US, of which $2bn deferred tax asset relates to US tax losses that expire in 16-20 years. Management expects the US deferred tax asset to be substantially recovered in six to seven years, with the majority recovered in the first five years. The most recent financial forecasts approved by management covers a five-year period and the forecasts have been extrapolated beyond five years by assuming that performance remains constant after the fifth year. The forecasts also include additional tax losses in 2017 – these losses expire in 2037 and are expected to be utilised by 2023. The US reported a loss for the current period, mainly due to the Household International class action litigation settlement. Excluding the Household International class action settlement the US would have reported a profit for the current year. In addition, the US reported a profit in 2014 and 2015. Management does not expect the current year loss to adversely impact future deferred tax asset recovery to a significant extent. The US deferred tax asset has been calculated using the current federal tax rate of 35%. Any possible future reduction of the US federal tax rate from 35% would reduce the value of the US deferred tax assets and create a tax charge in the period in which any change in the tax rate is enacted. This tax charge should be ultimately offset by the benefit of reduced US tax charges in future years. Unrecognised deferred tax The amount of gross temporary differences, unused tax losses and tax credits for which no deferred tax asset is recognised in the balance sheet was $18.2bn (2015: $15.5bn). These amounts included unused state losses arising in the Group’s US operations of $12.3bn (2015: $11.3bn). Of the total amounts unrecognised, $4.9bn (2015: $3.1bn) had no expiry date, $1.0bn (2015: $0.9bn) was scheduled to expire within 10 years and the remaining balance is expected to expire after 10 years. Deferred tax is not recognised in respect of the Group’s investments in subsidiaries and branches where HSBC is able to control the timing of remittance or other realisation and where remittance or realisation is not probable in the foreseeable future. The aggregate temporary differences relating to unrecognised deferred tax liabilities arising on investments in subsidiaries and branches is $10.6bn (2015: $9.1bn) and the corresponding unrecognised deferred tax liability is $0.7bn (2015: $0.6bn). 214 HSBC Holdings plc Annual Report and Accounts 2016 8 Dividends Dividends to shareholders of the parent company Dividends paid on ordinary shares In respect of previous year: – fourth interim dividend In respect of current year: – first interim dividend – second interim dividend – third interim dividend Total 2016 2015 2014 Per share $ Total $m Settled in scrip $m Per share $ Total $m Settled in scrip $m Per share $ Total $m Settled in scrip $m 0.21 4,137 408 0.20 3,845 2,011 0.19 3,582 1,827 0.10 0.10 0.10 1,981 1,991 1,990 703 994 935 0.51 10,099 3,040 0.10 0.10 0.10 0.50 1,951 1,956 1,958 9,710 231 160 760 3,162 0.10 0.10 0.10 0.49 1,906 1,914 1,918 9,320 284 372 226 2,709 Total dividends on preference shares classified as equity (paid quarterly) 62.00 90 62.00 90 62.00 90 Total coupons on capital securities classified as equity Perpetual subordinated capital securities – $2,200m – $3,800m Perpetual subordinated contingent convertible securities – $2,250m issued at 6.375% – $1,500m issued at 5.625% – €1,500m issued at 5.250% – $2,450m issued at 6.375% – €1,000m issued at 6.000% – $2,000m issued at 6.875% Total 2016 Footnotes First call date Per security 1, 3 2, 3 Apr 2013 Dec 2015 Sep 2024 Jan 2020 Sep 2022 Mar 2025 Sep 2023 Jun 2021 $2.032 $2.000 $63.750 $56.250 €52.500 $63.750 €60.000 $68.750 Total $m 179 304 143 84 88 156 67 69 2015 Total $m 179 304 143 70 86 78 — — 2014 Total $m 179 304 — — — — — — 1,090 860 483 1 Discretionary coupons are paid quarterly on the perpetual subordinated capital securities, in denominations of $25 per security. 2 Discretionary coupons are paid semi-annually on the perpetual subordinated contingent convertible securities, in denominations of 1,000 per security. 3 Further details of these securities can be found in Note 32. After the end of the year, the Directors declared a fourth interim dividend in respect of the financial year ended 31 December 2016 of $0.21 per ordinary share, a distribution of approximately $4,172m. The fourth interim dividend will be payable on 6 April 2017 to holders on the Principal Register in the UK, the Hong Kong Overseas Branch Register or the Bermuda Overseas Branch Register on 24 February 2017. No liability was recorded in the financial statements in respect of the fourth interim dividend for 2016. On 17 January 2017, HSBC paid a coupon on its $2,200m subordinated capital securities of $0.508 per security, a distribution of $45m. On 17 January 2017, HSBC paid a coupon on its $1,500m subordinated contingent convertible securities of $28.125 per security, a distribution of $42m. No liability was recorded in the balance sheet at 31 December 2016 in respect of these coupon payments. HSBC Holdings plc Annual Report and Accounts 2016 215 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 9 Earnings per share Basic earnings per ordinary share is calculated by dividing the profit attributable to ordinary shareholders of the parent company by the weighted average number of ordinary shares outstanding, excluding own shares held. Diluted earnings per ordinary share is calculated by dividing the basic earnings, which require no adjustment for the effects of dilutive potential ordinary shares, by the weighted average number of ordinary shares outstanding, excluding own shares held, plus the weighted average number of ordinary shares that would be issued on conversion of dilutive potential ordinary shares. Profit attributable to the ordinary shareholders of the parent company Profit attributable to shareholders of the parent company Dividend payable on preference shares classified as equity Coupon payable on capital securities classified as equity Year ended 31 Dec Basic and diluted earnings per share 2016 $m 2,479 (90) (1,090) 1,299 2015 $m 13,522 (90) (860) 12,572 2014 $m 13,688 (90) (483) 13,115 2016 Profit Number of shares Per share Profit 2015 Number of shares Footnote $m (millions) $ $m (millions) 2014 Number of shares Profit $m (millions) Per share $ Per share $ 0.69 Basic Effect of dilutive potential ordinary shares Diluted 1 1 1,299 19,753 0.07 12,572 19,380 0.65 13,115 18,960 92 137 96 1,299 19,845 0.07 12,572 19,517 0.64 13,115 19,056 0.69 1 Weighted average number of ordinary shares outstanding (basic) or assuming dilution (diluted). The weighted average number of dilutive potential ordinary shares excludes 10m employee share options that were (2015: 7m; 2014: 6m). 10 Trading assets Treasury and other eligible bills Debt securities Equity securities Trading securities Loans and advances to banks Loans and advances to customers At 31 Dec 1 Loans and advances to banks and customers include settlement accounts, stock borrowing, reverse repos and other amounts. Trading Securities1 US Treasury and US Government agencies UK Government Hong Kong Government Other governments Asset-backed securities Corporate debt and other securities Equity securities At 31 Dec Footnote 1 1 Footnotes 2 3 2016 $m 14,451 94,054 63,604 172,109 24,769 38,247 235,125 2016 $m 17,010 9,493 7,970 49,229 2,668 22,135 63,604 2015 $m 7,829 99,038 66,491 173,358 22,303 29,176 224,837 2015 $m 14,833 10,177 6,495 48,567 3,135 23,660 66,491 172,109 173,358 1 2 3 Included within these figures are debt securities issued by banks and other financial institutions of $14,630m (2015: $16,403m), of which $789m (2015: $1,034m) are guaranteed by various governments. Includes securities that are supported by an explicit guarantee issued by the US Government. Excludes asset-backed securities included under US Treasury and US Government agencies. 216 HSBC Holdings plc Annual Report and Accounts 2016 11 Fair values of financial instruments carried at fair value Control framework Fair values are subject to a control framework designed to ensure that they are either determined or validated by a function independent of the risk taker. Where fair values are determined by reference to externally quoted prices or observable pricing inputs to models, independent price determination or validation is used. For inactive markets, HSBC sources alternative market information, with greater weight given to information that is considered to be more relevant and reliable. Examples of the factors considered are price observability, instrument comparability, consistency of data sources, underlying data accuracy and timing of prices. For fair values determined using valuation models, the control framework includes development or validation by independent support functions of the model logic, inputs, model outputs and adjustments. Valuation models are subject to a process of due diligence before becoming operational and are calibrated against external market data on an ongoing basis. Changes in fair value are generally subject to a profit and loss analysis process and are disaggregated into high-level categories including portfolio changes, market movements and other fair value adjustments. The majority of financial instruments measured at fair value are in GB&M. GB&M’s fair value governance structure comprises its Finance function, Valuation Committees and a Valuation Committee Review Group. Finance is responsible for establishing procedures governing valuation and ensuring fair values are in compliance with accounting standards. The fair values are reviewed by the Valuation Committees, which consist of independent support functions. These Committees are overseen by the Valuation Committee Review Group, which considers all material subjective valuations. 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. When quoted market prices are unavailable, the own debt in issue is valued using valuation techniques, the inputs for which are either based on quoted prices in an inactive market for the instrument or are estimated by comparison with quoted prices in an active market for similar instruments. In both cases, the fair value includes the effect of applying the credit spread which is appropriate to 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 instruments 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. Financial instruments carried at fair value and bases of valuation 2016 2015 Level 1 Level 2 Level 3 $m $m $m Total $m Level 1 Level 2 Level 3 $m $m $m Total $m Recurring fair value measurements at 31 Dec Assets Trading assets Financial assets designated at fair value Derivatives Financial investments: available for sale Liabilities Trading liabilities Financial liabilities designated at fair value Derivatives 133,744 19,882 1,076 274,655 94,892 4,144 287,044 111,743 730 2,752 3,476 24,756 290,872 389,874 6,489 235,125 133,095 45,171 104,938 3,582 153,691 4,248 1,554 82,547 275,965 37 86,832 2,300 279,819 18,947 1,922 262,929 41,462 5,260 2,243 84,886 4,431 284,292 117,197 95,867 61,145 277,618 6,856 474 2,262 4,727 4,285 3 1,210 224,837 23,852 288,476 384,853 141,614 66,408 281,071 HSBC Holdings plc Annual Report and Accounts 2016 217 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Transfers between Level 1 and Level 2 fair values At 31 Dec 2016 Transfers from Level 1 to Level 2 Transfers from Level 2 to Level 1 At 31 Dec 2015 Transfers from Level 1 to Level 2 Transfers from Level 2 to Level 1 Assets Liabilities Available for sale Held for trading Designated at fair value Derivatives Held for trading Designated at fair value Derivatives $m $m 162 1,314 1,614 — — — 67 487 $m 122 — — — $m 465 — 56 2 $m 2,699 341 1,563 515 $m — — 857 2 $m 209 — 100 — Transfers between levels of the fair value hierarchy are deemed to occur at the end of each semi-annual reporting period. Fair value adjustments Fair value adjustments are adopted when HSBC determines there are additional factors considered by market participants that are not incorporated within the valuation model. Movements in the level of fair value adjustments do not necessarily result in the recognition of profits or losses within the income statement, such as when models are enhanced and fair value adjustments may no longer be required. Global Banking and Markets fair value adjustments Type of adjustment Risk-related – bid-offer – uncertainty – credit valuation adjustment (‘CVA’) – debit valuation adjustment (‘DVA’) – funding fair value adjustment (‘FFVA’) – other Model-related – model limitation – other Inception profit (Day 1 P&L reserves) (Note 14) At 31 Dec 2016 $m 2015 $m 1,131 1,402 416 87 633 (437) 429 3 14 14 — 99 477 95 853 (465) 442 — 97 92 5 97 1,244 1,596 Fair value adjustments declined by $352m during the year. The most significant movement was a decline of $220m in respect of the credit valuation adjustment, driven by the disposal of Brazilian operations, refinements to modelling methodology and as a result of tightening credit spreads. Bid-offer IFRS 13 ‘Fair value measurement’ 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 an adjustment may be necessary to reflect the likelihood that market participants would adopt more conservative values for uncertain parameters and/or model assumptions than those used in HSBC’s valuation model. Credit and debit valuation adjustments The CVA is an adjustment to the valuation of over-the-counter (‘OTC’) derivative contracts to reflect the possibility that the counterparty may default and that HSBC may not receive the full market value of the transactions. The DVA is an adjustment to the valuation of OTC derivative contracts to reflect the possibility that HSBC may default, and that it may not pay the full market value of the transactions. HSBC calculates a separate CVA and DVA for each legal entity, and for each counterparty to which the entity has exposure. With the exception of central clearing parties, all third-party counterparties are included in the CVA and DVA calculations, and these adjustments are not netted across Group entities. 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, which incorporates a range of potential exposures over the life of the portfolio, to calculate the expected positive exposure to a counterparty. The simulation methodology includes credit mitigants, such as counterparty netting agreements and collateral agreements with the counterparty. 218 HSBC Holdings plc Annual Report and Accounts 2016 The methodologies do not, in general, account for ‘wrong-way risk’ which arises when the underlying value of the derivative prior to any CVA is positively correlated to the PD of the counterparty. When there is significant wrong-way risk, a trade-specific approach is applied to reflect this risk in the valuation. Funding fair value adjustment The FFVA is calculated by applying future market funding spreads to the expected future funding exposure of any uncollateralised component of the OTC derivative portfolio. The expected future funding exposure is calculated by a simulation methodology, where available, and is adjusted for events that may terminate the exposure, such as the default of HSBC or the counterparty. The FFVA and DVA are calculated independently. Model limitation Models used for portfolio valuation purposes may be based upon a simplified set of assumptions that do not capture all current and future material market characteristics. In these circumstances, model limitation adjustments are adopted. 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 in Note 1. 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 Designated at fair value Derivatives Held for trading Designated at fair value Derivatives $m $m Private equity including strategic investments Asset-backed securities Loans held for securitisation Structured notes Derivatives with monolines Other derivatives Other portfolios At 31 Dec 2016 Private equity including strategic investments Asset-backed securities Loans held for securitisation Structured notes Derivatives with monolines Other derivatives Other portfolios At 31 Dec 2015 $m 2,435 761 — — — — $m 49 789 28 2 — — 280 3,476 5,621 6,489 3,443 1,053 — — — — 55 531 30 4 — — 231 4,727 6,236 6,856 $m 712 — — — — — 18 730 453 — — — — — 21 474 $m — — — — 175 2,577 — Total $m 3,196 1,550 28 2 175 2,577 5,919 $m 25 — — 3,557 — — — 2,752 13,447 3,582 — — — — 196 2,066 — 3,951 1,584 30 4 196 2,066 6,488 35 — — 4,250 — — — 2,262 14,319 4,285 Total $m 25 — — 3,557 — — — — — — 2,300 2,300 — 37 2,300 5,919 — — — — — 1,210 — 1,210 35 — — 4,250 — 1,210 3 5,498 — — — — — — 37 37 — — — — — — 3 3 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 ABSs are legacy positions. HSBC has the capability to hold these positions. Private equity including strategic investments The 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; 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 certain ABSs such as residential mortgage-backed securities, the valuation uses an industry standard model with 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. Structured notes The fair value of Level 3 structured notes 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. These structured notes comprise principally equity-linked notes issued by HSBC which provide the counterparty with a return linked to the performance of equity securities and other portfolios. Examples of the unobservable parameters include long-dated equity volatilities and correlations between equity prices, and interest and foreign exchange rates. Derivatives OTC derivative valuation models calculate the present value of expected future cash flows, based upon ‘no-arbitrage’ principles. For many vanilla derivative products, 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. HSBC Holdings plc Annual Report and Accounts 2016 219 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Reconciliation of fair value measurements in Level 3 of the fair value hierarchy Movement in Level 3 financial instruments Assets Liabilities Available for sale Held for trading Designated at fair value Derivatives Held for trading Designated at fair value Derivatives At 1 Jan 2016 Total gains/(losses) recognised in profit or loss – trading income/(expense) excluding net interest income – net income/(expense) from other financial instruments designated at fair value – gains less losses from financial investments – loan impairment charges and other credit risk provisions (‘LICs’) Total gains/(losses) recognised in other comprehensive income (‘OCI’) – available-for-sale investments: fair value gains/ (losses) – cash flow hedges: fair value gains/(losses) – exchange differences Purchases New issuances Sales Settlements Transfers out Transfers in At 31 Dec 2016 Unrealised gains/(losses) recognised in profit or loss relating to assets and liabilities held at 31 Dec 2016 – trading income/(expense) excluding net interest income – net income/(expense) from other financial instruments designated at fair value – loan impairment charges and other credit risk provisions At 1 Jan 2015 Total gains/(losses) recognised in profit or loss – trading income/(expense) excluding net interest income – net income from other financial instruments designated at fair value – gains less losses from financial investments – loan impairment charges and other credit risk provisions (‘LICs’) Total gains/(losses) recognised in other comprehensive income (‘OCI’) 1 – available-for-sale investments: fair value gains/ (losses) – cash flow hedges: fair value gains/(losses) – exchange differences Purchases New issuances Sales Settlements Transfers out Transfers in At 31 Dec 2015 Unrealised gains/(losses) recognised in profit or loss relating to assets and liabilities held at 31 Dec 2015 – trading income/(expense) excluding net interest income – net income from other financial instruments designated at fair value – loan impairment charges and other credit risk provisions Footnote $m 4,727 178 — — 91 87 $m 6,856 31 31 — — — 1 (162) (610) 123 — (285) 350 — — — (610) 823 — (1,212) (1,760) (311) (199) 1,659 6,489 (170) (170) — — 6,468 109 109 — — — (177) (947) 719 3,476 87 — — 87 4,988 (34) — — (269) 235 226 393 — (167) 594 — (757) (32) (1,471) 1,231 4,727 235 — — 235 $m 474 25 $m 2,262 1,107 $m 4,285 337 — 25 — — (8) — — (8) 359 — (7) (113) (2) 2 1,107 337 — — — — — — (335) (130) — — (335) — — — (107) (187) 12 — — (130) 20 1,882 (40) (1,907) (920) 55 730 2,752 3,582 21 — 21 — 726 30 — 30 — — 364 364 — — 2,924 95 95 — — — (143) (143) — — 6,139 (573) (573) — — — (192) (11) (126) (118) — — (192) 1,745 — (1,206) (146) (206) 284 6,856 (9) (9) — — — — (11) 250 — (50) (135) (336) — 474 12 — 12 — — (4) (122) — — — (38) (1,015) 422 2,262 89 89 — — — — (118) 2 1,471 (66) (1,260) (1,743) 433 4,285 384 384 — — $m 3 (1) — (1) — — (1) — — (1) 6 — (2) — — 32 37 1 — 1 — — (1) — (1) — — (1) — — (1) 9 — (4) — — — 3 (1) — (1) — $m 1,210 1,428 1,428 — — — (240) — 12 (252) — — — (239) (229) 370 2,300 (335) (335) — — 1,907 (209) (209) — — — (64) — — (64) — — — (241) (283) 100 1,210 267 267 — — 1 Included in ‘Available-for-sale investments: fair value gains/(losses)’ and ‘Exchange differences’ in the consolidated statement of comprehensive income. 220 HSBC Holdings plc Annual Report and Accounts 2016 Effect of changes in significant unobservable assumptions to reasonably possible alternatives Sensitivity of Level 3 fair values to reasonably possible alternative assumptions 2016 2015 Reflected in profit or loss Reflected in OCI Reflected in profit or loss Reflected in OCI Favourable changes Un- favourable changes Favourable changes Un- favourable changes Favourable changes Un- favourable changes Favourable changes Un- favourable changes Footnote Derivatives, trading assets and trading liabilities 1 Financial assets and liabilities designated at fair value Financial investments: available for sale At 31 Dec $m 238 48 72 358 $m $m $m (177) (38) (36) (251) — — 170 170 — — (149) (149) $m 335 24 35 394 $m (215) (24) (30) (269) $m — — 230 230 $m — — (243) (243) 1 Derivatives, trading assets and trading liabilities are presented as one category to reflect the manner in which these instruments are risk managed. Sensitivity of Level 3 fair values to reasonably possible alternative assumptions by instrument type 2016 2015 Reflected in profit or loss Reflected in OCI Reflected in profit or loss Reflected in OCI Favourable changes Un- favourable changes Favourable changes Un- favourable changes Favourable changes Un- favourable changes Favourable changes Un- favourable changes $m 112 43 1 10 3 141 48 358 $m (73) (15) (1) (7) (3) (94) (58) (251) $m 121 33 — — — — 16 170 $m $m (106) (27) — — — — (16) (149) 54 18 1 15 11 179 116 394 $m (53) (12) (1) (11) (11) (87) (94) $m 152 57 — — — — 21 (269) 230 $m (171) (51) — — — — (21) (243) Private equity including strategic investments Asset-backed securities Loans held for securitisation Structured notes Derivatives with monolines Other derivatives Other portfolios At 31 Dec 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 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. HSBC Holdings plc Annual Report and Accounts 2016 221 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Key unobservable inputs to Level 3 financial instruments Quantitative information about significant unobservable inputs in Level 3 valuations Fair value 2016 2015 Assets Liabilities Footnotes $m $m Valuation techniques Key unobservable inputs Full range of inputs Core range of inputs1 Full range of inputs Core range of inputs1 Lower Higher Lower Higher Lower Higher Lower Higher Private equity including strategic investments Asset-backed securities 2 3,196 1,550 25 — See page 224 See page 224 n/a n/a n/a n/a n/a n/a n/a n/a – CLO/CDO 498 — Market proxy Prepayment rate 2% 7% 2% 7% 1% 6% 1% 6% 1,052 — Market proxy Bid quotes Market proxy Bid quotes 0 0 101 96 42 57 94 90 3 0 147 147 54 44 117 109 28 — 2,577 2,300 – securitisation swaps 711 1,117 other ABSs Loans held for securitisation Structured notes – equity-linked notes – fund-linked notes – FX-linked notes – other Derivatives with monolines Other derivatives Interest rate – long-dated swaptions – other FX derivatives: – FX options – other Equity derivatives: – long-dated single stock options – other Credit derivatives: – other Other portfolios – structured certificates – EM corporate debt – other 3 2 — — — — 2 175 240 4 103 55 24 5,919 4,446 124 1,349 2 165 388 47 37 — 3,557 3,090 Model – Option model Equity volatility Model – Option model Equity correlation 300 Model – Option model 9 Fund volatility 11% 96% 16% 36% 12% 72% 19% 43% 33% 94% 46% 81% 35% 93% 43% 79% 6% 11% 6% 11% 6% 8% 6% 8% 87 71 — Model – Option model FX volatility 3% 29% 5% 18% 5% 35% 5% 20% Model – Discounted cash flow Credit spread Model – Discounted cash flow Prepayment rate 2% 2% 2% 2% 4% 4% 4% 4% 0% 90% 8% 27% 0% 90% 14% 71% 1,236 204 109 108 Model – Option model Model – IR volatility 8% 101% 21% 39% 3% 66% 20% 41% 364 Option model FX Volatility 0.6% 25% 7% 12% 0.5% 35% 5% 14% Model – Option model Equity volatility 11% 83% 16% 36% 8% 104% 18% 44% Model – Discounted cash flow Credit volatility — Market proxy Bid quotes 37 3% 96 4% 3% 4% 144 113 113 2% 70 4% 2% 4% 124 100 123 At 31 Dec 2016 13,447 5,919 1 2 3 The core range of inputs is the estimated range within which 90% of the inputs fall. Collateralised loan obligation/collateralised debt obligation. 'Other' includes a range of smaller asset holdings. 222 HSBC Holdings plc Annual Report and Accounts 2016 Private equity including strategic investments Given the bespoke nature of the analysis in respect of each holding, it is not practical to quote a range of key unobservable inputs. 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. They vary according to the nature of the loan portfolio and expectations of future market conditions, and may be estimated using a variety of evidence, such as prepayment rates implied from proxy observable security prices, current or historical prepayment rates and macroeconomic modelling. Market proxy Market proxy pricing may be used for an instrument when specific market pricing is not available but there is evidence from instruments with common characteristics. 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. Volatility Volatility is a measure of the anticipated future variability of a market price. It varies by underlying reference market price, and by strike and maturity of the option. Certain volatilities, typically those of a longer-dated nature, are unobservable and are estimated from observable data. The range of unobservable volatilities reflects the wide variation in volatility inputs by reference market price. The core range is significantly narrower than the full range because these examples with extreme volatilities occur relatively rarely within the HSBC portfolio. Correlation Correlation is a measure of the inter-relationship between two market prices and is expressed as a number between minus one and one. It is used to value more complex instruments where the payout is dependent upon more than one market price. There is a wide range of instruments for which correlation is an input, and consequently a wide range of both same-asset correlations and cross- asset correlations is used. In general, the range of same-asset correlations will be narrower than the range of cross-asset correlations. 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. 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 and 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. Furthermore, the effect of changing market variables on the HSBC portfolio will depend on HSBC’s net risk position in respect of each variable. HSBC Holdings Basis of valuing HSBC Holdings’ financial assets and liabilities measured at fair value Valuation technique using observable inputs: Level 2 Assets at 31 Dec – derivatives – available for sale Liabilities at 31 Dec – designated at fair value – derivatives 2016 $m 2,148 3,590 30,113 5,025 2015 $m 2,467 4,285 19,853 2,278 HSBC Holdings plc Annual Report and Accounts 2016 223 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 12 Fair values of financial instruments not carried at fair value Fair values of financial instruments not carried at fair value and bases of valuation At 31 Dec 2016 Assets Loans and advances to banks Loans and advances to customers Reverse repurchase agreements – non-trading Financial investments – debt securities Liabilities Deposits by banks Customer accounts Repurchase agreements – non-trading Debt securities in issue Subordinated liabilities At 31 Dec 2015 Assets Loans and advances to banks Loans and advances to customers Reverse repurchase agreements – non-trading Financial investments – debt securities Liabilities Deposits by banks Customer accounts Repurchase agreements – non-trading Debt securities in issue Subordinated liabilities Carrying amount $m 88,126 861,504 160,974 46,923 59,939 1,272,386 88,958 65,915 20,984 90,401 924,454 146,255 44,102 54,371 1,289,586 80,400 88,949 22,702 Fair value Quoted market price Level 1 Observable inputs Level 2 Significant unobservable inputs Level 3 $m $m $m Total $m 88,140 861,564 161,031 47,223 59,925 2,572 845,894 1,527 19 42 10,136 1,272,676 — — 292 88,939 66,386 23,556 2,255 910,057 959 19 76 9,421 — — 649 90,411 922,469 146,266 45,258 54,371 1,289,789 80,400 89,023 24,993 — — — 1,190 — — — — — — — — 1,163 — — — — — 85,568 15,670 159,504 46,014 59,883 1,262,540 88,939 66,386 23,264 88,156 12,412 145,307 44,076 54,295 1,280,368 80,400 89,023 24,344 Fair values of selected financial instruments not carried at fair value and bases of valuation – assets and disposal groups held for sale At 31 Dec 2016 Loans and advances to customers Customer accounts At 31 Dec 2015 Loans and advances to customers Customer accounts Fair value Quoted market price Level 1 Observable inputs Level 2 Significant unobservable inputs Level 3 $m $m $m — — — — 241 2,713 4,068 15,578 3,306 — 16,884 1,104 Carrying amount $m 3,756 2,713 21,109 16,682 Total $m 3,547 2,713 20,952 16,682 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. They include cash and balances at central banks, items in the course of collection from and transmission to other banks, Hong Kong Government certificates of indebtedness and Hong Kong currency notes in circulation, all of which are measured at amortised cost. 224 HSBC Holdings plc Annual Report and Accounts 2016 Carrying amount and fair value of loans and advances to customers by industry sector Loans and advances to customers – personal – corporate and commercial – financial At 31 Dec 2016 Loans and advances to customers – personal – corporate and commercial – financial At 31 Dec 2015 Carrying amount Not Impaired Impaired $m $m 332,574 453,151 63,316 849,041 361,716 485,933 60,049 907,698 5,252 7,058 153 12,463 9,487 7,145 124 16,756 Total $m 337,826 460,209 63,469 861,504 371,203 493,078 60,173 924,454 Fair value Not Impaired Impaired $m $m 330,167 456,816 63,411 850,394 359,559 487,196 59,941 906,696 4,597 6,393 180 11,170 9,024 6,592 157 15,773 Total $m 334,764 463,209 63,591 861,564 368,583 493,788 60,098 922,469 Loans and advances to customers are classified as not impaired or impaired in accordance with the criteria described on page 90. Valuation Fair value is an estimate of the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It does not reflect the economic benefits and costs that HSBC expects to flow from an instrument’s cash flow over its expected future life. Our valuation methodologies and assumptions in determining fair values for which no observable market prices are available may differ from those of other companies. Loans and advances to banks and customers To determine the fair value of loans and advances to banks and customers, loans are segregated, as far as possible, into portfolios of similar characteristics. Fair values are based on observable market transactions, when available. When they are unavailable, fair values are estimated using valuation models incorporating a range of input assumptions. These assumptions may include: value estimates from third-party brokers reflecting over-the-counter trading activity; forward-looking discounted cash flow models, taking account of expected customer prepayment rates, using assumptions that HSBC believes are consistent with those that would be used by market participants in valuing such loans; new business rates estimates for similar loans; and trading inputs from other market participants including observed primary and secondary trades. From time to time, we may engage a third party valuation specialist to measure the fair value of a pool of loans. The fair value of loans reflects 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. For impaired loans, fair value is estimated by discounting the future cash flows over the time period they are expected to be recovered. Financial investments The fair values of listed financial investments are determined using bid market prices. The fair values of unlisted financial investments are determined using valuation techniques that incorporate the prices and future earnings streams of equivalent quoted securities. Deposits by banks and customer accounts The fair values of on demand deposits are approximated by their carrying value. For deposits with longer-term maturities, fair values are estimated using discounted cash flows, applying current rates offered for deposits of similar remaining maturities. Debt securities in issue and subordinated liabilities Fair values are determined using quoted market prices at the balance sheet date where available, or by reference to quoted market prices for similar instruments. Repurchase and reverse repurchase agreements – non-trading Fair values approximate carrying amounts as 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 Assets at 31 Dec Loans and advances to HSBC undertakings Liabilities at 31 Dec Amounts owed to HSBC undertakings Debt securities in issue Subordinated liabilities 1 Fair values were determined using valuation techniques with observable inputs (Level 2). 2016 Carrying amount $m Fair value1 $m 2015 Carrying amount $m Fair value1 $m 77,421 79,985 44,350 45,180 2,157 21,805 15,189 2,156 23,147 17,715 2,152 960 15,895 2,152 1,224 18,297 HSBC Holdings plc Annual Report and Accounts 2016 225 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 13 Financial assets designated at fair value Securities – treasury and other eligible bills – debt securities – equity securities Loans and advances to banks and customers At 31 Dec Securities1 US Treasury and US Government agencies UK Government Hong Kong Government Other governments Asset-backed securities Corporate debt and other securities Equities At 31 Dec 2016 $m 24,677 204 4,189 20,284 79 24,756 2016 $m 104 41 16 747 20 3,465 20,284 24,677 2015 $m 23,732 396 4,341 18,995 120 23,852 2015 $m 145 103 33 1,020 25 3,411 18,995 23,732 Footnotes 2 3 1 2 3 Included within these figures are debt securities issued by banks and other financial institutions of $1,766m (2015: $1,536m), of which $19m (2015: $35m) are guaranteed by various governments. Includes securities that are supported by an explicit guarantee issued by the US Government. Excludes asset-backed securities included under US Treasury and US Government agencies. 14 Derivatives Notional contract amounts and fair values of derivatives by product contract type held by HSBC Foreign exchange Interest rate Equities Credit Commodity and other Notional contract amount Fair value – Assets Trading Hedging Trading Hedging $m 5,819,814 13,729,757 472,169 448,220 62,009 $m 26,281 215,006 — — — $m 126,185 253,398 7,410 5,199 2,020 $m 1,228 1,987 — — — Gross total fair values 20,531,969 241,287 394,212 3,215 Offset (Note 30) At 31 Dec 2016 Foreign exchange Interest rate Equities Credit Commodity and other Gross total fair values Offset (Note 30) At 31 Dec 2015 20,531,969 241,287 394,212 3,215 5,658,030 14,462,113 501,834 463,344 51,683 32,324 212,923 — — — 95,201 277,496 8,732 6,961 3,148 1,140 1,658 — — — 21,137,004 245,247 391,538 2,798 21,137,004 245,247 391,538 2,798 Total $m 127,413 255,385 7,410 5,199 2,020 397,427 (106,555) 290,872 96,341 279,154 8,732 6,961 3,148 394,336 (105,860) 288,476 Fair value – Liabilities Trading Hedging $m 118,813 245,941 9,240 5,767 1,564 $m 968 4,081 — — — 381,325 5,049 381,325 5,049 94,843 267,609 10,383 6,884 2,699 382,418 755 3,758 — — — 4,513 382,418 4,513 Total $m 119,781 250,022 9,240 5,767 1,564 386,374 (106,555) 279,819 95,598 271,367 10,383 6,884 2,699 386,931 (105,860) 281,071 The notional contract amounts of derivatives held for trading purposes and derivatives designated in qualifying hedge accounting indicate the nominal value of transactions outstanding at the balance sheet date; they do not represent amounts at risk. Derivative assets increased during 2016, driven by changes in foreign exchange rates and yield curve movements. 226 HSBC Holdings plc Annual Report and Accounts 2016 Notional contract amounts and fair values of derivatives by product contract type held by HSBC Holdings with subsidiaries Notional contract amount Fair value – Assets Trading Hedging Trading Hedging $m 23,442 26,858 50,300 19,036 10,150 29,186 $m 1,120 24,356 25,476 1,120 5,132 6,252 $m 223 1,478 1,701 390 1,600 1,990 $m — 447 447 — 477 477 Total $m 223 1,925 2,148 390 2,077 2,467 Fair value – Liabilities Trading Hedging $m 3,201 639 3,840 2,065 — 2,065 $m 239 946 1,185 213 — 213 Total $m 3,440 1,585 5,025 2,278 — 2,278 Foreign exchange Interest rate At 31 Dec 2016 Foreign exchange Interest rate At 31 Dec 2015 Use of derivatives For details regarding use of derivatives, see page 116 under ‘Market Risk’. 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. Substantially all of HSBC Holdings’ derivatives entered into with subsidiaries are managed in conjunction with financial liabilities designated at fair value. 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 Unamortised balance at 1 Jan Deferral on new transactions Recognised in the income statement during the year: – amortisation – subsequent to unobservable inputs becoming observable – maturity, termination or offsetting derivative Exchange differences Other Unamortised balance at 31 Dec 1 This amount is yet to be recognised in the consolidated income statement. Hedge accounting derivatives Fair value hedges Footnote 1 2016 $m 97 156 (140) (70) (5) (65) (13) (1) 99 2015 $m 114 196 (207) (121) (2) (84) (6) — 97 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. Notional contract amounts and fair values of derivatives designated as fair value hedges by product type HSBC Foreign exchange Interest rate At 31 Dec HSBC Holdings Foreign exchange Interest rate At 31 Dec Notional $m 618 124,361 124,979 1,120 24,356 25,476 2016 Assets $m 10 1,078 1,088 — 447 447 Liabilities $m 22 3,726 3,748 239 946 1,185 Notional $m 196 105,127 105,323 1,120 5,132 6,252 2015 Assets $m 2 672 674 — 477 477 Liabilities $m — 3,395 3,395 213 — 213 HSBC Holdings plc Annual Report and Accounts 2016 227 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Gains or losses arising from fair value hedges HSBC Gains/(losses): – on hedging instruments – on the hedged items attributable to the hedged risk Year ended 31 Dec HSBC Holdings Gains/(losses): – on hedging instruments – on the hedged items attributable to the hedged risk Year ended 31 Dec Cash flow hedges 2016 $m (439) 462 23 (909) 926 17 2015 $m 40 (51) (11) (4) 6 2 2014 $m (2,542) 2,561 19 423 (422) 1 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. Notional contract amounts and fair values of derivatives designated as cash flow hedges by product held by HSBC Foreign Exchange Interest rate At 31 Dec Notional $m 25,663 90,645 116,308 2016 Assets Liabilities $m 1,081 909 1,990 $m 939 355 1,294 Notional $m 32,128 107,796 139,924 2015 Assets Liabilities $m 1,027 986 2,013 $m 748 363 1,111 Forecast principal balances on which interest cash flows are expected to arise Net cash inflows/(outflows) exposure Assets Liabilities At 31 Dec 2016 Net cash inflows/(outflows) exposure Assets Liabilities At 31 Dec 2015 3 months More than 3 months 5 years or less More than or less but less than 1 year but more than 1 year $m $m $m 83,472 (13,169) 70,303 94,256 (16,241) 78,015 79,749 (12,977) 66,772 93,528 (17,179) 76,349 57,553 (11,761) 45,792 62,664 (11,681) 50,983 5 years $m 2,750 (1,502) 1,248 971 (3,326) (2,355) This table reflects the interest rate repricing profile of the underlying hedged items. During the year to 31 December 2016 a loss of $5m (2015: gain of $15m; 2014: gain of $34m) was recognised due to hedge ineffectiveness. A gain of $129m was recognised in respect of amounts reclassified from other comprehensive income to the income statement for partially discontinued macro cash flow hedges, where the hedged forecast transactions are no longer expected to occur (2015: nil; 2014: nil). 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 foreign currency borrowings. At 31 December 2016, the fair values of outstanding financial instruments designated as hedges of net investments in foreign operations were assets of $137m (2015: $111m), liabilities of $7m (2015: $12m) and notional contract values of $3,544m (2015: $4,210m). Ineffectiveness recognised in ‘Net trading income’ in the year ended 31 December 2016 was nil (2015: nil; 2014: nil). 228 HSBC Holdings plc Annual Report and Accounts 2016 15 Financial investments Carrying amount of financial investments Available for sale securities at fair value – treasury and other eligible bills – debt securities – equity securities Held to maturity securities at amortised cost – debt securities At 31 Dec 1 Fair value $47.2bn (2015: $45.3bn). Financial investments at amortised cost and fair value US Treasury US Government agencies US Government sponsored entities UK Government Hong Kong Government Other governments Asset-backed securities Corporate debt and other securities Equities At 31 Dec Footnote 1 2016 $m 389,874 99,226 285,981 4,667 46,923 46,923 436,797 2015 $m 384,853 104,551 274,467 5,835 44,102 44,102 428,955 Footnotes 2 2 3 2016 2015 Amortised cost Fair value1 Amortised cost Fair value1 $m 57,135 15,790 14,397 27,506 62,500 140,943 10,246 100,180 3,042 431,739 $m 56,625 15,682 14,442 28,480 62,475 142,594 9,392 102,741 4,667 437,098 $m 61,585 22,910 10,365 27,250 53,676 141,329 14,239 89,860 4,057 425,271 $m 61,779 22,843 10,627 27,316 53,674 143,370 13,375 91,292 5,835 430,111 1 2 3 Included within ‘Fair value’ figures are debt securities issued by banks and other financial institutions of $69bn (2015: $61bn), of which $20bn (2015: $18bn) are guaranteed by various governments. Includes securities that are supported by an explicit guarantee issued by the US Government. Excludes asset-backed securities included under US Government agencies and sponsored entities. Maturities of investments in debt securities at their carrying amount Available for sale Held to maturity At 31 Dec 2016 Available for sale Held to maturity At 31 Dec 2015 1 year or less 5 years or less but over 1 year 10 years or less but over 5 years Over 10 years $m 64,155 2,502 66,657 61,664 2,428 64,092 $m 142,700 10,210 152,910 131,023 10,242 141,265 $m 45,385 10,348 55,733 42,140 8,881 51,021 $m 33,741 23,863 57,604 39,640 22,551 62,191 Total $m 285,981 46,923 332,904 274,467 44,102 318,569 HSBC Holdings plc Annual Report and Accounts 2016 229 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Contractual maturities and weighted average yields of investment debt securities Available for sale US Treasury US Government agencies US Government-sponsored agencies UK Government Hong Kong Government Other governments Asset-backed securities Corporate debt and other securities Total amortised cost at 31 Dec 2016 Total carrying value Held to maturity US Treasury US Government agencies US Government-sponsored agencies Hong Kong Government Other governments Asset-backed securities Corporate debt and other securities Total amortised cost at 31 Dec 2016 Total carrying value 1 year or less 5 years or less but over 1 year 10 years or less but over 5 years Over 10 years Amount Yield Amount Yield Amount Yield Amount $m % $m % $m % $m Yield % 5,896 2 200 2,913 357 42,513 41 11,641 63,563 64,155 22 — — 26 41 — 2,413 2,502 2,502 1.0 9.5 3.3 1.3 0.7 1.8 1.8 2.0 4.8 — — 0.3 5.6 — 3.2 22,807 118 3,138 6,742 1,143 61,734 837 43,936 140,455 142,700 61 6 299 18 318 — 9,508 10,210 10,210 1.5 3.3 2.8 0.9 1.2 2.4 1.2 1.6 4.8 1.8 2.2 3.0 4.0 — 3.6 19,063 95 1,173 10,132 — 8,151 1,196 4,524 44,334 45,385 46 36 393 23 169 — 9,681 10,348 10,348 1.9 2.5 2.4 1.2 — 3.0 1.6 3.7 5.0 3.3 2.8 1.5 3.9 — 3.4 4,024 6,844 5,829 547 — 1,480 8,166 7,316 34,206 33,741 124 8,690 3,364 7 805 5 10,868 23,863 23,863 3.0 2.2 2.3 3.4 — 6.5 2.1 4.2 4.2 2.3 2.9 1.4 4.3 7.0 3.9 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 2016 by the book amount of available-for-sale debt securities at that date. The yields do not include the effect of related derivatives. 16 Assets pledged, collateral received and assets transferred Assets pledged Financial assets pledged as collateral Treasury bills and other eligible securities Loans and advances to banks Loans and advances to customers Debt securities Equity securities Other Assets pledged at 31 Dec 2016 $m 7,151 17,444 74,109 80,063 2,655 1,838 2015 $m 5,941 15,582 88,927 69,470 4,644 213 183,260 184,777 Assets pledged as collateral include all assets categorised as encumbered in the disclosure on page 76. The amount of assets pledged to secure liabilities may be greater than the book value of assets utilised as collateral. For example, in the case of securitisations and covered bonds, the amount of liabilities issued plus mandatory over-collateralisation is less than the book value of the pool of assets available for use as collateral. This is also the case where assets are placed with a custodian or a settlement agent which has a floating charge over all the 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 borrowing, repurchase agreements and derivative margining. HSBC places both cash and non-cash collateral in relation to derivative transactions. Financial assets pledged as collateral which the counterparty has the right to sell or repledge Trading assets Financial investments At 31 Dec 2016 $m 37,141 4,044 41,185 2015 $m 32,633 8,050 40,683 230 HSBC Holdings plc Annual Report and Accounts 2016 Collateral received The fair value of assets accepted as collateral, relating primarily to standard securities lending, reverse repurchase agreements and derivative margining, that HSBC is permitted to sell or repledge in the absence of default was $250,919m (2015: $222,065m). The fair value of any such collateral sold or repledged was $149,185m (2015: $139,532m). HSBC is obliged to return equivalent securities. These transactions are conducted under terms that are usual and customary to standard securities lending, reverse repurchase agreements and derivative margining. Assets transferred The assets pledged include transfers to third parties that do not qualify for derecognition, notably secured borrowings such as debt securities held by counterparties as collateral under repurchase agreements and equity securities lent under securities lending agreements. The transferred asset collateral continues to be recognised in full and a related liability, reflecting the Group’s obligation to repurchase the assets for a fixed price at a future date is also recognised on the balance sheet. The Group is unable to use, sell or pledge the transferred assets for the duration of the transaction, and remains exposed to interest rate risk and credit risk on these pledged assets. With the exception of ‘Other sales’ in the table below, the counterparty’s recourse is not limited to the transferred assets. Transferred financial assets not qualifying for full derecognition and associated financial liabilities At 31 Dec 2016 Repurchase agreements Securities lending agreements Other sales (recourse to transferred assets only) At 31 Dec 2015 Repurchase agreements Securities lending agreements Other sales (recourse to transferred assets only) Carrying amount of: Fair value of: Transferred assets Associated liabilities Transferred assets Associated liabilities $m $m $m $m Net position $m 40,364 3,324 2,441 36,153 5,275 2,717 39,568 2,655 2,466 35,913 5,704 2,768 2,455 2,458 (3) 2,720 2,726 (6) 17 Interests in associates and joint ventures Associates At 31 December 2016, the carrying amount of HSBC’s interests in associates was $19,874m (2015: $18,900m). Principal associates of HSBC Bank of Communications Co., Limited The Saudi British Bank At 31 Dec 2016 2015 Carrying amount $m 15,765 3,280 19,045 Fair value1 $m 10,207 3,999 14,206 Carrying amount $m 15,344 3,021 18,365 1 The fair values are based on the quoted market prices of the shares held (Level 1 in the fair value hierarchy). At 31 Dec 2016 Footnote 1 Country of incorporation and principal place of business Principal activity PRC Banking services Saudi Arabia Banking services Bank of Communications Co., Limited The Saudi British Bank 1 People’s Republic of China. A list of all associates and joint ventures is set out on page 271. Bank of Communications Co., Limited Fair value1 $m 9,940 3,957 13,897 HSBC’s interest % 19.03 40.00 The Group’s significant influence in Bank of Communications Co., Limited (‘BoCom’) was established via representation on BoCom’s board of directors and a technical cooperation and exchange programme (‘TCEP’). Under the TCEP, a number of HSBC staff have been seconded to assist in the maintenance of BoCom’s financial and operating policies. HSBC Holdings plc Annual Report and Accounts 2016 231 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Impairment testing At 31 December 2016, the fair value of HSBC’s investment in BoCom had been below the carrying amount for approximately 56 months. As a result, the Group performed an impairment test on the carrying amount of the investment in BoCom, which confirmed there was no impairment at 31 December 2016. Bank of Communications Co., Limited Basis of recoverable amount At 31 Dec 2016 At 31 Dec 2015 VIU $bn 16.1 Carrying value $bn 15.8 Fair value $bn 10.2 VIU $bn 17.0 Carrying value $bn 15.3 Fair value $bn 9.9 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 extrapolated in perpetuity using a long-term growth rate. An imputed capital maintenance charge (‘CMC’) is calculated to reflect expected regulatory capital requirements, and is deducted 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 value in use calculation The assumptions we used in our VIU calculation were: • Long-term profit growth rate 5% (2015: 5%) for periods after 2019, which does not exceed forecast GDP growth in mainland China. • Long-term asset growth rate: 4% (2015: 4%) for periods after 2019, which is the rate that assets are expected to grow to achieve long-term profit growth of 5%. • Discount rate: 13% (2015: 13%), which is derived from a range of values obtained by applying a capital asset pricing model (‘CAPM’) calculation for BoCom, using market data. Management also compares rates derived from the CAPM with discount rates from external sources, and HSBC’s discount rate for evaluating investments in mainland China. The discount rate used was within the range of 10.2% to 15.0% (2015: 10.1% to 14.2%) indicated by the CAPM and external sources. • Loan impairment charge as a percentage of customer advances: a range from 0.72% to 0.87% (2015: 0.71% to 0.78%) in the short to medium term, based on forecasts disclosed by external analysts. For periods after 2019, the ratio is 0.70% (2015: 0.70%), slightly higher than the historical average. • Risk-weighted assets as a percentage of total assets: 62% for all forecast periods (2015: 67%). This is consistent with the medium- term forecasts disclosed by external analysts. • Cost-income ratio: 40% (2015: 41%) in the short to medium term. The ratios were consistent with the short- to medium-term range forecasts of 39.9% to 40.2% (2015: 40.3% to 40.7%) disclosed by external analysts. The following table shows the change to each key assumption in the VIU calculation that on its own would reduce the headroom to nil. Key assumption • Long-term profit growth rate • Long-term asset growth rate • Discount rate • Loan impairment charge as a percentage of customer advances • Risk-weighted assets as a percentage of total assets • Cost-income ratio Changes to key assumption to reduce headroom to nil • Decrease by 13 basis points • • • • • Increase by 14 basis points Increase by 17 basis points Increase by 3 basis points Increase by 95 basis points Increase by 60 basis points 232 HSBC Holdings plc Annual Report and Accounts 2016 The following table illustrates the effect on VIU of reasonably possible changes to key assumptions. This reflects the sensitivity of the 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. Sensitivity of VIU to reasonably possible changes in key assumptions At 31 Dec 2016 Long-term profit growth rate Long-term asset growth rate Discount rate Loan impairment charge as a percentage of customer advances Risk-weighted assets as a percentage of total assets Cost-income ratio At 31 Dec 2015 Long-term profit growth rate Long-term asset growth rate Discount rate Loan impairment charge as a percentage of customer advances Risk-weighted assets as a percentage of total assets Cost income ratio Favourable change Unfavourable change Increase in VIU bps $bn — (80) (100) — (30) (170) 100 (50) (150) 70 throughout (350) (250) — 1.8 2.3 — 0.1 0.9 3.2 1.2 4.2 0.1 1.2 1.5 VIU $bn 16.1 17.8 18.4 16.1 16.2 17.0 20.3 18.2 21.2 17.2 18.2 18.5 Decrease In VIU bps $bn (150) (3.3) — — 2016-19: 0.93% 2020 onwards: 0.80% 170 250 (210) 100 110 2015-18: 0.85% 2019 onwards: 0.75% 10 120 — — (1.1) (0.6) (1.4) (4.7) (2.8) (2.1) (0.7) — (0.7) VIU $bn 12.8 16.1 16.1 15.0 15.5 14.7 12.3 14.3 14.9 16.4 17 16.4 Considering the interrelationship of the changes set out in the table above, management estimates that the reasonably possible range of VIU is $10.8bn to $19.0bn. Selected financial information of BoCom The statutory accounting reference date of BoCom is 31 December. For the year ended 31 December 2016, HSBC included the associate’s results on the basis of financial statements for the 12 months ended 30 September 2016, taking into account changes in the subsequent period from 1 October 2016 to 31 December 2016 that would have materially affected the results. Selected balance sheet information of BoCom Cash and balances at central banks Loans and advances to banks and other financial institutions Loans and advances to customers Other financial assets Other assets Total assets Deposits by banks and other financial institutions Customer accounts Other financial liabilities Other liabilities Total liabilities Total equity At 30 Sep 2016 $m 137,844 101,436 566,126 311,207 48,922 2015 $m 144,702 110,915 560,503 244,722 49,246 1,165,535 1,110,088 297,442 680,915 69,954 27,860 1,076,171 89,364 261,211 691,959 46,932 29,329 1,029,431 80,657 Reconciliation of BoCom’s total shareholders’ equity to the carrying amount in HSBC’s consolidated financial statements HSBC’s share of total shareholders’ equity Add: Goodwill and other intangible assets Carrying amount At 30 Sep 2016 $m 15,285 480 15,765 2015 $m 14,824 520 15,344 HSBC Holdings plc Annual Report and Accounts 2016 233 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Selected income statement information of BoCom Net interest income Net fee and commission income Loan impairment charges Depreciation and amortisation Tax expense Profit for the year Other comprehensive income Total comprehensive income Dividends received from BoCom Summarised aggregate financial information for all associates excluding BoCom Carrying amount HSBC’s share of: – total assets – total liabilities – revenues – profit or loss from continuing operations Joint ventures For the 12 months ended 30 Sep 2016 $m 20,614 5,493 (4,284) (1,216) (2,800) 10,151 875 11,026 580 2016 $m 4,109 20,757 16,661 923 454 2015 $m 22,397 5,432 (3,772) (1,012) (2,976) 10,634 377 11,011 624 2015 $m 3,556 21,645 18,166 821 508 At 31 December 2016, the carrying amount of HSBC’s interests in joint ventures was $155m (2015: $239m). Associates and joint ventures For the year ended 31 December 2016, HSBC’s share of associates’ and joint ventures’ tax on profit was $542m (2015: $575m). This is included within ‘Share of profit in associates and joint ventures’ in the ‘Consolidated income statement’. Movements in interests in associates and joint ventures At 1 Jan Additions Disposals Share of results Dividends Exchange differences Share of other comprehensive income of associates and joint ventures Other movements At 31 Dec 1 Includes goodwill of $488m (2015: $593m). Footnote 2016 $m 19,139 76 (25) 2,354 (751) (1,115) 54 297 2015 $m 18,181 3 (8) 2,556 (879) (718) (9) 13 1 20,029 19,139 234 HSBC Holdings plc Annual Report and Accounts 2016 18 Investments in subsidiaries Principal subsidiaries of HSBC Holdings Europe HSBC Bank plc HSBC France HSBC Assurances Vie (France) HSBC Private Banking Holdings (Suisse) SA HSBC Trinkaus & Burkhardt AG Asia Hang Seng Bank Limited HSBC Bank Australia Limited HSBC Bank (China) Company Limited HSBC Bank Malaysia Berhad HSBC Bank (Taiwan) Limited HSBC Life (International) Limited The Hongkong and Shanghai Banking Corporation Limited HSBC Bank (Singapore) Limited Middle East and North Africa HSBC Bank Middle East Limited HSBC Bank Egypt S.A.E. North America HSBC Bank Canada HSBC Bank USA, N.A. HSBC Securities (USA) Inc. Latin America At 31 Dec 2016 Country of incorporation or registration HSBC’s interest % Share class England and Wales France France Switzerland Germany 100 £1 Ordinary and Preferred Ordinary, $0.01 Non-cumulative third Dollar Preference Shares 99.99 €5 Actions 100 100 287.50 EUR Ordinary shares CHF1,000 Ordinary 80.65 Stückaktien no par value Hong Kong 62.14 HK$5 Ordinary Australia PRC4 Malaysia Taiwan Bermuda Hong Kong Singapore United Arab Emirates Egypt Canada USA USA 100 Ordinary no par value 100 100 100 CNY1 Ordinary RM0.50 Ordinary TWD10 Ordinary 100 HK$1 Ordinary 100 HK$2.50 Ordinary$1 CIP1, CRP2 and NIP3 100 SGD100 Ordinary 100 $1 Ordinary and $1 CRP2 94.53 EGP84 Ordinary 100 100 100 Common no par value and Preference no par value $100 Common and $0.01 Preference $0.05 Common HSBC Mexico, S.A., Institución de Banca Múltiple, Grupo Financiero HSBC Mexico 99.99 MXN2 Ordinary Cumulative Irredeemable Preference shares. 1 2 Cumulative Redeemable Preference shares. 3 Non-cumulative Irredeemable Preference shares. 4 People’s Republic of China. Details of the debt, subordinated debt and preference shares issued by the principal subsidiaries to parties external to the Group are included in Notes 25 ‘Debt securities in issue’, 28 ‘Subordinated liabilities’ and 31 ‘Non-controlling interests’, respectively. A list of all related undertakings is set out on pages 265 to 271. The principal countries of operation are the same as the countries of incorporation except for HSBC Bank Middle East Limited, which operates mainly in the Middle East and North Africa, and HSBC Life (International) Limited, which operates mainly in Hong Kong. HSBC is structured as a network of regional banks and locally incorporated regulated banking entities. Each bank is separately capitalised in accordance with applicable prudential requirements and maintains a capital buffer consistent with the Group’s risk appetite for the relevant country or region. HSBC’s capital management process is incorporated in the Annual Operating Plan, which is approved by the Board. HSBC Holdings is the primary provider of equity capital to its subsidiaries and also provides them with non-equity capital where necessary. These investments are substantially funded by HSBC Holdings’ issuance of equity and non-equity capital and by profit retention. As part of its capital management process, HSBC Holdings seeks to maintain a balance between the composition of its capital and its investment in subsidiaries. Subject to this, there is no current or foreseen impediment to HSBC Holdings’ ability to provide funding for such investments. During 2016, consistent with the Group's capital plan, the Group’s subsidiaries did not experience any significant restrictions on paying dividends or repaying loans and advances. Also, there are no foreseen restrictions envisaged with regard to planned dividends or payments. However, the ability of subsidiaries to pay dividends or advance monies to HSBC Holdings depends on, among other things, their respective local regulatory capital and banking requirements, exchange controls, statutory reserves, and financial and operating performance. The amount of guarantees by HSBC Holdings in favour of other HSBC Group entities is set out in Note 33. Information on structured entities consolidated by HSBC where HSBC owns less than 50% of the voting rights is included in Note 19 ‘Structured entities’. In each of these cases, HSBC controls and consolidates an entity when it is exposed, or has rights, to variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. HSBC Holdings plc Annual Report and Accounts 2016 235 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Subsidiaries with significant non-controlling interests Hang Seng Bank Limited Proportion of ownership interests and voting rights held by non-controlling interests Place of business Profit attributable to non-controlling interests Accumulated non-controlling interests of the subsidiary Dividends paid to non-controlling interests Summarised financial information: – total assets – total liabilities – net operating income before loan impairment – profit for the year – total comprehensive income for the year 19 Structured entities 2016 2015 37.86% 37.86% Hong Kong Hong Kong $m 814 5,792 811 175,242 159,035 3,937 2,148 2,044 $m 1,364 5,866 523 169,813 153,458 5,411 3,604 1,636 HSBC is mainly involved with both consolidated and unconsolidated structured entities through the securitisation of financial assets, conduits and investment funds, established either by HSBC or a third party. Consolidated structured entities Total assets of HSBC’s consolidated structured entities, split by entity type At 31 Dec 2016 At 31 Dec 2015 Conduits Conduits Securitisations HSBC managed funds $bn 15.8 25.9 $bn 5.7 5.6 $bn 4.8 8.2 Other $bn 3.7 5.7 Total $bn 30.0 45.4 HSBC has established and manages two types of conduits: securities investment conduits (‘SICs’) and multi-seller conduits. Securities investment conduits The SICs purchase highly rated ABSs to facilitate tailored investment opportunities. • Solitaire – At 31 December 2016, Solitaire, HSBC’s principal SIC held $4.7bn of ABSs (2015: $6.2bn). These are included within the disclosures of ABSs on page 105. It is currently funded entirely by commercial paper (‘CP’) issued to HSBC. Although HSBC continues to provide a liquidity facility, Solitaire has no need to draw on it as long as HSBC purchases its issued CP, which HSBC intends to do for the foreseeable future. At 31 December 2016, HSBC held $6.1bn of CP (2015: $8.0bn). • Mazarin, Barion and Malachite – All three SICs are predominantly funded by repurchase agreements and medium-term notes. HSBC is exposed to the par value of Mazarin assets through the provision of a liquidity facility equal to the lesser of the amortised cost of issued debt and the amortised cost of non-defaulted assets. At 31 December 2016, this amounted to $1.0bn (2015: $1.8bn). HSBC’s primary exposure to Barion and Malachite is represented by the amortised cost of the debt required to support the non-cash assets of the vehicles. At 31 December 2016, this amounted to $0.8bn (2015: $1.4bn). For all three SICs first loss protection is provided through the capital notes issued by these vehicles, which are held substantially by third parties. At 31 December 2016, HSBC held 12.2% of the capital notes (2015: 7.2%) issued by these vehicles with a par value of $69.5m (2015: $55.2m) and a carrying amount of $27.9m (2015: $24.7m). Multi-seller conduit HSBC’s multi-seller conduit was established to provide access to flexible market-based sources of finance for its clients. Currently, HSBC bears risk equal to the transaction-specific liquidity facility offered to the multi-seller conduit, amounting to $10.2bn at 31 December 2016 (2015: $19.8bn). First loss protection is provided by the originator of the assets, and not by HSBC, through transaction-specific credit enhancements. A layer of secondary loss protection is provided by HSBC in the form of programme-wide enhancement facilities. Securitisations HSBC uses structured entities to securitise customer loans and advances it originates in order to diversify its sources of funding for asset origination and capital efficiency purposes. The loans and advances are transferred by HSBC to the structured entities for cash or synthetically through credit default swaps, and the structured entities issue debt securities to investors. HSBC managed funds HSBC has established a number of money market and non-money market funds. Where it is deemed to be acting as principal rather than agent in its role as investment manager, HSBC controls these funds. 236 HSBC Holdings plc Annual Report and Accounts 2016 Other HSBC has also entered into a number of transactions in the normal course of business which include asset and structured finance transactions where it has control of the structured entity. In addition, HSBC is deemed to control a number of third-party managed funds through its involvement as a principal in the funds. Unconsolidated structured entities The term ‘unconsolidated structured entities’ refers to all structured entities not controlled by HSBC. The Group enters into transactions with unconsolidated structured entities in the normal course of business to facilitate customer transactions and for specific investment opportunities. Nature and risks associated with HSBC interests in unconsolidated structured entities Securitisations HSBC managed funds Non-HSBC managed funds Total assets of the entities Total assets in relation to HSBC’s interests in the unconsolidated structured entities – trading assets – financial assets designated at fair value – derivatives – loans and advances to banks – loans and advances to customers – financial investments – other assets Total liabilities in relation to HSBC’s interests in the unconsolidated structured entities – derivatives – other liabilities HSBC’s maximum exposure at 31 Dec 2016 Total assets of the entities Total assets in relation to HSBC’s interests in the unconsolidated structured entities – trading assets – financial assets designated at fair value – derivatives – loans and advances to banks – loans and advances to customers – financial investments – other assets Total liabilities in relation to HSBC’s interests in the unconsolidated structured entities – other liabilities HSBC’s maximum exposure at 31 Dec 2015 $bn 14.4 2.4 — — — — 2.4 — — — — — 2.4 12.9 1.4 — — — — 1.1 0.3 — — — 3.5 $bn 200.6 $bn 2,016.5 7.1 0.4 5.9 — — — 0.8 — — — — 7.1 8.3 0.1 7.5 — — — 0.7 — — — — 11 Other $bn 106.3 10.1 2.1 — 3.9 0.4 3.2 0.2 0.3 0.3 0.1 0.2 13.5 Total $bn 2,337.8 27.9 2.6 13.4 3.9 0.4 5.6 1.7 0.3 0.3 0.1 0.2 34 227.9 2,003.1 139.9 2,383.8 5.6 0.1 5.3 — — — 0.2 — — — 5.6 8.0 0.2 6.6 — — 0.1 1.1 — — — 8.0 9.8 2.6 — 3.8 0.1 2.9 0.2 0.2 0.1 0.1 24.8 2.9 11.9 3.8 0.1 4.1 1.8 0.2 0.1 0.1 14.6 31.7 The maximum exposure to loss from HSBC’s interests in unconsolidated structured entities represents the maximum loss it could incur as a result of its involvement with these entities regardless of the probability of the loss being incurred. • For commitments, guarantees and written credit default swaps, the maximum exposure to loss is the notional amount of potential future losses. • For retained and purchased investments in and loans to unconsolidated structured entities, the maximum exposure to loss is the carrying value of these interests at the balance sheet reporting date. The maximum exposure to loss is stated gross of the effects of hedging and collateral arrangements entered into to mitigate HSBC’s exposure to loss. Securitisations HSBC has interests in unconsolidated securitisation vehicles through holding notes issued by these entities. In addition, HSBC has investments in ABSs issued by third party structured entities as set out on page 105. HSBC managed funds HSBC establishes and manages money market funds and non-money market investment funds to provide customers with investment opportunities. Further information on funds under management is provided on page 61. HSBC, as fund manager, may be entitled to receive management and performance fees based on the assets under management. HSBC may also retain units in these funds. Non-HSBC managed funds HSBC purchases and holds units of third-party managed funds in order to facilitate business and meet customer needs. In addition, HSBC enters into derivative contracts to facilitate risk management solutions for non-HSBC managed funds. Note 14 provides information on derivatives entered into by HSBC. HSBC Holdings plc Annual Report and Accounts 2016 237 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Other HSBC has established structured entities in the normal course of business, such as structured credit transactions for customers, to provide finance to public and private sector infrastructure projects, and for asset and structured finance transactions. HSBC sponsored structured entities The amount of assets transferred to and income received from such sponsored entities during 2016 and 2015 were not significant. 20 Goodwill and intangible assets Goodwill Present value of in-force long-term insurance business Other intangible assets At 31 Dec 1 Included within other intangible assets is internally generated software with a net carrying value of $1,982m (2015: $1,934m). Movement analysis of goodwill Gross amount At 1 Jan Exchange differences Reclassified to held for sale Other At 31 Dec Accumulated impairment losses At 1 Jan Impairment losses Other At 31 Dec Net carrying amount at 31 Dec Impairment testing Footnote 1 2016 $m 12,330 6,502 2,514 21,346 2016 $m 22,187 (562) (183) 3 21,445 (5,893) (3,240) 18 (9,115) 12,330 2015 $m 16,294 5,685 2,626 24,605 2015 $m 25,092 (1,610) (1,319) 24 22,187 (5,923) — 30 (5,893) 16,294 The Group’s impairment test in respect of goodwill allocated to each cash generating unit (CGU) is performed as at 1 July each year. A review for indicators of impairment is undertaken at each subsequent quarter-end and as at 31 December 2016. Subsequent to the 1 July 2016 annual test the CGU for Global Banking and Markets was amended from a regional to a global basis. This change is discussed further below. 30 June and 31 December 2016 impairment indicators review At 30 June 2016, we reviewed the inputs used in our 2015 impairment tests in the light of current economic and market conditions. As a result, impairment tests were performed for Global Private Banking – Europe and Global Banking and Markets – Europe. Following these tests an impairment of $0.8bn was recognised in respect of the Global Private Banking – Europe. At 31 December 2016, we reviewed the inputs used in our 1 July 2016 impairment test and identified that indicators of impairment existed within the Global Private Banking – Europe CGU. There were no indicators of impairment in respect of our other CGUs at this time. Refreshed cash flow projections that became available for Global Private Banking – Europe were significantly adverse when compared to those used in the 1 July 2016 impairment test. The reduction in cash flow forecasts is driven by the continuing repositioning of the business and lower net new money and associated return on asset expectations. As a result, an impairment test was performed resulting in an impairment of $2.4bn. The assumptions and results of the Global Private Banking – Europe tests are presented below: Carrying amount of which goodwill Value in use Impairment $bn 4.4 3.5 $bn 3.3 2.4 $bn 3.6 1.1 $bn (0.8) (2.4) (3.2) Nominal growth rate beyond initial cash flow projections % 2.8 2.8 Discount rate % 9.7 9.7 30 Jun 2016 31 Dec 2016 2016 impairment recognised Basis of the recoverable amount The recoverable amount of all CGUs to which goodwill has been allocated was equal to its value in use (VIU) at each respective testing date for 2015 and 2016. For each CGU, the VIU is calculated by discounting management’s cash flow projections for the CGU. The key assumptions used in the VIU calculation for each significant CGU are discussed below. 238 HSBC Holdings plc Annual Report and Accounts 2016 Key assumptions in VIU calculation Goodwill at 1 Jul 2016 Discount rate Nominal growth rate beyond initial cash flow projections Goodwill at 1 Jul 2015 Goodwill at 31 Dec 2015 Footnote $m % % $m $m 3,446 2,520 2,517 918 584 8.9 10.7 9.7 10.0 11.0 3.6 3.8 3.8 4.6 7.4 3,562 2,690 2,603 929 792 1 931 Nominal growth rate beyond initial cash flow projections % 3.3 3.5 3.6 4.3 6.9 Discount rate % 6.9 9.9 9.0 10.0 11.0 Cash-generating unit Europe RBWM GB&M CMB North America GB&M Latin America RBWM 1 GB&M North America comparative discount rate and nominal growth rate beyond initial cash flow project rates are as at 31 December 2015. At 1 July 2016, aggregate goodwill of $3,025m (1 July 2015: $2,787m) 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. 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. For the goodwill impairment test conducted at 1 July 2016, management’s cash flow projections until the end of 2020 were used. Discount rate: The rate used to discount the cash flows is based on the cost of capital assigned to each CGU, which is derived using a capital asset pricing model (‘CAPM’). CAPM depends on a number of inputs reflecting 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. The discount rates for each CGU are refined to reflect the rates of inflation for the countries within which the CGU operate. 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 for businesses operating in similar markets. For the purpose of goodwill testing as at 1 July 2016, all European CGUs include a 100bps uplift to reflect the increased risk in European markets following the UK referendum on membership of the EU. Nominal long-term growth rate: The long-term growth rate is used to extrapolate the cash flows in perpetuity because of the perspective within the Group of business units making up the CGUs. These growth rates reflect GDP and inflation for the countries within which the CGU operates or derives revenue from. Global Banking and Markets CGU basis As described on page 44, the Group has changed its operating segments from a geographical region to a global businesses basis, and this change prompted a review of the goodwill allocation. Following this review it has been determined that Global Banking and Markets should be assessed as a single CGU rather than on a regional basis reflecting the global management and customer base of this business. An analysis was performed and Global Banking and Markets is considered to have significant headroom to support its goodwill. All other CGUs remain unchanged. Sensitivities of key assumptions in calculating VIU At 1 July 2016, Retail Banking and Wealth Management – Europe was sensitive to reasonably possible adverse changes in the discount rate, growth rate or management’s projections of cash flows assumptions supporting the recoverable amount. Changes in one or more of these assumptions could cause an impairment to be recognised. In making an estimate of reasonably possible changes to assumptions, management considers the available evidence in respect of each input to the model such as the external range of discount rates observable, historical performance against forecast and risks attaching to the key assumptions underlying cash flow projections. The following table presents a summary of the key assumptions underlying the most sensitive inputs to the model for this CGU; the key risks attached; and details of a reasonably possible change to assumptions where, in the opinion of management, these could result in an impairment. HSBC Holdings plc Annual Report and Accounts 2016 239 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Reasonably possible changes in key assumptions Input Key assumptions Associated risks Reasonably possible change Cash-generating unit RBWM – Europe Cash flow projections • Level of interest rates and • Uncertain regulatory yield curves. environment. • Competitors’ position within • Customer remediation and the market. regulatory actions. • Cash flow projections decrease by 10%. This does not result in an impairment. Discount rate • Level and change in unemployment rates. • Discount rate used is a reasonable estimate of a suitable market rate for the profile of the business. • External evidence suggests that the rate used is not appropriate to the business. • Discount rate increases by 100bps. Long-term growth rates • Business growth will reflect • Growth does not match GDP GDP growth rates in the long term. or there is a fall in GDP forecasts. • Real GDP growth does not occur or is not reflected in performance. Sensitivity of VIU to reasonably possible changes in key assumptions and changes to current assumptions to achieve nil headroom At 1 Jul 2016 In $ billions (unless otherwise stated) Carrying amount VIU Reasonably possible change in key assumption Discount rate – bps Cash flows – % Long-term growth rates – bps Impact on VIU Discount rate Cash flows Long-term growth rates Cumulative impact of all changes Changes to current assumptions to achieve nil headroom Discount rate – bps Cash flows – % Long-term growth rates – bps RBWM – Europe $bn 16.6 19.7 100 (10) (162) (3.1) (2.0) (3.9) (7.3) 102 (15.8) (122) Present value of in-force long-term insurance business When calculating the present value of in-force insurance business (‘PVIF’), expected cash flows are projected after adjusting for a 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. Variations in actual experience and changes to assumptions can contribute to volatility in the results of the insurance business. Actuarial Control Committees of each key insurance entity meet on a quarterly basis to review and approve PVIF assumptions. All changes to non-economic assumptions, economic assumptions that are not observable and model methodology must be approved by the Actuarial Control Committee. Movements in PVIF PVIF at 1 Jan Change in PVIF of long-term insurance business – value of new business written during the year – expected return – assumption changes and experience variances (see below) – other adjustments Transfer of assets classified as held for sale Exchange differences and other PVIF at 31 Dec Footnotes 1 2 2016 $m 5,685 902 900 (532) 513 21 (45) (40) 2015 $m 5,307 799 809 (552) 504 38 (219) (202) 6,502 5,685 1 2 ‘Expected return’ represents the unwinding of the discount rate and reversal of expected cash flows for the period. Relates to the Brazilian insurance operations which were classified as held for sale in 2015. Assumption changes and experience adjustments Included within this line item are: • $279m (2015: $114m), directly offsetting interest rate-driven changes to liabilities under insurance contracts. • $301m (2015: $209m), reflecting the future sharing of returns with policyholders on contracts with discretionary participation features (‘DPF’), to the extent this sharing is not already included in liabilities under insurance contracts. • $(67)m (2015: $181m), driven by other changes in assumptions and experience variances to projected future profits. 240 HSBC Holdings plc Annual Report and Accounts 2016 Key assumptions used in the computation of PVIF for main life insurance operations Economic assumptions are set in a way that is consistent with observable market values. The valuation of PVIF is sensitive to observed market movements and the impact of such changes is included in the sensitivities presented below. Weighted average risk free rate Weighted average risk discount rate Expense inflation 2016 2015 Hong Kong France1 Hong Kong France1 % 2.09 6.34 3.00 % 0.99 1.84 1.66 % 1.82 6.81 3.00 % 1.57 2.55 1.70 1 For 2016, the calculation of France’s PVIF assumes a risk discount rate of 1.84% (2015: 2.55%) plus a risk margin of $101m (2015: $51m). 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 the insurance operations 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 123 for further details of these guarantees and the impact of changes in economic assumptions on our insurance manufacturing subsidiaries. Sensitivity to changes in non-economic assumptions Policyholder liabilities and PVIF are determined by reference to non-economic assumptions including mortality and/or morbidity, lapse rates and expense rates. See page 125 for further details on the impact of changes in non-economic assumptions on our insurance manufacturing operations. 21 Prepayments, accrued income and other assets Prepayments and accrued income Bullion Endorsements and acceptances Reinsurers’ share of liabilities under insurance contracts (Note 3) Employee benefit assets (Note 5) Other accounts Property, plant and equipment At 31 Dec 2016 $m 7,335 15,406 8,574 1,820 4,714 12,298 9,373 59,520 2015 $m 7,765 11,501 9,149 1,378 5,272 9,410 9,923 54,398 Prepayments, accrued income and other assets include $26,927 (2015: $25,310m) of financial assets, the majority of which are measured at amortised cost. 22 Assets held for sale and liabilities of disposal groups held for sale Assets held for sale and liabilities of disposal groups held for sale Held for sale at 31 Dec Disposal groups Non-current assets held for sale Total assets Liabilities of disposal groups Disposal groups Brazil 2016 $m 1,882 2,507 4,389 2,790 2015 $m 41,715 2,185 43,900 36,840 On 1 July 2016, we completed the sale of our operations in Brazil to Banco Bradesco S.A. for a cash consideration of $4.8bn. This resulted in a loss on disposal of $1.7bn which includes the reclassification of cumulative foreign exchange differences of $1.9bn. HSBC Holdings plc Annual Report and Accounts 2016 241 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 23 Trading liabilities Deposits by banks Customer accounts Other debt securities in issue (Note 25) Other liabilities – net short positions in securities At 31 Dec Footnotes 1 1, 2 3 2016 $m 24,827 45,085 32,656 51,123 2015 $m 27,054 40,208 30,525 43,827 153,691 141,614 1 2 3 ‘Deposits by banks’ and ‘Customer accounts’ include repos, settlement accounts, stock lending and other amounts. Structured deposits placed at HSBC Bank USA and HSBC Trust Company (Delaware) National Association are insured by the Federal Deposit Insurance Corporation, a US government agency, up to $250,000 per depositor. ‘Other debt securities in issue’ comprises structured notes issued by HSBC for which market risks are actively managed as part of trading portfolios. At 31 December 2016, the cumulative amount of change in fair value attributable to changes in HSBC’s credit risk was a gain of $2m (2015: gain of $122m). 24 Financial liabilities designated at fair value HSBC Deposits by banks and customer accounts Liabilities to customers under investment contracts Debt securities in issue (Note 25) Subordinated liabilities (Note 28) Preferred securities (Note 28) At 31 Dec 2016 $m 135 6,002 57,112 23,172 411 86,832 The carrying amount of financial liabilities designated at fair value was $4,413m more than the contractual amount at maturity (2015: $4,147m more). The cumulative own credit loss recognised was $1,672m (2015: gain of $158m). HSBC Holdings Debt securities in issue (Note 25) Subordinated liabilities (Note 28) At 31 Dec 2016 $m 16,766 13,347 30,113 The carrying amount of financial liabilities designated at fair value was $2,681m more than the contractual amount at maturity (2015: $2,127m more). The cumulative amount of change in fair value attributable to changes in credit risk was a loss of $1,202m (2015: loss of $172m). 25 Debt securities in issue HSBC Bonds and medium-term notes Other debt securities in issue Total debt securities in issue Included within: – trading liabilities (Note 23) – financial liabilities designated at fair value (Note 24) At 31 Dec HSBC Holdings Debt securities Included within: – financial liabilities designated at fair value (Note 24) At 31 Dec 242 HSBC Holdings plc Annual Report and Accounts 2016 2016 $m 133,721 21,962 155,683 (32,656) (57,112) 65,915 2016 $m 38,571 (16,766) 21,805 2015 $m 193 6,027 37,678 21,168 1,342 66,408 2015 $m 7,897 11,956 19,853 2015 $m 128,348 28,804 157,152 (30,525) (37,678) 88,949 2015 $m 8,857 (7,897) 960 26 Accruals, deferred income and other liabilities Accruals and deferred income Endorsements and acceptances Employee benefit liabilities (Note 5) Other liabilities At 31 Dec 2016 $m 10,770 8,567 2,681 19,483 41,501 2015 $m 11,129 9,135 2,809 15,043 38,116 Accruals, deferred income and other liabilities include $30,932m (2015: $29,358m) of financial liabilities, the majority of which are measured at amortised cost. 27 Provisions At 1 Jan 2016 Additions Amounts utilised Unused amounts reversed Unwinding of discounts Exchange and other movements At 31 Dec 2016 At 1 Jan 2015 Additions Amounts utilised Unused amounts reversed Unwinding of discounts Exchange and other movements At 31 Dec 2015 Restructuring costs Contractual commitments Legal proceedings and regulatory matters Customer remediation Other provisions $m 463 415 (168) (115) — (44) 551 197 430 (95) (29) — (40) 463 $m 240 141 (1) (97) — 15 298 234 120 (2) (15) — (97) 240 $m 3,174 1,258 (1,831) (165) — — 2,436 2,184 2,153 (619) (95) 40 (489) 3,174 $m 1,340 762 (680) (94) — (204) 1,124 1,831 765 (856) (170) 6 (236) 1,340 $m 335 208 (118) (96) 6 29 364 552 138 (159) (133) — (63) 335 Total $m 5,552 2,784 (2,798) (567) 6 (204) 4,773 4,998 3,606 (1,731) (442) 46 (925) 5,552 Further details of ‘Legal proceedings and regulatory matters’ are set out in Note 35. Legal proceedings include: civil court, arbitration or tribunal proceedings brought against HSBC companies (whether by way of claim or counterclaim); or civil disputes that may, if not settled, result in court, arbitration or tribunal proceedings. Regulatory matters refers to investigations, reviews and other actions carried out by, or in response to the actions of, regulators or law enforcement agencies in connection with alleged wrongdoing by HSBC. Customer remediation refers to HSBC’s activities to compensate customers for losses or damages associated with a failure to comply with regulations or to treat customers fairly. Customer remediation is often initiated by HSBC in response to customer complaints and/or industry developments in sales practices, and is not necessarily initiated by regulatory action. Further details of customer remediation are set out in this note. Payment protection insurance At 31 December 2016, a provision of $919m (2015: $1,039m) was held relating to the estimated liability for redress in respect of the possible mis-selling of payment protection insurance (‘PPI’) policies in previous years. Cumulative provisions made since the Judicial Review ruling in the first half of 2011 amount to $5.1bn, of which $4.1bn has been paid as at 31 December 2016. An increase in provisions of $492m was recognised during the year, primarily reflecting a delay to the inception of the expected time bar on inbound complaints; and an anticipated adjustment to the redress parameters surrounding ‘Plevin’ (a 2014 decision of the UK Supreme Court which held that, judged on its own facts, non-disclosure of the amounts of commissions payable in connection with the sale of PPI to a customer created an unfair relationship under the provisions of the UK Consumer Credit Act). The estimated liability for redress is calculated on the basis of the total premiums paid by the customer plus simple interest of 8% per annum (or the rate inherent in the related loan product where higher). The basis for calculating the redress liability is the same for single premium and regular premium policies. Future estimated redress levels are based on the historically observed redress per policy. A total of 5.4 million PPI policies have been sold since 2000, generating estimated revenues of $3.5bn at 2016 average exchange rates. The gross written premiums on these policies were approximately $4.6bn. At 31 December 2016, the estimated total complaints expected to be received were 2.0 million, representing 37% of total policies sold. It is estimated that contact will be made with regard to 2.4 million policies, representing 45% of total policies sold. This estimate includes inbound complaints as well as the group's proactive contact exercise on certain policies (‘outbound contact’). The following table details the cumulative number of complaints received at 31 December 2016 and the number of claims expected in the future: HSBC Holdings plc Annual Report and Accounts 2016 243 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Cumulative PPI complaints received to 31 December 2016 and future claims expected Inbound complaints (000s of policies) Outbound contact (000s of policies) Response rate to outbound contact Average uphold rate per claim Average redress per claim ($) Complaints to Financial Ombudsman Service (000s of policies) Average uphold rate per Financial Ombudsman Service claim 1 2 Excludes invalid claims for which no PPI policy exists. Claims include inbound and responses to outbound contact. Footnotes Cumulative actual to 31 Dec 2016 Future expected 1 2 1,363 725 42% 76% 2,670 138 41% 320 — n/a 84% 2,702 47 55% A 100,000 increase/decrease in the total inbound complaints would increase/decrease the redress provision by approximately $203m at 2016 average exchange rates. Each 1% increase/decrease in the response rate to our outbound contact exercise would increase/decrease the redress provision by approximately $12m. 28 Subordinated liabilities HSBC At amortised cost – subordinated liabilities – preferred securities Designated at fair value (Note 24) – subordinated liabilities – preferred securities At 31 Dec Issued by HSBC subsidiaries Issued by HSBC Holdings HSBC’s subordinated liabilities 2016 $m 20,984 19,230 1,754 23,583 23,172 411 44,567 16,860 27,707 2015 $m 22,702 20,773 1,929 22,510 21,168 1,342 45,212 19,150 26,062 Subordinated liabilities rank behind senior obligations and generally count towards the capital base of HSBC. Capital securities may be called and redeemed by HSBC subject to prior notification to the PRA and, where relevant, the consent of the local banking regulator. If not redeemed at the first call date, coupons payable may step up or become floating rate based on interbank rates. On capital securities other than floating rate notes, interest is payable at fixed rates of up to 10.176%. The balance sheet amounts disclosed below are presented on an IFRSs basis and do not reflect the amount that the instruments contribute to regulatory capital due to the inclusion of issuance costs, regulatory amortisation and regulatory eligibility limits prescribed in the grandfathering provisions under CRD IV. 244 HSBC Holdings plc Annual Report and Accounts 2016 HSBC’s subordinated liabilities in issue Additional tier 1 capital securities guaranteed by HSBC Holdings plc €750m $900m 5.13% non-cumulative step-up perpetual preferred securities 10.176% non-cumulative step-up perpetual preferred securities, series 2 Additional tier 1 capital securities guaranteed by HSBC Bank plc £300m £700m 5.862% non-cumulative step-up perpetual preferred securities 5.844% non-cumulative step-up perpetual preferred securities Tier 2 securities issued by HSBC Bank plc £350m £300m £350m £500m £225m £600m $300m $750m $500m $300m 5.00% callable subordinated notes 6.50% subordinated notes 5.375% callable subordinated step-up notes 5.375% subordinated notes 6.25% subordinated notes 4.75% subordinated notes 7.65% subordinated notes Undated floating rate primary capital notes Undated floating rate primary capital notes Undated floating rate primary capital notes, series 3 Tier 2 securities issued by The Hongkong and Shanghai Banking Corporation Ltd $400m $400m Primary capital undated floating rate notes Primary capital undated floating rate notes (third series) Tier 2 securities issued by HSBC Bank Malaysia Berhad MYR500m 4.35% subordinated bonds MYR500m 5.05% subordinated bonds Tier 2 securities issued by HSBC USA Inc. $750m $250m 5.00% subordinated notes 7.20% subordinated debentures Other subordinated liabilities each less than $150m Tier 2 securities issued by HSBC Bank USA, N.A. $500m $1,250m $1,000m $750m $700m 6.00% subordinated notes 4.875% subordinated notes 5.875% subordinated notes 5.625% subordinated notes 7.00% subordinated notes Tier 2 securities issued by HSBC Finance Corporation $2,939m 6.676% senior subordinated notes Tier 2 securities issued by HSBC Bank Canada CAD400m 4.80% subordinated debentures CAD200m 4.94% subordinated debentures Other subordinated liabilities each less than $150m Securities issued by HSBC Mexico, S.A. $300m Non-convertible subordinated obligations Other subordinated liabilities each less than $150m Securities issued by other HSBC subsidiaries Other subordinated liabilities each less than $200m Subordinated liabilities issued by HSBC subsidiaries at 31 Dec 1 2 1 3 4 5 6 7 5 First call Maturity Footnotes date date Mar 2016 Jun 2030 Apr 2020 Nov 2031 Mar 2018 Mar 2023 — Jul 2023 Nov 2025 Nov 2030 — Aug 2033 — Jan 2041 — Mar 2046 — May 2025 Jun 1990 Sep 1990 Jun 1992 Aug 1990 Jul 1991 Jun 2017 Jun 2022 Nov 2022 Nov 2027 — Sep 2020 — Jul 2097 — Aug 2017 — Aug 2020 — Nov 2034 — Aug 2035 — Jan 2039 2016 $m — 891 891 411 863 1,274 466 369 489 750 276 731 372 750 500 300 2015 $m 856 891 1,747 488 1,038 1,526 562 444 569 846 332 879 386 750 500 300 5,003 5,568 — 400 400 112 112 224 748 220 284 401 400 801 116 116 232 747 220 299 1,252 1,266 498 1,257 1,137 862 701 4,455 502 1,258 1,142 850 691 4,443 — Jan 2021 2,192 2,188 Apr 2017 Apr 2022 Mar 2016 Mar 2021 Oct 1996 Nov 2083 8, 9 Jun 2014 Jun 2019 8 6 299 — 29 328 240 198 438 298 144 29 471 240 236 476 403 16,860 432 19,150 See paragraph below, ‘Guaranteed by HSBC Holdings or HSBC Bank plc’. In February 2016, HSBC gave notice that it will call and redeem the €750m 5.13% non-cumulative step-up perpetual preferred securities. The interest rate payable after March 2018 is the sum of the gross redemption yield of the then prevailing five-year UK gilt plus 1.80 percentage points. The interest rate payable after November 2025 is the sum of the three-month sterling Libor plus 1.50 percentage points. In January 2016, HSBC called and redeemed $400m Primary capital undated floating rate notes and CAD200m 4.94% subordinated debentures. Some securities included here are ineligible for inclusion in the capital base of HSBC in accordance with CRD IV rules. 1 2 3 4 5 6 7 Approximately $731m of the senior subordinated notes are held by HSBC Holdings. 8 9 Approximately $60m of the subordinated obligations are held by HSBC Holdings. These securities are ineligible for inclusion in the capital base of HSBC in accordance with CRD IV rules. HSBC Holdings plc Annual Report and Accounts 2016 245 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements HSBC Holdings At amortised cost Designated at fair value (Note 24) At 31 Dec HSBC Holdings’ subordinated liabilities Tier 2 securities issued by HSBC Holdings plc Amounts owed to third parties $488m $222m $2,000m $2,500m $1,500m $2,000m $1,500m $1,500m $1,500m £900m £650m £650m £750m £900m €1,600m €1,750m €1,500m €1,500m €1,500m 7.625% subordinated notes 7.35% subordinated notes 6.5% subordinated notes 6.5% subordinated notes 6.8% subordinated notes 4.25% subordinated notes 5.25% subordinated notes 4.25% subordinated notes 4.375% subordinated notes 6.375% callable subordinated notes 5.75% subordinated notes 6.75% subordinated notes 7.0% subordinated notes 6.0% subordinated notes 6.25% subordinated notes 6.0% subordinated notes 3.0% subordinated notes 3.125% subordinated notes 3.375% subordinated notes Amounts owed to HSBC undertakings Footnotes First call date Maturity date 1 1 1 1 1 2,4 2,4 2 2 1,3 2 2 2 2 2 2 2 2 — — — — — — — — — Oct 2017 — — — — — — — — 2,4 Jan 2019 May 2032 Nov 2032 May 2036 Sep 2037 Jun 2038 Mar 2024 Mar 2044 Jun 2025 Nov 2026 Oct 2022 Dec 2027 Sep 2028 Apr 2038 Mar 2040 Mar 2018 Jun 2019 Jun 2025 Jun 2028 Jan 2024 5.13% fixed/floating subordinated notes 10.176% subordinated step-up cumulative notes Mar 2016 Jun 2030 Dec 2044 Jun 2040 €750m $900m At 31 Dec 2016 $m 15,189 13,347 28,536 2016 $m 528 278 2,029 3,170 1,487 2,060 1,747 1,539 1,520 1,163 932 793 971 1,086 1,693 2,168 1,716 1,139 1,626 27,645 — 891 891 28,536 2015 $m 15,895 11,956 27,851 2015 $m 531 278 2,029 3,085 1,487 2,078 1,735 1,529 — 1,432 1,079 955 1,159 1,310 1,748 2,284 1,691 — 1,694 26,104 856 891 1,747 27,851 1 Amounts owed to third parties represent securities included in the capital base of HSBC as tier 2 securities in accordance with the grandfathering provisions under CRD IV 2 3 4 rules. These securities are included in the capital base of HSBC as fully CRD IV compliant tier 2 securities on an end point basis. The interest rate payable after October 2017 is the sum of the three-month sterling Libor plus 1.3 percentage points. These subordinated notes are measured at amortised cost in HSBC Holdings, where the interest rate risk is hedged using a fair value hedge, while they are measured at fair value in the Group. Additional tier 1 capital securities Additional tier 1 capital securities are perpetual subordinated securities on which coupon payments may be deferred or cancelled at the discretion of HSBC Holdings. The securities presented in this Note are accounted for as liabilities because HSBC has an obligation to pay dividends in perpetuity. See Note 35 for additional tier 1 capital securities accounted for as equity. The additional tier 1 securities presented in this section do not meet the identifying criteria in full for recognition as tier 1 capital under CRD IV but are eligible as regulatory capital subject to grandfathering limits and progressive phase-out. Guaranteed by HSBC Holdings or HSBC Bank plc These capital securities were issued by the Jersey limited partnerships and proceeds lent to the respective guarantors by the limited partnerships in the form of subordinated notes. They qualify as additional tier 1 capital for HSBC under CRD IV by virtue of the application of grandfathering provisions, and the two capital securities guaranteed by HSBC Bank plc (‘HSBC Bank’) also qualify as additional tier 1 capital for HSBC Bank (on a solo and a consolidated basis) under CRD IV by virtue of the same grandfathering process. These preferred securities, together with the guarantee, are intended to provide investors with economic rights equivalent to the rights that they would have had if they had purchased non-cumulative perpetual preference shares of the relevant issuer. There are limitations on the payment of distributions if such payments are prohibited under UK banking regulations or other requirements, if a payment would cause a breach of HSBC’s capital adequacy requirements or if HSBC Holdings or HSBC Bank has insufficient distributable reserves (as defined). HSBC Holdings and HSBC Bank have individually covenanted that if prevented under certain circumstances from paying distributions on the preferred securities in full, they will not pay dividends or other distributions in respect of their ordinary shares, or repurchase or redeem their ordinary shares, until the distribution on the preferred securities has been paid in full. Preference shares of HSBC Holdings that have economic terms equal in all material respects to the preferred securities and their guarantee together will be substituted for the preferred securities guaranteed by HSBC Holdings if the total capital ratio of HSBC Holdings falls below the regulatory minimum required, or the Directors expect it to in the near term. 246 HSBC Holdings plc Annual Report and Accounts 2016 Preference shares of HSBC Bank that have economic terms equal in all material respects to the preferred securities and their guarantee together will be substituted for the preferred securities guaranteed by HSBC Bank if any of the two issues of preferred securities are outstanding in April 2049 or November 2048, respectively; or the total capital ratio of HSBC Bank on a solo and consolidated basis falls below the regulatory minimum required, or the Directors expect it to in the near term. Tier 2 capital securities These capital securities are included within HSBC’s regulatory capital base as tier 2 capital under CRD IV by virtue of the application of grandfathering provisions (with the exception of identified HSBC Holding securities which are compliant with CRD IV end point rules). Tier 2 capital securities are either perpetual subordinated securities or dated securities on which there is an obligation to pay coupons. In accordance with CRD IV, the capital contribution of all tier 2 securities is amortised for regulatory purposes in their final five years before maturity. 29 Maturity analysis of assets, liabilities and off-balance sheet commitments The table on page 248 provides an analysis of consolidated total assets, liabilities and off-balance sheet commitments by residual contractual maturity at the balance sheet date. These balances are included in the maturity analysis as follows: • Trading assets and liabilities (including trading derivatives but excluding reverse repos, repos and debt securities in issue) are included in the ‘Due not more than 1 month’ time bucket, because trading balances are typically held for short periods of time. • Financial assets and liabilities with no contractual maturity (such as equity securities) are included in the ‘Due over 5 years’ time bucket. Undated or perpetual instruments are classified based on the contractual notice period which the counterparty of the instrument is entitled to give. Where there is no contractual notice period, undated or perpetual contracts are included in the ‘Due over 5 years’ time bucket. • Non-financial assets and liabilities with no contractual maturity are included in the ‘Due over 5 years’ time bucket. • Financial instruments included within assets and liabilities of disposal groups held for sale are classified on the basis of the contractual maturity of the underlying instruments and not on the basis of the disposal transaction. • Liabilities under insurance contracts are included in the ‘Due over 5 years’ time bucket. Liabilities under investment contracts are classified in accordance with their contractual maturity. Undated investment contracts are included in the ‘Due over 5 years’ time bucket, however, such contracts are subject to surrender and transfer options by the policyholders. • Loan and other credit-related commitments are classified on the basis of the earliest date they can be drawn down. HSBC Holdings plc Annual Report and Accounts 2016 247 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements HSBC Maturity analysis of assets, liabilities and off-balance sheet commitments Due not more than 1 month Due over 1 month but not more than 3 months Due over 3 months but not more than 6 months Due over 6 months but not more than 9 months Due over 9 months but not more than 1 year Due over 1 year but not more than 2 years Due over 2 years but not more than 5 years Due over 5 years $m $m $m $m $m $m $m $m Financial assets Cash and balances at central banks 128,009 Items in the course of collection from other banks Hong Kong Government certificates of indebtedness Trading assets Financial assets designated at fair value Derivatives Loans and advances to banks Loans and advances to customers – personal – corporate and commercial – financial Reverse repurchase agreements – non-trading Financial investments Assets held for sale Accrued income and other financial assets Financial assets at 31 Dec 2016 Off-balance sheet commitments received Loan and other credit-related commitments Financial liabilities Hong Kong currency notes in circulation Deposits by banks Customer accounts1 – personal – corporate and commercial – financial Repurchase agreements – non-trading Items in the course of transmission to other banks — — — 758 182 149 — — — 230 75 207 — — — 415 178 96 13,404 61,693 7,812 48,333 5,548 4,494 47,664 6,723 35,180 5,761 2,375 30,115 5,928 21,317 2,870 — — — 1,172 363 110 1,765 30,362 6,799 19,573 3,990 5,003 31,228 232,550 176 287,749 59,636 167,531 39,295 108,906 19,330 Total $m 128,009 5,003 31,228 235,125 — — — — — — — — — — — — 749 704 2,879 85,144 22,664 54,739 7,741 2,486 1,056 2,298 20,547 24,756 801 290,872 1,275 88,126 192,787 246,208 861,504 53,620 194,985 337,826 126,890 45,271 460,209 12,277 5,952 63,469 115,942 25,525 10,378 5,220 2,350 479 1,080 — 160,974 36,932 893 59,826 1,663 120 15,992 6,387 1,617 30,403 16,800 19,564 50,255 104,933 118,084 436,797 64 343 64 398 205 216 682 351 283 3,974 1,624 26,928 1,081,641 169,587 95,188 55,606 56,148 140,631 305,673 388,822 2,293,296 2,050 — — 110 2,813 31,228 46,306 1,180,641 590,654 436,666 153,321 — — 4,075 45,245 22,222 17,460 5,563 — 2,085 19,187 12,024 6,178 985 82,330 2,707 2,871 5,977 — — — 665 10,277 5,823 3,951 503 50 — — 489 8,325 4,786 3,082 457 — — — 422 4,709 3,484 1,200 25 — — — — 4,842 3,500 2,483 967 50 1,000 — — — 1,055 4,973 31,228 59,939 502 1,272,386 121 360 21 — — 641,597 469,864 160,925 88,958 5,977 Non-financial assets — — — — — — — 81,690 81,690 Total assets at 31 Dec 2016 1,081,641 169,587 95,188 55,606 56,148 140,631 305,673 470,512 2,374,986 Trading liabilities 121,707 2,053 1,423 1,845 3,013 6,219 9,010 8,421 153,691 Financial liabilities designated at fair value – debt securities in issue: covered bonds – debt securities in issue: unsecured – subordinated liabilities and preferred securities – other Derivatives Debt securities in issue – covered bonds – otherwise secured – unsecured Liabilities of disposal groups held for sale Accruals and other financial liabilities Subordinated liabilities Total financial liabilities at 31 Dec 2016 1,659 1,587 25 — 47 274,965 958 — 15 — 943 39 1,396 303 1,091 — 2 39 4,708 8,598 8,280 — 3,207 1,501 2,472 16,580 12 — 823 7,775 107 8,065 — 1 893 7,386 113 2,279 143 3 — 3 — — 112 5,996 71 114 1,701 — 1,700 — 1 273 4,610 1 329 5,811 4,280 36 797 61 34 485 497 5,046 207 4,839 — — 506 10,953 3 1,882 9,068 7 878 1,788 17,989 58,080 86,832 1,348 2,558 14,056 29,380 6,003 51,109 2,578 21,005 23,583 7 1,471 19,432 24 2,680 16,728 21 1,278 5,056 5,137 2,414 3,338 26 1,181 2,131 — 568 13,427 6,137 279,819 65,915 126 11,109 54,680 2,790 30,930 20,984 1,768,585 71,847 37,816 19,842 19,427 30,528 63,599 87,805 2,099,449 Non-financial liabilities — — — — — — — 92,959 92,959 Total liabilities at 31 Dec 2016 1,768,585 71,847 37,816 19,842 19,427 30,528 63,599 180,764 2,192,408 Off-balance sheet commitments given Loan and other credit-related – personal – corporate and commercial – financial 466,780 158,054 259,231 49,495 39,922 4,932 33,421 1,569 14,909 12,537 5,297 9,248 364 287 11,592 658 36,281 4,063 26,829 5,389 11,241 45,778 28,395 655,843 1,129 7,242 2,870 788 9,260 183,810 40,740 15,173 403,476 4,250 3,962 68,557 248 HSBC Holdings plc Annual Report and Accounts 2016 Maturity analysis of assets, liabilities and off-balance sheet commitments (continued) Due not more than 1 month Due over 1 month but not more than 3 months Due over 3 months but not more than 6 months Due over 6 months but not more than 9 months Due over 9 months but not more than 1 year Due over 1 year but not more than 2 years Due over 2 years but not more than 5 years Due over 5 years $m $m $m $m $m $m $m $m Financial assets Cash and balances at central banks Items in the course of collection from other banks Hong Kong Government certificates of indebtedness Trading assets Financial assets designated at fair value Derivatives Loans and advances to banks Loans and advances to customers – personal – corporate and commercial – financial Reverse repurchase agreements – non-trading Financial investments Assets held for sale Accrued income and other financial assets 98,934 5,768 28,410 224,691 429 285,797 57,296 176,862 39,191 123,901 13,770 110,478 35,104 15,816 12,732 — — — 34 194 215 14,530 69,638 8,328 54,711 6,599 21,978 59,098 2,628 6,682 — — — — 222 223 4,063 54,730 8,510 40,489 5,731 7,220 36,897 2,544 1,995 — — — — 83 198 1,964 33,095 7,457 21,081 4,557 2,786 19,102 1,218 483 — — — — 390 33 2,499 34,774 9,350 21,811 3,613 580 17,293 2,611 395 — — — 112 896 499 5,134 81,560 22,438 50,355 8,767 2,985 48,634 4,675 463 Total $m 98,934 5,768 28,410 — — — — — — — — 224,837 2,603 19,035 23,852 841 3,274 670 288,476 1,641 90,401 201,253 272,542 924,454 57,283 218,646 371,203 131,166 49,564 493,078 12,804 4,332 60,173 228 — 146,255 94,549 118,278 428,955 6,365 445 4,422 2,115 40,279 25,310 Financial assets at 31 Dec 2015 1,052,317 174,997 107,894 58,929 58,575 144,958 309,558 418,703 2,325,931 Non-financial assets — — — — — — — 83,725 83,725 Total assets at 31 Dec 2015 1,052,317 174,997 107,894 58,929 58,575 144,958 309,558 502,428 2,409,656 Off-balance sheet commitments received Loan and other credit-related commitments 3,472 Financial liabilities Hong Kong currency notes in circulation Deposits by banks Customer accounts1 – personal – corporate and commercial – financial Repurchase agreements – non-trading Items in the course of transmission to other banks Trading liabilities Financial liabilities designated at fair value – debt securities in issue: covered bonds – debt securities in issue: unsecured – subordinated liabilities and preferred securities – other Derivatives Debt securities in issue – covered bonds – otherwise secured – unsecured Liabilities of disposal groups held for sale Accruals and other financial liabilities Subordinated liabilities 28,410 46,693 1,185,091 574,468 459,813 150,810 73,478 5,638 111,691 2,036 — 1,972 — 64 276,765 16,536 — 8,436 8,100 20,350 14,802 — — — 2,225 50,831 27,646 18,802 4,383 3,788 — 1,471 1,822 — 973 848 1 34 2,149 — 1,049 21,397 13,032 7,314 1,051 1,816 — 1,529 2,943 — 2,926 — 17 251 9,326 16,295 — 173 1 195 9,153 16,099 — — 325 10,421 7,371 2,479 571 164 — 882 342 — 342 — — 213 5,542 — 206 5,336 — — 116 10,869 7,990 2,495 384 154 — 2,184 1,900 — 1,786 — 114 52 111 — 712 6,596 3,566 2,926 104 — — — — 3,182 3,852 2,920 828 104 500 — — — 69 5,732 28,410 54,371 529 1,289,586 354 156 19 500 637,347 494,813 157,426 80,400 — 5,638 4,344 10,105 9,408 141,614 4,930 2,012 2,918 — — 524 14,316 38,119 66,408 1,608 9,819 2,577 10,745 6,197 31,481 2,773 18,889 22,510 116 1,063 17 4,354 18,495 1,484 1,454 4,579 5,908 2,169 6,265 33 1,118 5,114 115 665 17,038 6,220 281,071 88,949 135 16,737 72,077 32,553 29,358 22,702 1,365 10,754 22,866 1 173 1,191 83 2,082 8,589 1,416 7,965 401 1,548 2,467 — 1,344 1,246 5,050 659 — 421 34 925 650 Total financial liabilities at 31 Dec 2015 1,781,490 79,279 49,295 19,892 18,341 34,485 63,401 74,877 2,121,060 Non-financial liabilities — — — — — — — 91,078 91,078 Total liabilities at 31 Dec 2015 1,781,490 79,279 49,295 19,892 18,341 34,485 63,401 165,955 2,212,138 Off-balance sheet commitments given Loan and other credit-related commitments – personal – corporate and commercial – financial 472,277 161,843 272,044 38,390 45,792 11,547 32,764 1,481 16,271 6,333 9,126 812 9,798 963 8,372 463 47,122 19,607 23,984 3,531 11,325 48,756 15,089 666,430 1,207 8,227 1,891 425 1,018 202,943 38,838 12,558 405,913 9,493 1,513 57,574 1 ‘Customer accounts’ includes $343,782m (2015: $342,908m) insured by guarantee schemes. HSBC Holdings plc Annual Report and Accounts 2016 249 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements HSBC Holdings Maturity analysis of assets, liabilities and off-balance sheet commitments Due not more than 1 month Due over 1 month but not more than 3 months Due over 3 months but not more than 6 months Due over 6 months but not more than 9 months Due over 9 months but not more than 1 year Due over 1 year but not more than 2 years Due over 2 years but not more than 5 years Due over 5 years $m $m $m $m $m $m $m $m Total $m — — — — — — — — — — — — — — — — — — — — — — — 93 — 353 247 2,148 167 14,204 46,678 77,421 — — 167 — 167 838 2,710 3,590 — 107 119 15,135 49,848 83,525 — 97,273 97,273 15,135 147,121 180,798 — 105 — 2,157 2,167 — 2,167 — 953 — 1,693 5,845 5,845 22,101 30,113 10,921 16,766 11,180 13,347 — 592 592 4,822 16,030 — — — 13,496 5,025 21,805 1,507 15,189 4,813 11,364 52,219 75,796 — — 144 144 4,813 11,364 52,363 75,940 — — — — Financial assets Cash at bank and in hand: – balances with HSBC undertakings Derivatives Loans and advances to HSBC undertakings Financial investments in HSBC undertakings Accrued income and other financial assets Total financial assets at 31 Dec 2016 Non-financial assets Total assets at 31 Dec 2016 Financial liabilities 247 1,702 16,372 40 12 18,373 — 18,373 Amounts owed to HSBC undertakings 2,052 Financial liabilities designated at fair value – debt securities in issue – subordinated liabilities and preferred securities Derivatives Debt securities in issue Accruals and other financial liabilities Subordinated liabilities Total financial liabilities at 31 Dec 2016 Non-financial liabilities — — — 3,841 — 75 — — — — 2 — 2 — 2 — — — — — — 1,268 — — — — — — — — — — — — — — — 142 — 142 — 142 — — — — — — — — — — — — — — 22 — 22 — 22 5,968 1,268 — — Total liabilities at 31 Dec 2016 5,968 1,268 Off-balance sheet commitments given Undrawn formal standby facilities, credit lines and other commitments to lend — — — — 250 HSBC Holdings plc Annual Report and Accounts 2016 Maturity analysis of assets, liabilities and off-balance sheet commitments (continued) Due not more than 1 month Due over 1 month but not more than 3 months Due over 3 months but not more than 6 months Due over 6 months but not more than 9 months Due over 9 months but not more than 1 year Due over 1 year but not more than 2 years Due over 2 years but not more than 5 years Due over 5 years $m $m $m $m $m $m $m $m Total $m Amounts owed to HSBC undertakings 1,629 Financial assets Cash at bank and in hand: – balances with HSBC undertakings Derivatives Loans and advances to HSBC undertakings Financial investments in HSBC undertakings Accrued income and other financial assets Total financial assets at 31 Dec 2015 Non-financial assets Total assets at 31 Dec 2015 Financial liabilities Financial liabilities designated at fair value – debt securities in issue – subordinated liabilities and preferred securities Derivatives Debt securities in issue Accruals and other financial liabilities Subordinated liabilities Total financial liabilities at 31 Dec 2015 Non-financial liabilities Total liabilities at 31 Dec 2015 Off-balance sheet commitments given Undrawn formal standby facilities, credit lines and other commitments to lend 242 1,990 — — — — 7,805 2,629 4,618 40 7 10,084 — 10,084 — — — 2,065 — 1,231 — 4,928 — 4,925 6 — 2,635 — 2,635 — 960 — — — — 195 — 1,155 — 1,155 — — 4,618 — 4,618 — — — — — — 132 — 132 — 132 — — — — — — — — — — — — — — — — — 20 — 20 — 20 — — — — — — — — — — — — — — — — — — — — — — — — — — — — — 415 — — — — — — — 415 — 415 — 109 — — — 109 — 109 — — 368 242 2,467 29,298 44,350 4,239 4,285 109 34,014 98,734 116 51,460 98,734 132,748 150,194 108 2,152 2,285 — 16,608 6,937 19,853 7,897 2,285 9,671 11,956 213 — — 1,749 4,247 — 4,247 — 960 — 14,146 31,822 64 2,278 960 1,578 15,895 42,716 64 31,886 42,780 — — — — HSBC Holdings plc Annual Report and Accounts 2016 251 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 30 Offsetting of financial assets and financial liabilities The ‘Amounts not set off in the balance sheet’ include transactions where: • • the counterparty has an offsetting exposure with HSBC and a master netting or similar arrangement is in place with a right to set off only in the event of default, insolvency or bankruptcy, or the offset criteria are otherwise not satisfied; and in the case of derivatives and reverse repurchase/repurchase, stock borrowing/lending and similar agreements, cash and non- cash collateral has been received/pledged. For risk management purposes, the net amounts of loans and advances to customers are subject to limits, which are monitored and the relevant customer agreements are subject to review and updated, as necessary, to ensure that the legal right to set off remains appropriate. Amounts subject to enforceable netting arrangements Amounts not set off in the balance sheet Gross amounts Amounts offset Net amounts in the balance sheet Financial instruments Non-cash collateral Cash collateral Net amount Amounts not subject to enforceable netting arrangements5 Footnotes $m $m $m $m $m $m $m $m Total $m Financial assets Derivatives (Note 14) Reverse repos, stock borrowing and similar agreements classified as: – trading assets – non-trading assets Loans and advances to customers At 31 Dec 2016 Derivatives (Note 14) Reverse repos, stock borrowing and similar agreements classified as: – trading assets – non-trading assets Loans and advances to customers At 31 Dec 2015 Financial liabilities Derivatives (Note 14) Repos, stock lending and similar agreements classified as: – trading liabilities – non-trading liabilities Customer accounts At 31 Dec 2016 Derivatives (Note 14) Repos, stock lending and similar agreements classified as: – trading liabilities – non-trading liabilities Customer accounts At 31 Dec 2015 1 2 3 1 2 3 1 2 4 1 2 4 387,999 (106,555) 281,444 (210,067) (11,647) (40,188) 19,542 9,428 290,872 9,859 — 9,859 (475) (9,383) 222,485 (87,929) 134,556 (4,779) (129,373) — (215) 1 189 348 10,207 26,418 160,974 46,296 (14,602) 31,694 (24,459) — (248) 6,987 743 32,437 666,639 (209,086) 457,553 (239,780) (150,403) (40,651) 26,719 36,937 494,490 385,682 (105,860) 279,822 (215,531) (8,621) (34,040) 21,630 8,654 288,476 7,496 — 7,496 — (7,495) 200,921 (77,925) 122,996 (544) (121,981) — (270) 1 201 60 7,556 23,259 146,255 77,547 (31,643) 45,904 (40,790) — — 5,114 1,487 47,391 671,646 (215,428) 456,218 (256,865) (138,097) (34,310) 26,946 33,460 489,678 378,571 (106,555) 272,016 (210,035) (15,512) (33,754) 12,715 7,803 279,819 5,034 — 148,443 (87,929) 45,422 (14,602) 5,034 60,514 30,820 (475) (4,515) (6,202) (54,126) (24,459) — — (146) (248) 44 40 6,113 37 5,071 28,444 88,958 228 31,048 577,470 (209,086) 368,384 (241,171) (74,153) (34,148) 18,912 36,512 404,896 377,930 (105,860) 272,070 (215,508) (13,629) (30,063) 12,870 9,001 281,071 9,300 126,740 83,085 — (77,925) (31,643) 9,300 48,815 51,442 — (9,299) (2,034) (46,731) (40,790) — — (26) (1) 597,055 (215,428) 381,627 (258,332) (69,659) (30,090) 1 24 10,651 23,546 1 31,585 729 9,301 80,400 52,171 41,316 422,943 1 At 31 December 2016, the amount of cash margin received that had been offset against the gross derivatives assets was $3,720m (2015: $4,135m). The amount of cash margin 2 paid that had been offset against the gross derivatives liabilities was $5,862m (2015: $4,224m). For the amount of repos, reverse repos, stock lending, stock borrowing and similar agreements recognised on the balance sheet within 'Trading assets' $10,207m (2015: $7,556m) and 'Trading liabilities' $5,071m (2015: $9,301m), see the ‘Funding sources and uses’ table on page 107. 3 At 31 December 2016, the total amount of 'Loans and advances to customers' was $861,504m (2015: $924,454m) of which $31,694m (2015: $45,904m) was subject to offsetting. 4 At 31 December 2016, the total amount of 'Customer accounts' was $1,272,386m (2015: $1,289,586m) of which $30,820m (2015: $51,442m) was subject to offsetting. 5 These exposures continue to be secured by financial collateral, but we may not have sought or been able to obtain a legal opinion evidencing enforceability of the right of offset. 252 HSBC Holdings plc Annual Report and Accounts 2016 31 Non-controlling interests Non-controlling interests attributable to holders of ordinary shares in subsidiaries Preferred securities issued by subsidiaries At 31 Dec 2016 $m 6,932 260 7,192 2015 $m 6,981 2,077 9,058 Hang Seng Bank Limited is the only subsidiary in the Group that gives rise to significant non-controlling interest. For summarised financial information of Hang Seng Bank Limited see Note 18 ‘Investment in subsidiaries’. Preferred securities issued by subsidiaries Preferred securities are securities for which there is no obligation to pay a dividend and, if the dividend is not paid, it may not be cumulative. Such securities do not generally carry voting rights but rank higher than ordinary shares for dividend payments and in the event of a winding-up. These securities have no stated maturity date but may be called and redeemed by the issuer, subject to prior notification to the PRA and, where relevant, the consent of the local banking regulator. All non-cumulative preferred securities are classified as additional tier 1 capital. Preferred securities issued by HSBC’s subsidiaries HSBC USA Inc. $518m $374m $374m Floating rate non-cumulative preferred stock, series F Floating rate non-cumulative preferred stock, series G 6.50% non-cumulative preferred stock, series H HSBC Finance Corporation $575m 6.36% non-cumulative preferred stock, series B HSBC Bank Canada C$175m C$175m At 31 Dec Non-cumulative redeemable class 1 preferred shares, series C Non-cumulative class 1 preferred shares, series D 1 2 In June 2016, HSBC redeemed its floating non-cumulative preferred stock, series F and G for $892m. In June 2016, HSBC redeemed its non-cumulated preferred stock, series H and B, for $949m. 32 Called up share capital and other equity instruments Called up share capital and share premium HSBC Holdings ordinary shares of $0.50 each, issued and fully paid Footnotes First call date 1 1 2 2 Apr 2010 Jan 2011 Jul 2011 Jun 2010 Jun 2010 Dec 2010 2016 $m — — — — 130 130 260 At 1 Jan Shares issued under HSBC employee share plans Shares issued in lieu of dividends At 31 Dec 2016 2015 Footnote Number $m Number 19,685,096,934 9,842 19,217,874,260 69,187,052 437,302,228 35 219 91,265,909 375,956,765 1 20,191,586,214 10,096 19,685,096,934 HSBC Holdings non-cumulative preference shares of $0.01 each At 1 Jan and 31 Dec HSBC Holdings share premium At 31 Dec Total called up share capital and share premium At 31 Dec Footnote 2 2016 Number 1,450,000 $m — 2015 Number 1,450,000 2016 $m 12,619 2016 $m 22,715 2015 $m 518 374 374 559 126 126 2,077 $m 9,609 45 188 9,842 $m — 2015 $m 12,421 2015 $m 22,263 1 All HSBC Holdings ordinary shares in issue, excluding 325,273,407 shares held in treasury, confer identical rights, including in respect of capital, dividends and voting. 2 Included in the capital base of HSBC as additional tier 1 capital in accordance with the CRD IV rules, by virtue of the application of grandfathering provisions. HSBC Holdings plc Annual Report and Accounts 2016 253 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements HSBC Holdings non-cumulative preference shares of $0.01 HSBC Holdings pays dividends on non-cumulative preference shares of $0.01 each (‘dollar preference shares’) quarterly, at the sole and absolute discretion of the Board. The Board will not declare a dividend on them if this would stop the company from meeting the PRA’s capital adequacy requirements, or if profit available for distribution as dividends is insufficient to also pay dividends on other shares that are equally entitled and scheduled on the same date. HSBC Holdings may not declare or pay dividends on shares ranking lower in the right to dividends than dollar preference shares, or redeem or purchase any of its other shares ranking equal or lower than dollar preference shares, unless it has fully paid, or set aside an amount to fully pay, the dividends on the dollar preference shares for the then current dividend period. The dollar preference shares carry no rights to conversion into ordinary shares. Holders of dollar preference shares are only entitled to attend and vote at shareholder meetings if dividends on these shares have not been paid in full on four consecutive dividend payment dates. In such circumstances, holders of these shares are entitled to vote at shareholder meetings until HSBC Holdings has paid a full dividend on them. Since 16 December 2010, HSBC Holdings has been able to redeem dollar preference shares at any time, subject to prior notification to the PRA. HSBC Holdings non-cumulative preference share of £0.01 The one non-cumulative sterling preference share of £0.01 (‘sterling preference share’) has been in issue since 29 December 2010 and is held by a subsidiary of HSBC Holdings. Dividends are paid quarterly at the sole and absolute discretion of the Board. The sterling preference share carries no rights of conversion into ordinary shares of HSBC Holdings and no rights to attend and vote at shareholder meetings of HSBC Holdings. HSBC Holdings may redeem it at any time. Other equity instruments HSBC Holdings includes three types of additional tier 1 capital securities in its tier 1 capital. Two are presented in this Note and are accounted for as equity because HSBC does not have an obligation to transfer cash or a variable number of its own ordinary shares to holders under any circumstances outside its control. See Note 28 for additional tier 1 securities accounted for as liabilities. Additional tier 1 capital securities Additional tier 1 capital securities are perpetual subordinated securities on which coupon payments may be deferred at HSBC Holdings’ discretion. While any coupon payments are unpaid or deferred, HSBC Holdings will not declare or pay dividends or make distributions or similar periodic payments in respect of any securities of lower or equal rank, or repurchase or redeem them. Such securities do not generally carry voting rights but rank higher than ordinary shares for coupon payments, and in the event of a winding-up. They do not meet the identifying criteria in full for recognition as tier 1 capital under CRD IV but are eligible as regulatory capital subject to grandfathering limits and progressive phase-out. At HSBC Holdings’ discretion, and subject to certain conditions being satisfied, the capital securities may be exchanged on any coupon payment date for non-cumulative preference shares to be issued by HSBC Holdings and ranking pari passu with the dollar and sterling preference shares in issue. The preference shares would be issued at a nominal value of $0.01 per share and a premium of $24.99 per share, with both amounts being subscribed and fully paid. These securities may be called and redeemed by HSBC subject to prior notification to the PRA. HSBC’s additional tier 1 capital securities in issue which are accounted for in equity $2,200m $3,800m At 31 Dec 8.125% perpetual subordinated capital securities 8.00% perpetual subordinated capital securities, Series 2 Additional tier 1 capital – contingent convertible securities First call date Apr 2013 Dec 2015 2016 $m 2,133 3,718 5,851 2015 $m 2,133 3,718 5,851 During 2016, HSBC continued to issue contingent convertible securities that are included in HSBC’s capital base as fully CRD IV compliant additional tier 1 capital securities on an end point basis. The net proceeds of the issuances will be used for general corporate purposes and to further strengthen the capital base to meet requirements under CRD IV. These securities bear a fixed rate of interest until their initial call dates. After the initial call dates, if they are not redeemed, the securities will bear interest at rates fixed periodically in advance for five-year periods based on prevailing market rates. Interest on the contingent convertible securities will be due and payable only at the sole discretion of HSBC, and HSBC has sole and absolute discretion at all times to cancel for any reason (in whole or in part) any interest payment that would otherwise be payable on any payment date. Distributions will not be paid if they are prohibited under UK banking regulations or if the company has insufficient reserves or fails to meet the solvency conditions defined in the securities’ terms. The contingent convertible securities are undated and are repayable, at the option of HSBC, in whole at the initial call date, or on any fifth anniversary after this date. In addition, the securities are repayable at the option of HSBC in whole for certain regulatory or tax reasons. Any repayments require the prior consent of the PRA. These securities rank pari passu with HSBC’s dollar and sterling preference shares and are therefore ahead of ordinary shares. The contingent convertible securities will be converted into fully paid ordinary shares of HSBC at a pre-determined price, should HSBC’s consolidated end point CET1 ratio fall below 7.0%. Therefore, in accordance with the terms of the securities, if the end point CET1 ratio breaches the 7.0% trigger, the securities will convert into ordinary shares at fixed contractual conversion prices in the issuance currencies of the relevant securities, equivalent to £2.70 at the prevailing rate of exchange on the issuance date, subject to certain anti-dilution adjustments. 254 HSBC Holdings plc Annual Report and Accounts 2016 HSBC’s additional tier 1 capital – contingent convertible securities in issue which are accounted for in equity $2,250m $1,500m €1,500m $2,450m €1,000m $2,000m At 31 Dec 6.375% perpetual subordinated contingent convertible securities 5.625% perpetual subordinated contingent convertible securities 5.25% perpetual subordinated contingent convertible securities 6.375% perpetual subordinated contingent convertible securities 6.000% perpetual subordinated contingent convertible securities 6.875% perpetual subordinated contingent convertible securities Shares under option First call date Sep 2024 Jan 2020 Sep 2022 Mar 2025 Sep 2023 Jun 2021 2016 $m 2,244 1,494 1,943 2,459 1,121 1,998 11,259 2015 $m 2,244 1,494 1,943 2,459 1,121 — 9,261 For details of the options outstanding to subscribe for HSBC Holdings ordinary shares under the HSBC Holdings savings-related share option plans, see Note 5. Aggregate options outstanding under these plans 31 Dec 2016 31 Dec 2015 Number of HSBC Holdings ordinary shares Period of exercise Exercise price 69,217,725 2016 to 2022 £4.0472–5.4738 504,467 86,916 217,738 2016 to 2018 HK$55.4701–63.9864 2016 to 2018 €5.3532–5.7974 2016 to 2018 $7.1456–8.2094 Number of HSBC Holdings ordinary shares 72,840,810 1,114,830 153,610 665,445 Period of exercise Exercise price 2015 to 2021 £4.0472–5.4738 2015 to 2018 HK$55.4701–63.9864 2015 to 2018 2015 to 2018 €5.3532–6.0657 $7.1456–8.2094 Maximum obligation to deliver HSBC Holdings ordinary shares At 31 December 2016, the maximum obligation to deliver HSBC Holdings ordinary shares under all of the above option arrangements and the HSBC International Employee Share Purchase Plan, together with GPSP awards and restricted share awards granted under the HSBC Share Plan and/or the HSBC Share Plan 2011, was 198,483,750 (2015: 193,178,906). The total number of shares at 31 December 2016 held by employee benefit trusts that may be used to satisfy such obligations to deliver HSBC Holdings ordinary shares was 3,997,619 (2015: 4,753,747). 33 Contingent liabilities, contractual commitments and guarantees Guarantees and other contingent liabilities: – financial guarantees and similar contracts – other guarantees – other contingent liabilities At 31 Dec Commitments: – documentary credits and short-term trade-related transactions – forward asset purchases and forward deposits placed – standby facilities, credit lines and other commitments to lend At 31 Dec 1 Guarantees by HSBC Holdings are all in favour of other Group entities. HSBC 2016 $m 37,072 44,394 553 82,019 9,190 5,386 641,267 655,843 2015 $m 46,116 39,739 490 86,345 10,168 981 655,281 666,430 HSBC Holdings1 2016 $m 2015 $m 7,619 68,333 — — — — 7,619 68,333 — — — — — — — — The above table discloses the nominal principal amounts, which represents the maximum amounts at risk should the contracts be fully drawn upon and clients default. As a significant portion of guarantees and commitments is expected to expire without being drawn upon, the total of the nominal principal amounts is not indicative of future liquidity requirements. Approximately half the guarantees have a term of less than one year, while guarantees with terms of more than one year are subject to HSBC’s annual credit review process. Contingent liabilities arising from legal proceedings, regulatory and other matters against Group companies are disclosed in Notes 27 and 35. Financial Services Compensation Scheme The Financial Services Compensation Scheme (‘FSCS’) has provided compensation to consumers following the collapse of a number of deposit takers. The compensation paid out to consumers is currently funded through loans from HM Treasury, which at 31 December 2016 stood at approximately £15.7bn ($19.3bn). The Group could be liable to pay a proportion of the outstanding amount that the FSCS has borrowed from HM Treasury. The ultimate FSCS levy to the industry as a result of the collapses cannot currently be estimated reliably as it is dependent on various uncertain factors including the potential recoveries of assets by the FSCS and changes in the level of protected deposits and the population of FSCS members at the time. Associates HSBC’s share of associates’ contingent liabilities amounted to $35.3bn at 31 December 2016 (2015: $39.2bn). No matters arose where HSBC was severally liable. HSBC Holdings plc Annual Report and Accounts 2016 255 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements 34 Lease commitments Operating lease commitments At 31 December 2016, future minimum lease payments under non-cancellable operating leases for land, buildings and equipment were $3,893m (2015: $5,333m). Finance lease receivables HSBC leases a variety of assets to third parties under finance leases, including transport assets (such as aircraft), property and general plant and machinery. At the end of lease terms, assets may be sold to third parties or leased for further terms. Rentals are calculated to recover the cost of assets less their residual value, and earn finance income. Lease receivables: No later than one year Later than one year and no later than five years Later than five years At 31 Dec Total future minimum payments 2016 Unearned finance income $m $m 3,248 6,563 4,548 (330) (702) (633) Present value $m 2,918 5,861 3,915 14,359 (1,665) 12,694 Total future minimum payments 2015 Unearned finance income $m $m 3,382 7,219 4,897 15,498 (332) (837) (702) (1,871) Present value $m 3,050 6,382 4,195 13,627 35 Legal proceedings and regulatory matters HSBC is party to legal proceedings and regulatory matters in a number of jurisdictions arising out of its normal business operations. Apart from the matters described below, HSBC considers that none of these matters are material. The recognition of provisions is determined in accordance with the accounting policies set out in Note 1. While the outcome of legal proceedings and regulatory matters is inherently uncertain, management believes that, based on the information available to it, appropriate provisions have been made in respect of these matters as at 31 December 2016 (see Note 27). Where an individual provision is material, the fact that a provision has been made is stated and quantified, except to the extent doing so would be seriously prejudicial. Any provision recognised does not constitute an admission of wrongdoing or legal liability. It is not practicable to provide an aggregate estimate of potential liability for our legal proceedings and regulatory matters as a class of contingent liabilities. Securities litigation Household International, Inc. (‘Household International’) and certain former officers were named as defendants in a securities class action lawsuit, Jaffe v. Household International, Inc., et al., filed in the US District Court for the Northern District of Illinois (the ‘Illinois District Court’) in August 2002. The complaint asserted claims under the US Securities Exchange Act and alleged that the defendants knowingly or recklessly made false and misleading statements of material fact relating to Household International’s Consumer Lending operations (some of which ultimately led to a 2002 settlement with 46 states and the District of Columbia) and certain accounting practices, as evidenced by an August 2002 restatement of previously reported consolidated financial statements. A class was certified on behalf of all persons who acquired and disposed of Household International common stock between July 1999 and October 2002. In April 2009, a jury trial was decided partly in favour of the plaintiffs and, in October 2013, the Illinois District Court entered a partial final judgment against the defendants in the amount of approximately $2.5bn (including pre-judgment interest). The defendants appealed the partial final judgment and, in May 2015, the US Court of Appeals for the Seventh Circuit reversed the partial final judgment of the Illinois District Court and remanded the case for a new trial on loss causation. In June 2016, HSBC reached an agreement to pay $1.6bn to settle all claims. Final court approval of the settlement and a final court order of dismissal with prejudice was granted in November 2016. Bernard L. Madoff Investment Securities LLC Bernard L. Madoff (‘Madoff’) was arrested in December 2008 and later pleaded guilty to running a Ponzi scheme. His firm, Bernard L. Madoff Investment Securities LLC (‘Madoff Securities’), is being liquidated in the US by a trustee (the ‘Trustee’). Various non-US HSBC companies provided custodial, administration and similar services to a number of funds incorporated outside the US whose assets were invested with Madoff Securities. Based on information provided by Madoff Securities, as at 30 November 2008, the purported aggregate value of these funds was $8.4bn, including fictitious profits reported by Madoff. Based on information available to HSBC, the funds’ actual transfers to Madoff Securities minus their actual withdrawals from Madoff Securities during the time HSBC serviced the funds are estimated to have totalled approximately $4bn. Various HSBC companies have been named as defendants in lawsuits arising out of Madoff Securities’ fraud. US/UK litigation: The Trustee has brought lawsuits against various HSBC companies in the US Bankruptcy Court and in the English High Court, seeking recovery of transfers from Madoff Securities to HSBC in an amount not yet pleaded or determined. HSBC and other parties to the action have moved to dismiss the Trustee’s US actions. The US Bankruptcy Court granted HSBC’s motion to dismiss with respect to certain of the Trustee’s claims in November 2016, though this ruling is subject to appeal. The deadline by which the Trustee must serve HSBC with his English action has been extended to September 2017 for UK-based defendants and November 2017 for all other defendants. Alpha Prime Fund Ltd (‘Alpha Prime’) and Senator Fund SPC (‘Senator’), co-defendants in one of the Trustee’s US actions, have each brought cross-claims against certain HSBC defendants. In December 2016, the US Bankruptcy Court granted HSBC’s motion to dismiss the cross-claims and Alpha Prime and Senator’s failure to appeal renders the court’s ruling final. Fairfield Sentry Limited, Fairfield Sigma Limited and Fairfield Lambda Limited (together, ‘Fairfield’) (in liquidation since July 2009) have brought lawsuits in the US and the British Virgin Islands (‘BVI’) against fund shareholders, including HSBC companies that 256 HSBC Holdings plc Annual Report and Accounts 2016 acted as nominees for clients, seeking restitution of redemption payments. In October 2016, the liquidators for Fairfield ('Fairfield Liquidators') filed a motion seeking leave to amend their complaints in the US Bankruptcy Court. Briefing on the defendants' opposition to the Liquidators' motion and the defendants' own motion to dismiss is underway. In January 2017, the defendants filed their consolidated motion to dismiss and opposition to the Fairfield Liquidators’ motion seeking leave to amend. In December 2014, three additional actions were filed in the US. A purported class of direct investors in Madoff Securities asserted common law claims against various HSBC companies in the United States District Court for the Southern District of New York (the ‘New York District Court’). In September 2016, the New York District Court granted HSBC’s motion to dismiss this action and the plaintiffs’ failure to appeal renders the court’s ruling final. Two investors in Hermes International Fund Limited (‘Hermes’) also asserted common law claims against various HSBC companies in the New York District Court. HSBC's motion to dismiss this action remains pending. In addition, SPV Optimal SUS Ltd (‘SPV OSUS’), the purported assignee of the Madoff-invested company, Optimal Strategic US Equity Ltd (‘Optimal’), filed a lawsuit in New York state court against various HSBC companies and others, seeking damages on various alleged grounds, including breach of fiduciary duty and breach of trust. This action has been stayed pending the issuance of a potentially dispositive decision in an action initiated by Optimal regarding the validity of the assignment of its claims to SPV OSUS. BVI litigation: Beginning in October 2009, the Fairfield Liquidators commenced lawsuits against fund shareholders, including HSBC companies that acted as nominees for clients, seeking recovery of redemption payments. In March 2016, the BVI court denied a motion brought by certain non-HSBC defendants challenging the Fairfield Liquidators’ authorisation to pursue their US claims, which those defendants have appealed. In August 2016, the Fairfield Liquidators voluntarily discontinued their actions against the HSBC defendants. Bermuda litigation: In January 2009, Kingate Global Fund Limited and Kingate Euro Fund Limited (together, ‘Kingate’) brought an action against HSBC Bank Bermuda Limited (‘HBBM’) for recovery of funds held in Kingate’s accounts, fees and dividends. This action is pending, but is not expected to move forward until the resolution of the Trustee’s US actions against Kingate and HBBM. Thema Fund Limited (‘Thema’) and Hermes each brought three actions in 2009. The first set of actions seeks recovery of funds in frozen accounts held at HSBC Institutional Trust Services (Bermuda) Limited. The second set of actions asserts liability against HSBC Institutional Trust Services (Bermuda) Limited in relation to claims for mistake, recovery of fees and damages for breach of contract. The third set of actions seeks return of fees from HBBM and HSBC Securities Services (Bermuda) Limited. The parties have agreed to a standstill in respect of all three sets of actions. Cayman Islands litigation: In February 2013, Primeo Fund Limited (‘Primeo’) (in liquidation since April 2009) brought an action against HSBC Securities Services Luxembourg (‘HSSL’) and The Bank of Bermuda (Cayman), alleging breach of contract and breach of fiduciary duty, and claiming damages and equitable compensation. Trial began in November 2016 and is scheduled to run until the end of February 2017. Luxembourg litigation: In April 2009, Herald Fund SPC (‘Herald’) (in liquidation since July 2013) brought an action against HSSL before the Luxembourg District Court, seeking restitution of cash and securities Herald purportedly lost because of Madoff Securities’ fraud, or money damages. The Luxembourg District Court dismissed Herald’s securities restitution claim, but reserved Herald’s cash restitution claim and its claim for money damages. Herald has appealed this judgment to the Court of Appeal. In March 2010, Herald (Lux) SICAV (‘Herald (Lux)’) (in liquidation since April 2009) brought an action against HSSL before the Luxembourg District Court seeking restitution of securities, or the cash equivalent, or money damages. Herald (Lux) has also requested the restitution of fees paid to HSSL. In October 2009, Alpha Prime and, in December 2014, Senator, each brought an action against HSSL before the Luxembourg District Court, seeking the restitution of securities, or the cash equivalent, or money damages. The action initiated by Senator has been temporarily suspended at Senator's request. In April 2015, Senator commenced an action against the Luxembourg branch of HSBC Bank plc asserting identical claims before the Luxembourg District Court. HSSL has also been named as a defendant in various actions by shareholders in Primeo Select Fund, Herald, Herald (Lux), and Hermes. Most of these actions have been dismissed, suspended or postponed. Ireland litigation: In November 2013, Defender Limited brought an action against HSBC Institutional Trust Services (Ireland) Limited (‘HTIE’) and others, alleging breach of contract and claiming damages and indemnification for fund losses. A trial date has not yet been scheduled. In May 2016, following a hearing on two preliminary issues, HTIE was successful in obtaining an order dismissing two remaining claims by purported shareholders in Thema International Fund plc. SPV OSUS’s action against HTIE and HSBC Securities Services (Ireland) Limited alleging breach of contract and claiming damages and indemnification for fund losses was dismissed in October 2015. SPV OSUS’s appeal against this first instance decision was heard in January 2017. There are many factors that may affect the range of possible outcomes, and the resulting financial impact, of the various Madoff- related proceedings described above, including but not limited to the multiple jurisdictions in which the proceedings have been brought. Based upon the information currently available, management’s estimate of possible aggregate damages that might arise as a result of all claims in the various Madoff-related proceedings is up to or exceeding $800m, excluding costs and interest. Due to uncertainties and limitations of this estimate, the ultimate damages could differ significantly from this amount. US mortgage-related investigations In April 2011, HSBC Bank USA N.A. (‘HSBC Bank USA’) entered into a consent order (the 'OCC Servicing Consent Order') with the Office of the Comptroller of the Currency (‘OCC’), and HSBC Finance Corporation (‘HSBC Finance’) and HSBC North America Holdings Inc. (‘HNAH’) entered into a similar consent order with the Federal Reserve Board (‘FRB’) (together with the OCC Servicing Consent Order, the ‘Servicing Consent Orders’). The Servicing Consent Orders required prescribed actions to address certain foreclosure practice deficiencies. The Servicing Consent Orders also required an independent foreclosure review which, pursuant to amendments to the Servicing Consent Orders in February 2013, ceased and was replaced by a settlement under which HSBC and 12 other participating servicers agreed to provide cash payments and other assistance to eligible borrowers. In June 2015, the OCC issued an amended OCC Servicing Consent Order citing HSBC Holdings plc Annual Report and Accounts 2016 257 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements the failure of HSBC Bank USA to be in compliance with all requirements of the OCC Servicing Consent Order and stating that the failure to satisfy all requirements of the OCC Servicing Consent Order may result in a variety of regulatory consequences for HSBC Bank USA, including the imposition of civil money penalties. In January 2017, the OCC terminated the OCC Servicing Consent Order, together with its February 2013 and June 2015 amendments, after determining that HSBC Bank USA had satisfied the requirements thereunder. In connection with the termination of the Servicing Consent Order, the OCC also assessed a civil money penalty against HSBC Bank USA finding that HSBC Bank USA failed to correct deficiencies identified under the OCC Servicing Consent Order in a timely fashion. In February 2016, HSBC Bank USA, HSBC Finance, HSBC Mortgage Services Inc. and HNAH entered into an agreement with the US Department of Justice (the ‘DoJ’), the US Department of Housing and Urban Development, the Consumer Financial Protection Bureau, other federal agencies (the ‘Federal Parties’) and the Attorneys General of 49 states and the District of Columbia (the ‘State Parties’) to resolve civil claims related to past residential mortgage loan origination and servicing practices (the ‘National Mortgage Settlement Agreement’). In addition, in February 2016, the FRB announced the imposition against HSBC Finance and HNAH of a $131m civil money penalty in connection with the FRB’s consent order of April 2011. Pursuant to the terms of the FRB’s civil money penalty order, the penalty will be satisfied through the cash payments made to the Federal Parties and the consumer relief provided under the National Mortgage Settlement Agreement. The Servicing Consent Orders and the National Mortgage Settlement Agreement do not completely preclude other enforcement actions by regulatory, governmental or law enforcement agencies related to foreclosure and other mortgage servicing practices, including, but not limited to, matters relating to the securitisation of mortgages for investors, which could include the imposition of civil money penalties, criminal fines or other sanctions. In addition, these practices have in the past resulted in private litigation, and may result in further private litigation. US mortgage securitisation activity and litigation HSBC Bank USA was a sponsor or seller of loans used to facilitate whole loan securitisations underwritten by HSBC Securities (USA) Inc. (‘HSI’). From 2005 to 2007, HSBC Bank USA purchased and sold approximately $24bn of such loans to HSI, which were subsequently securitised and sold by HSI to third parties. The outstanding principal balance was approximately $4.6bn as at 31 December 2016. HSBC notes that the scale of its mortgage securitisation activities was more limited in relation to a number of other banks in the industry. In addition, HSI served as an underwriter on securitisations issued by HSBC Finance or third parties, and HSBC Bank USA served as trustee on behalf of various mortgage securitisation trusts. Mortgage foreclosure and trustee matters: As the industry’s residential mortgage foreclosure issues continue, HSBC Bank USA has taken title to a number of foreclosed homes as trustee on behalf of various mortgage securitisation trusts. As nominal record owner of these properties, HSBC Bank USA has been sued by municipalities and tenants alleging various violations of law, including laws relating to property upkeep and tenants’ rights. While HSBC believes and continues to maintain that these obligations and any related liabilities are those of the servicer of each trust, HSBC continues to receive significant adverse publicity in connection with these and similar matters, including foreclosures that are serviced by others in the name of ‘HSBC, as trustee’. Beginning in June 2014, a number of lawsuits were filed in state and federal court in New York and Ohio against HSBC Bank USA as trustee of over 320 mortgage securitisation trusts. These lawsuits are brought on behalf of the trusts by a putative class of investors including, among others, BlackRock and PIMCO funds. The complaints allege that the trusts have sustained losses in collateral value of approximately $38bn. The lawsuits seek unspecified damages resulting from alleged breaches of the US Trust Indenture Act, breach of fiduciary duty, negligence, breach of contract and breach of the common law duty of trust. HSBC’s motions to dismiss in several of these lawsuits were, for the most part, denied. It is not practicable to estimate the possible financial impact of these matters, as there are many factors that may affect the range of possible outcomes; however, the resulting financial impact could be significant. Loan repurchase matters: HSBC Bank USA, HSBC Finance and Decision One Mortgage Company LLC (an indirect subsidiary of HSBC Finance) (‘Decision One’) have been named as defendants in various mortgage loan repurchase actions brought by trustees of mortgage securitisation trusts. In the aggregate, these actions seek to have the HSBC defendants repurchase mortgage loans, or pay compensatory damages, totalling at least $1bn. In August 2016, HSBC reached an agreement in principle to settle one of the matters and the other matters remain pending. HSBC Mortgage Corporation (USA) Inc. and Decision One have also been named as defendants in two separate actions filed by Residential Funding Company LLC (‘RFC’), a mortgage loan purchase counterparty, seeking unspecified damages in connection with approximately 25,000 mortgage loans. It is not practicable to estimate the possible financial impact of these matters, as there are many factors that may affect the range of possible outcomes; however, the resulting financial impact could be significant. FIRREA: Since 2010, various HSBC entities have received subpoenas and requests for information from the DoJ and the Massachusetts state Attorney General seeking the production of documents and information regarding HSBC’s involvement in certain RMBS transactions as an issuer, sponsor, underwriter, depositor, trustee, custodian or servicer. In November 2014, HNAH, on behalf of itself and various subsidiaries including, but not limited to, HSBC Bank USA, HSI Asset Securitization Corp., HSI, HSBC Mortgage Corporation (USA), HSBC Finance and Decision One, received a subpoena from the US Attorney’s Office for the District of Colorado, pursuant to the Financial Industry Reform, Recovery and Enforcement Act (‘FIRREA’), concerning the origination, financing, purchase, securitisation and servicing of subprime and non-subprime residential mortgages. HSBC continues to cooperate with the DoJ’s investigation, which is at or nearing completion. In December 2016, HSBC had an initial discussion with the DoJ, wherein the DoJ stated its preliminary view that HSBC is subject to liability under FIRREA in connection with certain securitisations from 2005 to 2007 with respect to which HSBC Bank USA served as sponsor or seller of loans and HSI served as underwriter. HSBC disagrees with the DoJ’s preliminary view, and the DoJ has offered HSBC an opportunity to respond. There can be no assurance as to how or when this matter will be resolved, or whether this matter will be resolved prior to the institution of formal legal proceedings by the DoJ. Moreover, it is possible that any such resolution could result in significant penalties and other costs. To date, at least one bank has been sued by the DoJ and at least eight other banks have reported settlements of mortgage-backed securities-related matters pursuant to FIRREA. The prior DoJ settlements provide no clear guidance as to how those individual settlement amounts were calculated, and due to the high degree of uncertainty involved, it is not practicable to estimate any possible financial effect of this matter, which could be significant. 258 HSBC Holdings plc Annual Report and Accounts 2016 HSBC expects the focus on mortgage securitisations to continue and may be subject to additional claims, litigation and governmental or regulatory scrutiny relating to its participation in the US mortgage securitisation market. Anti-money laundering and sanctions-related matters In October 2010, HSBC Bank USA entered into a consent order with the OCC, and HNAH entered into a consent order with the FRB (each an ‘Order’ and together, the ‘Orders’). These Orders required improvements to establish an effective compliance risk management programme across HSBC’s US businesses, including risk management related to the Bank Secrecy Act (‘BSA’) and AML compliance. HSBC Bank USA is not currently in compliance with the OCC Order. Steps are being taken to address the requirements of the Orders. In December 2012, HSBC Holdings, HNAH and HSBC Bank USA entered into agreements with US and UK government agencies regarding past inadequate compliance with the BSA, AML and sanctions laws. Among those agreements, HSBC Holdings and HSBC Bank USA entered into a five-year deferred prosecution agreement with, among others, the DoJ (the ‘US DPA’); and HSBC Holdings consented to a cease-and-desist order, and HSBC Holdings and HNAH consented to a civil money penalty order with the FRB. HSBC Holdings also entered into an agreement with the Office of Foreign Assets Control (‘OFAC’) regarding historical transactions involving parties subject to OFAC sanctions, as well as an undertaking with the UK FCA to comply with certain forward-looking AML and sanctions-related obligations. In addition, HSBC Bank USA entered into civil money penalty orders with the Financial Crimes Enforcement Network of the US Treasury Department and the OCC. Under these agreements, HSBC Holdings and HSBC Bank USA made payments totalling $1.9bn to US authorities and undertook various further obligations, including, among others, to continue to cooperate fully with the DoJ in any and all investigations, not to commit any crime under US federal law subsequent to the signing of the agreement, and to retain an independent compliance monitor (the ‘Monitor’). In February 2017, the Monitor delivered his third annual follow-up review report. Through his country-level reviews, the Monitor identified potential anti-money laundering and sanctions compliance issues that the DoJ and HSBC are reviewing further. Additionally, as discussed elsewhere in this Note, HSBC is the subject of other ongoing investigations and reviews by the DoJ. HSBC Bank plc is also the subject of an investigation by the FCA into its compliance with UK money laundering regulations and financial crime systems and controls requirements. The potential consequences of breaching the US DPA, as well as the role of the Monitor and his third annual review, are discussed on page 82. HSBC Bank USA also entered into two consent orders with the OCC. These required HSBC Bank USA to correct the circumstances noted in the OCC’s report and to adopt an enterprise-wide compliance programme, and imposed restrictions on acquiring control of, or holding an interest in, any new financial subsidiary, or commencing a new activity in its existing financial subsidiary, without the OCC’s prior approval. These settlements with US and UK authorities have led to private litigation, and do not preclude further private litigation related to HSBC’s compliance with applicable BSA, AML and sanctions laws or other regulatory or law enforcement actions for BSA, AML, sanctions or other matters not covered by the various agreements. In May 2014, a shareholder derivative action was filed by a shareholder of HSBC Holdings purportedly on behalf of HSBC Holdings, HSBC Bank USA, HNAH and HSBC USA Inc. (the ‘Nominal Corporate Defendants’) in New York state court against certain current and former directors and officers of those HSBC companies (the ‘Individual Defendants’). The complaint alleges that the Individual Defendants breached their fiduciary duties to the Nominal Corporate Defendants and caused a waste of corporate assets by allegedly permitting and/or causing the conduct underlying the US DPA. In November 2015, the New York state court granted the Nominal Corporate Defendants’ motion to dismiss. The plaintiff has appealed that decision. In July 2014, a claim was filed in the Ontario Superior Court of Justice against HSBC Holdings and a former employee purportedly on behalf of a class of persons who purchased HSBC common shares and American Depositary Shares between July 2006 and July 2012. The complaint, which seeks monetary damages of up to CA$20bn, alleges that the defendants made statutory and common law misrepresentations in documents released by HSBC Holdings and its wholly owned indirect subsidiary, HSBC Bank Canada, relating to HSBC’s compliance with BSA, AML, sanctions and other laws. Since November 2014, four lawsuits have been filed in federal court in New York, Illinois and Texas, against various HSBC companies and others, on behalf of plaintiffs who are, or are related to, victims of terrorist attacks in Iraq, Jordan and Mexico. In each case, it is alleged that the defendants aided and abetted the unlawful conduct of various sanctioned parties in violation of the US Anti-Terrorism Act. These actions are at an early stage. Based on the facts currently known, it is not practicable at this time for HSBC to predict the resolution of these lawsuits, including the timing or any possible impact on HSBC, which could be significant. Tax-related investigations Various tax administration, regulatory and law enforcement authorities around the world, including in the US, France, Belgium, Argentina and India, are conducting investigations and reviews of HSBC Private Bank (Suisse) SA (‘HSBC Swiss Private Bank’) and other HSBC companies in connection with allegations of tax evasion or tax fraud, money laundering and unlawful cross-border banking solicitation. HSBC continues to cooperate in ongoing investigations by the DoJ and the US Internal Revenue Service regarding whether certain HSBC companies and employees, including those associated with HSBC Swiss Private Bank and an HSBC company in India, acted appropriately in relation to certain customers who had US tax reporting obligations. In connection with these investigations, HSBC Swiss Private Bank, with due regard for Swiss law, has produced records and other documents to the DoJ. In August 2013, the DoJ informed HSBC Swiss Private Bank that it was not eligible for the ‘Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks’ since a formal investigation had previously been authorised. In November 2014, HSBC Swiss Private Bank was placed under formal criminal examination in Belgium for alleged tax-related offences. In November 2014, HSBC Swiss Private Bank was also placed under formal criminal examination in France for alleged tax- related offences in 2006 and 2007 and required to pay bail of €50m. In April 2015, HSBC Holdings was informed that it had been placed under formal criminal examination in France in connection with the conduct of HSBC Swiss Private Bank, and a €1bn bail was imposed. HSBC Holdings appealed the bail decision and, in June 2015, bail was reduced to €100m. The ultimate financial impact of these matters could differ significantly, however, from the bail amounts of €150m. In March 2016, HSBC was informed that the HSBC Holdings plc Annual Report and Accounts 2016 259 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements French magistrates had completed their investigation with respect to HSBC Swiss Private Bank and HSBC Holdings, and have referred the matter to the French public prosecutor for a recommendation on any potential charges. In October 2016, HSBC Swiss Private Bank and HSBC Holdings received the French public prosecutor`s brief in which the prosecutor recommended the judge to refer the cases to trial, and HSBC Swiss Private Bank and HSBC Holdings have responded to the prosecutor’s brief. In November 2014, the Argentine tax authority initiated a criminal action against various individuals, including current and former HSBC employees. The criminal action includes allegations of tax evasion, conspiracy to launder undeclared funds and an unlawful association among HSBC Swiss Private Bank, HSBC Bank Argentina, HSBC Bank USA and certain HSBC employees, which allegedly enabled numerous HSBC customers to evade their Argentine tax obligations. In February 2015, the Indian tax authority issued a summons and request for information to an HSBC company in India. In August 2015 and November 2015, HSBC companies received notices issued by two offices of the Indian tax authority, alleging that the Indian tax authority had sufficient evidence to initiate prosecution against HSBC Swiss Private Bank and an HSBC company in Dubai for allegedly abetting tax evasion of four different Indian individuals and/or families and requesting that the HSBC companies show why such prosecution should not be initiated. HSBC Swiss Private Bank and the HSBC company in Dubai have responded to the show cause notices. HSBC is cooperating with the relevant authorities. As at 31 December 2016, HSBC has recognised a provision for these various matters in the amount of $773m. There are many factors that may affect the range of outcomes, and the resulting financial impact, of these investigations and reviews. Due to uncertainties and limitations of these estimates, the ultimate penalties could differ significantly from the amount provided. In light of the media attention regarding these matters, it is possible that other tax administration, regulatory or law enforcement authorities will also initiate or enlarge similar investigations or regulatory proceedings. Mossack Fonseca & Co. HSBC has received requests for information from various regulatory and law enforcement authorities around the world concerning persons and entities believed to be linked to Mossack Fonseca & Co., a service provider of personal investment companies. HSBC is cooperating with the relevant authorities. Based on the facts currently known, it is not practicable at this time for HSBC to predict the resolution of this matter, including the timing or any possible impact on HSBC, which could be significant. London interbank offered rates, European interbank offered rates and other benchmark interest rate investigations and litigation Various regulators and competition and law enforcement authorities around the world, including in the UK, the US, the EU and Switzerland, are conducting investigations and reviews related to certain past submissions made by panel banks and the processes for making submissions in connection with the setting of Libor, Euribor and other benchmark interest rates. As certain HSBC companies are members of such panels, HSBC has been the subject of regulatory demands for information and is cooperating with those investigations and reviews. In December 2016, the European Commission (the ‘Commission’) issued a decision finding that HSBC, among other banks, engaged in anti-competitive practices in connection with the pricing of euro interest rate derivatives in early 2007. The Commission determined that the duration of HSBC’s infringement was 1 month and fined HSBC. HSBC has appealed the decision. US dollar Libor: Beginning in 2011, HSBC and other panel banks have been named as defendants in a number of private lawsuits filed in the US with respect to the setting of US dollar Libor. The complaints assert claims under various US laws, including US antitrust and racketeering laws, the US Commodity Exchange Act (‘US CEA’), and state law. The lawsuits include individual and putative class actions, most of which have been transferred and/or consolidated for pre-trial purposes before the New York District Court. The New York District Court has issued decisions dismissing certain of the claims in response to motions filed by the defendants. Those decisions resulted in the dismissal of the plaintiffs’ federal and state antitrust claims, racketeering claims, and unjust enrichment claims. Dismissal of certain of these claims was appealed to the US Court of Appeals for the Second Circuit, which reversed the New York District Court’s dismissal of plaintiffs’ antitrust claims in May 2016. In July 2016, defendants filed a joint motion to dismiss all antitrust claims and, in December 2016, the New York District Court granted in part and denied in part the motion, leaving only certain antitrust claims to be litigated. Separately, in October 2016, the New York District Court granted a motion to dismiss claims brought by an individual plaintiff for lack of personal jurisdiction, which dismissal is currently on appeal to the Second Circuit. Finally, in January 2017, the District Court granted defendants’ motion to dismiss certain of the remaining antitrust claims against defendants that did not serve on the US dollar Libor submission panel. Euroyen Tokyo interbank offered rate (‘Tibor’) and/or Japanese yen Libor: In April 2012 and July 2015, HSBC and other panel banks were named as defendants in putative class actions filed in the New York District Court on behalf of persons who transacted in financial instruments allegedly related to the euroyen Tibor and/or Japanese yen Libor. The complaints allege, among other things, misconduct related to euroyen Tibor, although HSBC is not a member of the Japanese Bankers Association’s euroyen Tibor panel, as well as Japanese yen Libor, in violation of US antitrust laws, the US CEA, and state law. In May 2016, HSBC reached an agreement in principle with plaintiffs to resolve both of these actions, and the settlement was granted final court approval in November 2016. Euribor: In November 2013, HSBC and other panel banks were named as defendants in a putative class action filed in the New York District Court on behalf of persons who transacted in euro futures contracts and other financial instruments allegedly related to Euribor. The complaint alleges, among other things, misconduct related to Euribor in violation of US antitrust laws, the US CEA and state law. In May 2016, HSBC reached an agreement in principle with plaintiffs to resolve this action, subject to court approval. Singapore Interbank Offered Rate (‘SIBOR’), Singapore Swap Offer Rate (‘SOR’) and Australia Bank Bill Swap Rate ('BBSW'): In July 2016 and August 2016, HSBC and other panel banks were named as defendants in two putative class actions filed in the New York District Court on behalf of persons who transacted in products related to the SIBOR, SOR and BBSW benchmark rates. The complaints allege, among other things, misconduct related to these benchmark rates in violation of US antitrust, commodities and racketeering laws, and state law. These matters are at an early stage. 260 HSBC Holdings plc Annual Report and Accounts 2016 US dollar International Swaps and Derivatives Association fix (‘ISDAfix’): In September 2014, HSBC and other panel banks were named as defendants in a number of putative class actions consolidated in the New York District Court on behalf of persons who transacted in interest rate derivatives or purchased or sold financial instruments that were either tied to ISDAfix rates or were executed shortly before, during, or after the time of the daily ISDAfix setting window. The consolidated complaint alleges, among other things, misconduct related to these activities in violation of US antitrust laws, the US CEA and state law. HSBC’s motion to dismiss the complaint was denied in March 2016. There are many factors that may affect the range of outcomes, and the resulting financial impact, of these matters, which could be significant. Foreign exchange rate investigations and litigation Various regulators and competition and law enforcement authorities around the world, including in the US, the EU, Switzerland, Brazil, South Korea and South Africa are conducting investigations and reviews into trading by HSBC and others on the foreign exchange markets. HSBC is cooperating with these investigations and reviews. In May 2015, the DoJ resolved its investigations with respect to five non-HSBC financial institutions, four of whom agreed to plead guilty to criminal charges of conspiring to manipulate prices in the foreign exchange spot market, and resulting in the imposition of criminal fines in the aggregate of more than $2.5bn. Additional penalties were imposed at the same time by the FRB and other banking regulators. HSBC was not a party to these resolutions. In August 2016, the DoJ indicted one current and one former HSBC employee and charged them with wire fraud and conspiracy relating to a 2011 foreign exchange transaction. The trial is currently scheduled to begin in September 2017. HSBC was not named as a defendant in the indictment, and investigations into HSBC by the DoJ, FRB and others continue. In December 2016, HSBC Bank plc entered into a settlement with Brazil’s Administrative Council of Economic Defense (‘CADE’) in connection with its investigation into 15 banks, including HSBC Bank plc, as well as 30 individuals, relating to practices in the offshore foreign exchange market. Under the terms of the settlement, HSBC Bank plc agreed to pay a financial penalty to CADE. In February 2017, the Competition Commission of South Africa referred a complaint for proceedings before the South African Competition Tribunal against 18 financial institutions, including HSBC Bank plc, for alleged misconduct related to the foreign exchange market in violation of South African antitrust laws. These proceedings are at an early stage. In late 2013 and early 2014, HSBC and other banks were named as defendants in various putative class actions consolidated in the New York District Court. The consolidated complaint alleged, among other things, that the defendants conspired to manipulate the WM/Reuters foreign exchange benchmark rates. In September 2015, HSBC reached an agreement with plaintiffs to resolve the consolidated action, subject to court approval. In December 2015, the court granted preliminary approval of the settlement, and HSBC made payment of the agreed settlement amount into an escrow account. The final settlement approval hearing is scheduled for October 2017. In June 2015, a putative class action was filed in the New York District Court making similar allegations on behalf of Employee Retirement Income Security Act of 1974 (‘ERISA’) plan participants, and another complaint was filed in the US District Court for the Northern District of California in May 2015. The court dismissed the claims in the ERISA action, and the plaintiffs have appealed to the US Court of Appeals for the Second Circuit. HSBC filed a motion to transfer the California action to New York, which was granted in November 2015. In September 2016, a putative class action making similar allegations on behalf of purported ‘indirect’ purchasers of foreign exchange products was filed in New York. This action is at an early stage. In September 2015, two additional putative class actions making similar allegations under Canadian law were issued in Canada against various HSBC companies and other financial institutions. As at 31 December 2016, HSBC has recognised a provision for these various matters in the amount of $1.2bn. There are many factors that may affect the range of outcomes, and the resulting financial impact, of these matters. Due to uncertainties and limitations of these estimates, the ultimate penalties could differ significantly from the amount provided. Precious metals fix-related investigations and litigation Various regulators and competition and law enforcement authorities, including in the US and the EU, are conducting investigations and reviews relating to HSBC’s precious metals operations and trading. HSBC is cooperating with these investigations and reviews. In November 2014, the Antitrust Division and Criminal Fraud Section of the DoJ issued a document request to HSBC Holdings, seeking the voluntary production of certain documents in connection with a criminal investigation that the DoJ is conducting of alleged anti-competitive and manipulative conduct in precious metals trading. In January 2016, the Antitrust Division of the DoJ informed HSBC that it was closing its investigation; however, the Criminal Fraud Section’s investigation remains ongoing. Gold: Beginning in March 2014, numerous putative class actions were filed in the New York District Court and the US District Courts for the District of New Jersey and the Northern District of California, naming HSBC and other members of The London Gold Market Fixing Limited as defendants. The complaints allege that, from January 2004 to the present, defendants conspired to manipulate the price of gold and gold derivatives for their collective benefit in violation of US antitrust laws, the US CEA and New York state law. The actions were consolidated in the New York District Court. Defendants' motion to dismiss the consolidated action was granted in part and denied in part in October 2016. In December 2015, a putative class action under Canadian law was filed in the Ontario Superior Court of Justice against various HSBC companies and other financial institutions. Plaintiffs allege that, among other things, from January 2004 to March 2014, defendants conspired to manipulate the price of gold and gold derivatives in violation of the Canadian Competition Act and common law. This action is at an early stage. Silver: Beginning in July 2014, numerous putative class actions were filed in the US District Courts for the Southern and Eastern Districts of New York, naming HSBC and other members of The London Silver Market Fixing Ltd as defendants. The complaints allege that, from January 1999 to the present, defendants conspired to manipulate the price of silver and silver derivatives for their collective benefit in violation of US antitrust laws, the US CEA and New York state law. The actions were consolidated in the New York District Court. Defendants’ motion to dismiss the consolidated action was granted in part and denied in part in October 2016. In April 2016, two putative class actions under Canadian law were filed in the Ontario and Quebec Superior Courts of Justice against various HSBC companies and other financial institutions. Plaintiffs in both actions allege that, from January 1999 to August 2014, HSBC Holdings plc Annual Report and Accounts 2016 261 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements defendants conspired to manipulate the price of silver and silver derivatives in violation of the Canadian Competition Act and common law. The Ontario action is at an early stage. The Quebec action has been temporarily stayed. Platinum and palladium: Between late 2014 and early 2015, numerous putative class actions were filed in the New York District Court, naming HSBC and other members of The London Platinum and Palladium Fixing Company Limited as defendants. The complaints allege that, from January 2008 to the present, defendants conspired to manipulate the price of platinum group metals (‘PGM’) and PGM-based financial products for their collective benefit in violation of US antitrust laws and the US CEA. Defendants have moved to dismiss the action. There are many factors that may affect the range of outcomes, and the resulting financial impact, of these matters, which could be significant. Credit default swap litigation Various HSBC companies, among other financial institutions, ISDA, and Markit, were named as defendants in numerous putative class actions filed in the New York District Court and the Illinois District Court. The actions alleged that the defendants violated US antitrust laws by, among other things, conspiring to restrict access to credit default swap pricing exchanges and block new entrants into the exchange market. The actions were subsequently consolidated in the New York District Court. In September 2015, the HSBC defendants reached an agreement with the plaintiffs to resolve the consolidated action, and final court approval of that settlement was granted in April 2016. Treasury auctions Beginning in July 2015, HSI, amongst other financial institutions, was named as a defendant in several putative class actions filed in the New York District Court. The complaints generally allege that the defendants violated US antitrust laws and the US CEA by colluding to manipulate prices of US Treasury securities sold at auction. The cases have been consolidated in the New York District Court. This matter is at an early stage. The DoJ has requested information from HSBC and reportedly other banks regarding US Treasury securities trading practices. HSBC is cooperating with this ongoing investigation. Based on the facts currently known, it is not practicable at this time for HSBC to predict the resolution of these matters, including the timing or any possible impact on HSBC, which could be significant. Interest rate swap litigation In February 2016, various HSBC companies, among others, were named as defendants in a putative class action filed in the New York District Court. The complaint alleged that the defendants violated US antitrust laws by, among other things, conspiring to boycott and eliminate various entities and practices that would have brought exchange trading to buy-side investors in the interest rate swaps marketplace. In June 2016, this action along with other complaints filed in the New York District Court and the Illinois District Court were consolidated in the New York District Court, and in January 2017, the defendants filed a motion to dismiss. This matter is at an early stage. Based on the facts currently known, it is not practicable at this time for HSBC to predict the resolution of this matter, including the timing or any possible impact on HSBC, which could be significant. Fédération Internationale de Football Association (‘FIFA’) related investigations HSBC has received inquiries from the DoJ regarding its banking relationships with certain individuals and entities that are or may be associated with FIFA. The DoJ is investigating whether multiple financial institutions, including HSBC, permitted the processing of suspicious or otherwise improper transactions, or failed to observe applicable AML laws and regulations. HSBC is cooperating with the DoJ’s investigation. Based on the facts currently known, it is not practicable at this time for HSBC to predict the resolution of this matter, including the timing or any possible impact on HSBC, which could be significant. Hiring practices investigation The US Securities and Exchange Commission (the ‘SEC’) is investigating multiple financial institutions, including HSBC, in relation to hiring practices of candidates referred by or related to government officials or employees of state-owned enterprises in Asia-Pacific. HSBC has received various requests for information and is cooperating with the SEC’s investigation. Based on the facts currently known, it is not practicable at this time for HSBC to predict the resolution of this matter, including the timing or any possible impact on HSBC, which could be significant. 36 Related party transactions Related parties of the Group and HSBC Holdings include subsidiaries, associates, joint ventures, post-employment benefit plans for HSBC employees, Key Management Personnel ('KMP') as defined by IAS 24, close family members of KMP and entities which are controlled or jointly controlled by KMP or their close family members. KMP are defined as those persons having authority and responsibility for planning, directing and controlling the activities of HSBC Holdings. These individuals also constitute 'senior management' for the purposes of the Hong Kong Listing Rules. Following a review of the application of IAS 24, it was determined that the roles of Chief Legal Officer, Group Head of Internal Audit and Group Head of Human Resources did not meet the criteria for KMP as provided for in the standard. Particulars of transactions with related parties are tabulated below. The disclosure of the year-end balance and the highest amounts outstanding during the year is considered to be the most meaningful information to represent the amount of the transactions and outstanding balances during the year. Key Management Personnel Details of Directors’ remuneration and interest in shares are disclosed in the Directors’ remuneration report on pages 153 to 170. IAS 24 ‘Related party disclosures’ requires the following additional information for key management compensation. 262 HSBC Holdings plc Annual Report and Accounts 2016 Compensation of Key Management Personnel Short-term employee benefits Post-employment benefits Other long-term employee benefits Share-based payments Year ended 31 Dec Shareholdings, options and other securities of Key Management Personnel Number of options held over HSBC Holdings ordinary shares under employee share plans Number of HSBC Holdings ordinary shares held beneficially and non-beneficially At 31 Dec Transactions and balances during the year with Key Management Personnel 2016 $m 41 — 5 37 83 2015 $m 40 1 9 51 101 2016 (000s) 18 22,283 22,301 2014 $m 41 1 7 54 103 2015 (000s) 29 18,961 18,990 Key Management Personnel Advances and credits Guarantees Deposits Footnote 1 2016 2015 Balance at 31 Dec Highest amounts outstanding during year Balance at 31 Dec Highest amounts outstanding during year $m 215 55 229 $m 220 63 677 $m 218 67 387 $m 411 91 768 1 Advances and credits entered into by subsidiaries of HSBC Holdings during 2016 with Directors, disclosed pursuant to Section 413 of the Companies Act 2006, totalled $2m (2015: $4m). Some of the transactions were connected transactions as defined by the Rules Governing The Listing of Securities on The Stock Exchange of Hong Kong Limited, but were exempt from any disclosure requirements under the provisions of those rules. The above transactions were made in the ordinary course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with persons of a similar standing or, where applicable, with other employees. The transactions did not involve more than the normal risk of repayment or present other unfavourable features. Associates and joint ventures The Group provides certain banking and financial services to associates and joint ventures including loans, overdrafts, interest and non-interest bearing deposits and current accounts. Details of the interests in associates and joint ventures are given in Note 17. Transactions and balances during the year with associates and joint ventures Unsubordinated amounts due from joint ventures Unsubordinated amounts due from associates Amounts due to associates Guarantees and commitments 2016 2015 Highest balance during the year Balance at 31 Dec Highest balance during the year Balance at 31 Dec $m 126 3,136 1,112 776 $m 113 2,881 576 594 $m 195 4,209 1,047 905 $m 151 2,035 92 904 The above outstanding balances arose in the ordinary course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with third-party counterparties. Post-employment benefit plans At 31 December 2016, $4.4bn (2015: $4.3bn) of HSBC post-employment benefit plan assets were under management by HSBC companies, earning management fees of $6m in 2016 (2015: $8m). At 31 December 2016 HSBC’s post-employment benefit plans had placed deposits of $710m (2015: $811m) with its banking subsidiaries, earning interest payable to the schemes of $1m (2015: nil). The above outstanding balances arose from the ordinary course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with third-party counterparties. The HSBC Bank (UK) Pension Scheme and International Staff Retirement Benefit Scheme enter into swap transactions with HSBC to manage inflation and interest rate sensitivity of its liabilities and selected assets. At 31 December 2016 the gross notional value of the swaps with HSBC Bank (UK) Pension Scheme was $10.5bn (2015: $13.3bn); these swaps had a positive fair value to the scheme of $0.9bn (2015: $0.5bn); and HSBC had delivered collateral of $0.9bn (2015: $1.1bn) to the scheme in respect of these arrangements. At 31 December 2016, the gross notional value of the swaps with the International Staff Retirement Benefit Scheme was $1.2bn (2015: $1.7bn) and the swaps had a net negative fair value to the scheme of $85m (2015: $96m negative). All swaps were executed at prevailing market rates and within standard market bid/offer spreads. HSBC Holdings HSBC Holdings plc Annual Report and Accounts 2016 263 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Details of HSBC Holdings’ subsidiaries are shown in Note 38. Transactions and balances during the year with subsidiaries Assets Cash at bank Derivatives Loans and advances Financial investments Investments in subsidiaries Total related party assets at 31 Dec Liabilities Amounts owed to HSBC undertakings Derivatives Subordinated liabilities Total related party liabilities at 31 Dec Guarantees and commitments 2016 2015 Highest balance during the year Balance at 31 Dec Highest balance during the year $m $m $m 997 4,494 77,732 4,314 97,827 247 2,148 77,421 3,590 95,850 620 3,409 47,229 4,427 97,770 Balance at 31 Dec $m 242 2,466 44,350 4,285 97,770 185,364 179,256 153,455 149,113 3,823 5,025 1,749 10,597 63,719 2,157 5,025 891 8,073 7,619 2,892 2,459 2,652 8,003 68,349 2,152 2,277 1,746 6,175 68,333 The above outstanding balances arose in the ordinary course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with third-party counterparties. Some employees of HSBC Holdings are members of the HSBC Bank (UK) Pension Scheme, which is sponsored by a separate Group company. HSBC Holdings incurs a charge for these employees equal to the contributions paid into the scheme on their behalf. Disclosure in relation to the scheme is made in Note 5. 37 Events after the balance sheet date A fourth interim dividend for 2016 of $0.21 per ordinary share (a distribution of approximately $4,172m) was declared by the Directors after 31 December 2016. On 21 February 2017, the Board approved a share buy-back programme of up to $1.0bn. These accounts were approved by the Board of Directors on 21 February 2017 and authorised for issue. 264 HSBC Holdings plc Annual Report and Accounts 2016 38 HSBC Holdings’ subsidiaries, joint ventures and associates In accordance with Section 409 of the Companies Act 2006 a list of HSBC Holdings plc’s subsidiaries, joint ventures and associates, the registered office address and the effective percentage of equity owned at 31 December 2016 is disclosed below. Unless otherwise stated, the share capital comprises ordinary or common shares which are held by Group subsidiaries. The ownership percentage is provided for each undertaking. The undertakings below are consolidated by HSBC unless otherwise indicated. Subsidiaries Subsidiaries ACN 087 652 113 Pty Limited AEA Investors (Cayman) IA L.P. Allblack Investments Limited Almacenadora Banpacifico S.A. AMP Client HSBC Custody Nominee (UK) Limited Assetfinance December (F) Limited Assetfinance December (H) Limited Assetfinance December (M) Limited Assetfinance December (P) Limited Assetfinance December (R) Limited Assetfinance December (W) Limited Assetfinance June (A) Limited Assetfinance June (D) Limited Assetfinance June (E) Limited Assetfinance Limited Assetfinance March (B) Limited Assetfinance March (D) Limited Assetfinance March (F) Limited Assetfinance September (F) Limited Assetfinance September (G) Limited B&Q Financial Services Limited Banco Nominees (Guernsey) Limited Banco Nominees 2 (Guernsey) Limited Banco Nominees Limited Bank of Bermuda (Cayman) Limited Beau Soleil Limited Partnership Beijing Miyun HSBC Rural Bank Company Limited Beneficial Company LLC Beneficial Consumer Discount Company Beneficial Financial I Inc. Beneficial Florida Inc. Beneficial Homeowner Service Corporation Beneficial Kentucky Inc. Beneficial Loan & Thrift Co. Beneficial Louisiana Inc. Beneficial Maine Inc. Beneficial Massachusetts Inc. Beneficial Michigan Inc. Beneficial New Hampshire Inc. Beneficial Oregon Inc. Beneficial Rhode Island Inc. Beneficial South Dakota Inc. Beneficial Tennessee Inc. Beneficial West Virginia, Inc. Beneficial Wyoming Inc. BerCay Holdings Limited Bermuda International Securities Limited BFC Insurance Agency of Nevada Billingsgate City Securities Limited Billingsgate Nominees Limited Cal-Pacific Services, Inc. Canada Crescent Nominees (UK) Limited Canada Square Nominees (UK) Limited Canada Square Property Participations Limited Canada Water Nominees (UK) Limited Capco/Cove, Inc. Group interest % Footnotes Subsidiaries Group interest % Footnotes 100.00 100.00 100.00 99.99 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 99.98 100.00 100.00 100.00 99.99 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 182 Card-Flo #1, Inc. 1,19, 130 16, 162 201 1, 94 94 94 94 94 94 94 94 94 94 94 84 94 94 94 94 131 1, 108 108 87 166 19, 27 22, 148 10, 127 135 142 127 127 127 127 127 127 127 127 127 127 127 127 141 143 136 166 87 61 94 94 142 1, 94 94 1, 94 1, 94 101 Card-Flo #3, Inc. Cayman International Finance Limited Cayman Nominees Limited CBS/Holdings, Inc. CC&H Holdings LLC CCF & Partners Asset Management Limited CCF Charterhouse GmbH CCF Charterhouse GmbH & Co Asset Leasing KG CCF Holding (LIBAN) S.A.L. (in liquidation) Charterhouse Administrators ( D.T.) Limited Charterhouse Development Limited Charterhouse Management Services Limited Charterhouse Pensions Limited Chongqing Dazu HSBC Rural Bank Company Limited Chongqing Fengdu HSBC Rural Bank Company Limited Chongqing Rongchang HSBC Rural Bank Company Limited CL Residential Limited COIF Nominees Limited Cordico Management AG Corhold Limited Dalian Pulandian HSBC Rural Bank Company Limited Decision One Mortgage Company, LLC Dem 5 Dem 9 Dempar 1 Dempar 4 Desarrollo Turistico, S.A. de C.V. Eagle Rock Holdings, Inc. Ellenville Holdings, Inc. Elysees GmbH Elysées Immo Invest Emerging Growth Real Estate II GP Limited EMTT Limited Endeavour Personal Finance Limited Equator Holdings Limited Eton Corporate Services Limited Far East Leasing SA Fdm 5 SAS FEPC Leasing Ltd. Finanpar 2 Finanpar 7 First Corporate Director Inc. First Direct Investments (UK) Limited Flandres Contentieux S.A. Foncière Elysées Forward Trust Rail Services Limited Fujian Yongan HSBC Rural Bank Company Limited Fulcher Enterprises Company Limited Fundacion HSBC, A.C. G.M. Gilt-Edged Nominees Limited Gesellschaft fur Industrielle Beteiligungen und Finanzierung mbH Gesico International SA 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 74.99 100.00 100.00 100.00 100.00 100.00 36 127 166 228 101 10, 133 94 4, 233 9, 233 1, 220 94 94 94 1, 94 22, 190 100.00 22, 191 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 62.14 60.00 100.00 100.00 100.00 22, 195 94 1, 8, 94 109 151 22, 147 10, 139 4, 74 4, 74 4, 29 4, 29 201 101 101 6, 233 4, 89 108 1, 94 153 94 200 1, 189 4, 74 16, 234 4, 89 4, 89 151 94 1, 4, 44 4, 29 16, 94 22, 192 96 1, 20, 201 1, 94 176 113 HSBC Holdings plc Annual Report and Accounts 2016 265 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Subsidiaries Giller Ltd. GPIF Co-Investment, LLC GPIF-I Equity Co., Ltd. GPIF-I Finance Co., Ltd Griffin International Limited Grundstuecksgesellschaft Trinkausstrasse Kommanditgesellschaft Grupo Financiero HSBC, S. A. de C. V. Guangdong Enping HSBC Rural Bank Company Limited GZ Trust Corporation Hang Seng (Nominee) Limited Hang Seng Bank (China) Limited Hang Seng Bank (Trustee) Limited Hang Seng Bank Limited Hang Seng Bullion Company Limited Hang Seng Credit Limited Hang Seng Data Services Limited Hang Seng Finance Limited Hang Seng Financial Information Limited Hang Seng Futures Limited Hang Seng Indexes Company Limited Hang Seng Insurance Company Limited Hang Seng Investment Management Limited Hang Seng Investment Services Limited Hang Seng Life Limited Hang Seng Real Estate Management Limited Hang Seng Securities Limited Hang Seng Security Management Limited Haseba Investment Company Limited HBL Nominees Limited HDSAP GP Limited HFC Bank Limited HFC Company LLC High Meadow Management, Inc. High Time Investments Limited HITG Administration GmbH Honey Green Enterprises Ltd. Hongkong International Trade Finance (Holdings) Limited Household Capital Markets LLC Household Commercial Financial Services, Inc. Household Finance Consumer Discount Company Household Finance Corporation II Household Finance Corporation III Household Finance Corporation of Alabama Household Finance Corporation of California Household Finance Corporation of West Virginia Household Finance Industrial Loan Company of Iowa Household Finance Realty Corporation of Nevada Household Finance Realty Corporation of New York Household Financial Center Inc. Household Industrial Finance Company Household Industrial Loan Company of Kentucky Household Insurance Group Holding Company Household International Europe Limited Household Pooling Corporation Household Realty Corporation HPUT A Limited HPUT B Limited HRMG Nominees Limited HSBC (BGF) Investments Limited HSBC (General Partner) Limited HSBC (Kuala Lumpur) Nominees Sdn Bhd HSBC (Malaysia) Trustee Berhad HSBC (Singapore) Nominees Pte Ltd Group interest % Footnotes Subsidiaries Group interest % Footnotes 100.00 80.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 62.14 100.00 100.00 100.00 100.00 100.00 62.14 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 101 HSBC Administradora de Inversiones S.A. 10, 127 1, 11, 118 1, 11, 118 HSBC AFS (USA) LLC HSBC Agency (India) Private Limited HSBC Alpha Funding (UK) Holdings 94 176 201 22, 196 151 96 22, 71 96 96 96 96 96 96 96 96 96 96 96 96 96 96 96 96 96 1, 94 108 94 HSBC Alternative Investments Limited HSBC Amanah Malaysia Berhad HSBC Americas Corporation (Delaware) HSBC Argentina Holdings S.A. HSBC Asia Holdings (UK) Limited HSBC Asia Holdings B.V. HSBC Asia Pacific Holdings (UK) Limited HSBC Asset Finance (UK) Limited HSBC Asset Finance Holdings Limited HSBC Asset Finance M.O.G. Holdings (UK) Limited HSBC Asset Management (India) Private Limited HSBC Assurances Vie (France) HSBC Australia Holdings Pty Limited HSBC Bank (Chile) HSBC Bank (China) Company Limited HSBC Bank (General Partner) Limited HSBC Bank (Mauritius) Limited HSBC Bank (RR) (Limited Liability Company) HSBC Bank (Singapore) Limited HSBC Bank (Taiwan) Limited HSBC Bank (Uruguay) S.A. HSBC Bank (Vietnam) Ltd. HSBC Bank A.S. HSBC Bank Argentina S.A. HSBC Bank Armenia cjsc HSBC Bank Australia Limited HSBC Bank Bermuda Limited HSBC Bank Canada HSBC Bank Capital Funding (Sterling 1) LP 10, 127 HSBC Bank Capital Funding (Sterling 2) LP 101 96 34 103 HSBC Bank Egypt S.A.E HSBC Bank International Limited HSBC Bank Malaysia Berhad HSBC Bank Malta p.l.c. HSBC Bank Middle East Limited 94 10, 127 HSBC Bank Middle East Limited, Representative Office Morocco SARL 127 127 127 127 137 127 143 138 127 127 141 126 140 86 HSBC Bank Nominee (Jersey) Limited HSBC Bank Oman S.A.O.G. HSBC Bank Pension Trust (UK) Limited HSBC Bank plc HSBC Bank Polska S.A. HSBC Bank USA, National Association HSBC Branch Nominee (UK) Limited HSBC Brasil Holding S.A. HSBC BRASIL S.A. BANCO DE INVESTIMENTO HSBC Broking Forex (Asia) Limited HSBC Broking Futures (Asia) Limited HSBC Broking Futures (Hong Kong) Limited HSBC Broking Nominees (Asia) Limited HSBC Broking Securities (Asia) Limited 16, 94 HSBC Broking Securities (Hong Kong) Limited 226 127 1,94 1,94 108 94 HSBC Broking Services (Asia) Limited HSBC Canada Holdings (UK) Limited HSBC Capital (Canada) Inc. HSBC Capital (USA), Inc. HSBC Capital Funding (Dollar 1) L.P. HSBC Capital Limited 2, 163 HSBC Card Services Inc. 31 40 58 HSBC Casa de Bolsa, S.A. de C.V., Grupo Financiero HSBC HSBC Cayman Services Limited 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 72.96 100.00 100.00 100.00 100.00 100.00 100.00 99.99 70.00 100.00 100.00 100.00 100.00 100.00 94.53 100.00 100.00 70.03 100.00 100.00 100.00 51.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 111 10, 101 85 166 94 94 127 150 94 16,94 16,94 94 94 94 76 4, 44 16, 182 171 22, 157 163 91 23, 57 58 38 211 227 146 149 90 182 87 16, 98 19, 163 19, 163 69 162 31 35 16, 177 229 162 105 94 2, 16, 94 16, 214 16, 52 1, 94 216 216 27 14, 27 27 27 27 27 27 94 68 127 19,163 27 127 201 166 266 HSBC Holdings plc Annual Report and Accounts 2016 Subsidiaries HSBC City Funding Holdings HSBC Client Holdings Nominee (UK) Limited HSBC Client Share Offer Nominee (UK) Limited HSBC Columbia Funding, LLC HSBC Consumer Lending (USA) Inc. HSBC Corporate Advisory (Malaysia) Sdn Bhd HSBC Corporate Finance (Hong Kong) Limited HSBC Corporate Trustee Company (UK) Limited HSBC Credit Center, Inc. HSBC Custody Nominees (Australia) Limited HSBC Custody Services (Guernsey) Limited HSBC Daisy Investments (Mauritius) Limited HSBC Electronic Data Processing (Guangdong) Limited HSBC Electronic Data Processing (Malaysia) Sdn Bhd HSBC Electronic Data Processing (Philippines), Inc. HSBC Electronic Data Processing India Private Limited HSBC Electronic Data Processing Lanka (Private) Limited HSBC Electronic Data Service Delivery (Egypt) S.A.E. HSBC Enterprise Investment Company (UK) Limited HSBC Epargne Entreprise (France) HSBC Equator (UK) Limited HSBC Equipment Finance (UK) Limited HSBC Equities (Luxembourg) S.a r.l. HSBC Equity (UK) Limited HSBC Europe B.V. HSBC European Clients Depositary Receipts Nominee (UK) Limited HSBC Executor & Trustee Company (UK) Limited HSBC Factoring (France) HSBC Finance (Brunei) Berhad HSBC Finance (Netherlands) HSBC Finance Corporation HSBC Finance Limited HSBC Finance Mortgages Inc. HSBC Finance Transformation (UK) Limited HSBC Financial Services (Middle East) Limited HSBC Financial Services (Lebanon) s.a.l. HSBC Financial Services (Uruguay) S.A. HSBC Fondo 1, S.A. de C.V., Sociedad de Inversion de Renta Variable Group interest % Footnotes Subsidiaries 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 99.70 100.00 94 1, 94 1, 94 10, 127 127 31 27 94 127 182 108 123 HSBC Global Asset Management (Japan) K. K. HSBC Global Asset Management (Malta) Limited HSBC Global Asset Management (México), S.A. de C.V., Sociedad Operadora de Fondos de Inversión, Grupo Financiero HSBC HSBC Global Asset Management (Oesterreich) GmbH HSBC Global Asset Management (Singapore) Limited HSBC Global Asset Management (Switzerland) AG HSBC Global Asset Management (Taiwan) Limited HSBC Global Asset Management (UK) Limited HSBC Global Asset Management (USA) Inc. HSBC Global Asset Management Holdings (Bahamas) Limited 22, 77 HSBC Global Asset Management Limited 222 169 165 79 219 94 4,44 94 94 1,45 94 94 1, 94 94 4,29 230 2,94 HSBC Global Custody Nominee (UK) Limited HSBC Global Custody Proprietary Nominee (UK) Limited HSBC Global Services (UK) Limited HSBC Global Services Limited HSBC Global Shared Services (India) Private Limited HSBC Group Management Services Limited HSBC Group Nominees UK Limited HSBC Guyerzeller Trust Company HSBC Holdings B.V. HSBC Home Equity Loan Corporation II HSBC IM Pension Trust Limited HSBC Infrastructure Limited HSBC INKA Investment-AG TGV HSBC Inmobiliaria (Mexico), S.A. de C.V. HSBC Institutional Trust Services (Asia) Limited HSBC Institutional Trust Services (Bermuda) Limited HSBC Institutional Trust Services (Ireland) DAC HSBC Institutional Trust Services (Mauritius) Limited HSBC Institutional Trust Services (Singapore) Limited 16, 127 HSBC Insurance (Asia) Limited 94 224 2, 94 158 158 237 HSBC Insurance (Asia-Pacific) Holdings Limited HSBC Insurance (Bermuda) Limited HSBC Insurance (Singapore) Pte. Limited HSBC Insurance Agency (USA) Inc. HSBC Insurance Brokers (Philippines) Inc HSBC Insurance Brokers (Taiwan) Limited HSBC Insurance Holdings Limited 100.00 1, 201 HSBC Insurance Management Services Limited HSBC Fondo 3, S.A. de C.V., Sociedad de Inversion de Renta Variable 100.00 1, 201 HSBC Insurance Services Holdings Limited HSBC Insurance Services (Lebanon) S.A.L. HSBC Fondo 4, S.A. de C.V., Sociedad de Inversion de Renta Variable HSBC Fondo 5, S.A. de C.V., Sociedad de Inversion de Renta Variable 100.00 1, 201 HSBC International Financial Services (UK) Limited HSBC International Finance Corporation (Delaware) 100.00 1, 201 HSBC International Nominees Limited HSBC International Holdings (Jersey) Limited HSBC Fondo 6, S.A. de C.V., Sociedad de Inversion de Renta Variable 100.00 1, 201 HSBC International Trustee (BVI) Limited HSBC International Trade Finance Limited HSBC Fondo Global 1, S.A. de C.V., Sociedad de Inversion de Renta Variable HSBC France HSBC Fund Administration (Jersey) Limited HSBC Fund Services (Korea) Limited HSBC Funding (UK) Holdings HSBC Funds Nominee (Jersey) Limited HSBC Germany Holdings GmbH HSBC Gestion (Monaco) SA HSBC Global Asset Management (Bermuda) Limited HSBC Global Asset Management (Canada) Limited HSBC Global Asset Management (Deutschland) HSBC Global Asset Management (France) HSBC Global Asset Management (Hong Kong) Limited HSBC Global Asset Management (International) Limited 100.00 99.99 100.00 92.96 100.00 100.00 100.00 99.80 100.00 100.00 100.00 100.00 100.00 100.00 1, 201 24, 29 162 1, 178 94 162 176 48 16,87 64 176 4,170 27 168 HSBC International Trustee (Holdings) Pte. Limited HSBC International Trustee Limited HSBC Inversiones S.A. HSBC Inversiones y Servicios Financieros Limitada HSBC InvestDirect (India) Limited HSBC InvestDirect Financial Services (India) Limited HSBC InvestDirect Sales & Marketing (India) Limited HSBC InvestDirect Securities (India) Private Limited HSBC Investment Asia Holdings Limited HSBC Investment Bank Holdings B.V. HSBC Investment Bank Holdings Limited HSBC Investment Company (Egypt) S.A.E HSBC Investment Funds (Canada) Inc. HSBC Investment Funds (Hong Kong) Limited HSBC Investment Funds (Luxembourg) SA HSBC Investment Holdings (Guernsey) Limited HSBC Investment Services (Africa) (Pty) Limited Group interest % Footnotes 100.00 70.03 155 95 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 99.96 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 99.54 100.00 99.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 201 6, 152 58 4, 109 63 94 80 187 94 1, 94 1, 94 94 2, 94 1, 85 94 1, 2, 94 82 16, 94 127 1, 94 94 24, 112 201 27 87 26 160 58 53 16, 181 87 58 80 102 46 2,94 94 158 94 66 15, 94 162 1, 208 94 17, 235 58 208 171 171 100 100 85 16, 100 27 94 2, 94 1,65 16, 64 27 45 200 56 HSBC Holdings plc Annual Report and Accounts 2016 267 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Subsidiaries HSBC Investments (Bahamas) Limited HSBC Invoice Finance (UK) Limited HSBC Iris Investments (Mauritius) Ltd HSBC Issuer Services Common Depositary Nominee (UK) Limited HSBC Issuer Services Depositary Nominee (UK) Limited HSBC Land Title Agency (USA) LLC HSBC Latin America B.V. HSBC Latin America Holdings (UK) Limited HSBC Leasing (Asia) Limited HSBC Leasing (France) HSBC Life (International) Limited HSBC Life (UK) Limited HSBC Life Assurance (Malta) Limited HSBC Life Insurance Company Limited HSBC Lodge Funding (UK) Holdings HSBC London Holdings Limited HSBC LU Nominees Limited HSBC Management (Guernsey) Limited HSBC Markets (Asia) Limited (In Liquidation) HSBC Markets (USA) Inc. HSBC Marking Name Nominee (UK) Limited HSBC Mexico, S.A., Institucion de Banca Multiple, Grupo Financiero HSBC HSBC Middle East Finance Company Limited HSBC Middle East Holdings B.V. HSBC Middle East Leasing Partnership HSBC Middle East Securities L.L.C HSBC Mortgage Corporation (Canada) HSBC Mortgage Corporation (USA) HSBC Mortgage Services Inc. HSBC Nominees (Asing) Sdn Bhd HSBC Nominees (Hong Kong) Limited HSBC Nominees (New Zealand) Limited HSBC Nominees (Tempatan) Sdn Bhd HSBC North America Holdings Inc. HSBC Odeme Sistemleri Bilgisayar Teknolojileri Basin Yayin Ve Musteri Hizmetleri HSBC Overseas Holdings (UK) Limited HSBC Overseas Investments (UK) Limited HSBC Overseas Investments Corporation (New York) HSBC Overseas Nominee (UK) Limited HSBC Participaciones (Argentina) S.A. HSBC PB Corporate Services 1 Limited HSBC PB Services (Suisse) SA HSBC Pension Trust (Ireland) DAC HSBC Pensiones, S.A. HSBC PI Holdings (Mauritius) Limited HSBC Portfoy Yonetimi A.S. HSBC Preferential LP (UK) HSBC Private Bank (C.I.) Limited HSBC Private Bank (Luxembourg) S.A. HSBC Private Bank (Monaco) SA HSBC Private Bank (Suisse) SA HSBC Private Bank (UK) Limited HSBC Private Bank International HSBC Private Banking Holdings (Suisse) SA HSBC Private Banking Nominee 3 (Jersey) Limited HSBC Private Equity Advisors LLC HSBC Private Equity Investments (UK) Limited HSBC Private Trustee (Hong Kong) Limited HSBC Private Wealth Services (Canada) Inc. HSBC Professional Services (India) Private Limited HSBC Property (UK) Limited HSBC Property Funds (Holding) Limited HSBC Property Funds Investment Limited Group interest % Footnotes Subsidiaries Group interest % Footnotes 100.00 100.00 100.00 188 59 123 HSBC Provident Fund Trustee (Hong Kong) Limited HSBC Quest Trustee (UK) Limited HSBC Rail (UK) Limited HSBC Real Estate Leasing (France) 100.00 1, 94 HSBC Realty Credit Corporation (USA) 100.00 55.00 100.00 100.00 100.00 100.00 100.00 100.00 70.03 50.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 99.99 80.00 100.00 100.00 49.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 99.99 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 1, 94 10, 70 94 2, 94 27 4, 74 87 94 95 51 94 HSBC REIM (France) HSBC Representative Office (Nigeria) Limited HSBC Republic Management Services (Guernsey) Limited HSBC Retail Services Inc. HSBC Retirement Benefits Trustee (UK) Limited HSBC Saudi Arabia Limited HSBC Savings Bank (Philippines) Inc. HSBC Securities (Asia) Limited HSBC Securities (B) Berhad HSBC Securities (Canada) Inc. HSBC Securities (Egypt) S.A.E. 1, 2, 94 HSBC Securities (Japan) Limited 94 108 25 127 HSBC Securities (Philippines) Inc. HSBC Securities (Singapore) Pte Limited HSBC Securities (South Africa) (Pty) Limited HSBC Securities (Taiwan) Corporation Limited 1, 94 HSBC Securities (USA) Inc. 201 218 16, 94 19, 183 154 16, 98 127 127 31 27 164 31 HSBC Securities and Capital Markets (India) Private Limited HSBC Securities Asia International Nominees Limited HSBC Securities Asia Nominees Limited HSBC Securities Brokers (Asia) Limited HSBC Securities Investments (Asia) Limited HSBC Securities Services (Bermuda) Limited HSBC Securities Services (Guernsey) Limited HSBC Securities Services (Ireland) DAC HSBC Securities Services (Luxembourg) S.A. HSBC Securities Services (USA) Inc. HSBC Securities Services Holding Limited HSBC Securities Services Holdings (Ireland) DAC 16, 127 HSBC Seguros de Retiro (Argentina) S.A. 115 2, 94 2, 94 128 1, 94 150 167 210 26 202 160 114 94 200 45 4, 48 210 94 41 210 167 HSBC Seguros de Vida (Argentina) S.A. HSBC Seguros, S.A de C.V., Grupo Financiero HSBC HSBC Service Delivery (Polska) Sp. z o.o. HSBC Services (France) HSBC Services Japan Limited HSBC Servicios Financieros, S.A. de C.V HSBC Servicios, S.A. DE C.V., Grupo Financiero HSBC HSBC SFH (France) HSBC Software Development (Canada) Inc HSBC Software Development (Guangdong) Limited HSBC Software Development (India) Private Limited HSBC Software Development (Malaysia) Sdn Bhd HSBC South Point Investments (Barbados) LLP HSBC Specialist Investments Limited HSBC Stockbroker Services (Client Assets) Nominees Limited HSBC Stockbrokers Nominee (UK) Limited HSBC Structured Funds (Asia) Limited HSBC Taxpayer Financial Services Inc. HSBC Technology & Services (China) Limited HSBC Technology & Services (USA) Inc. HSBC TFS I 2005 LLC 10, 127 HSBC TKM Limited 94 27 HSBC Transaction Services GmbH HSBC Trinkaus & Burkhardt (International) S.A. 16, 64 HSBC Trinkaus & Burkhardt AG 85 94 94 153 HSBC Trinkaus & Burkhardt Gesellschaft fur Bankbeteiligungen mbH HSBC Trinkaus Consult GmbH HSBC Trinkaus Europa Immobilien-Fonds Nr. 5 GmbH 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 69.40 100.00 100.00 100.00 100.00 94.53 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 80.65 80.65 80.65 80.65 80.65 80.65 27 1, 2, 94 94 4, 44 16, 127 4, 44 221 200 127 1, 2, 94 1, 156 231 14, 27 1, 161 93 69 94 1, 12, 92 12, 58 56 38 127 16, 85 199 27 27 27 87 108 26 45 134 208 26 150 150 202 174 4, 29 188 201 201 4,44 223 22, 215 159 222 19, 42 16, 94 1, 94 1, 94 27 127 22, 179 127 10, 36 1, 94 6, 238 1, 45 24, 176 176 176 176 268 HSBC Holdings plc Annual Report and Accounts 2016 Group interest % Footnotes Subsidiaries Group interest % Footnotes Subsidiaries HSBC Trinkaus Family Office GmbH HSBC Trinkaus Immobilien Beteiligungs KG HSBC Trinkaus Real Estate GmbH HSBC Trust Company (BVI) Limited HSBC Trust Company (Canada) HSBC Trust Company (Delaware), National Association HSBC Trust Company (UK) Limited HSBC Trust Company AG HSBC Trustee (C.I.) Limited HSBC Trustee (Cayman) Limited HSBC Trustee (Guernsey) Limited HSBC Trustee (Hong Kong) Limited HSBC Trustee (Mauritius) Limited HSBC Trustee (Singapore) Limited HSBC UK RFB Limited HSBC USA Inc. HSBC Valores S.A. HSBC Violet Investments (Mauritius) Limited HSBC Wealth Advisory Israel Ltd HSBC Wealth Client Nominee Limited HSBC Yatirim Menkul Degerler A.S. HSBC-D1, S.A. de C.V., Sociedad de Inversion en Instrumentos de Deuda HSBCD10, S. A. de C. V., Sociedad de Inversion en Instrumentos de Deuda HSBC-D2, S.A. de C.V., Sociedad de Inversion en Instrumentos de Deuda HSBC-D7, S.A. de C.V., Sociedad de Inversion en Instrumentos de Deuda HSBC-D9, S.A. de C.V., Sociedad de Inversion en Instrumentos de Deuda HSBC-DE, S.A. de C.V., Sociedad de Inversion en Instrumentos de Deuda HSBC-DG, S. A. de C. V., Sociedad de Inversion en Instrumentos de Deuda HSBC-DH, S. A. de C. V., Sociedad de Inversion en Instrumentos de Deuda 80.65 80.65 80.65 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 6, 176 176 6, 176 151 98 James Capel (Custodian) Nominees Limited James Capel (Nominees) Limited James Capel (Second Nominees) Limited James Capel (Taiwan) Nominees Limited James Capel (Third Nominees) Limited John Lewis Financial Services Limited 1,67 Katonah Close Corp. 94 109 167 207 200 27 122 58 1, 2, 94 16, 119 110 123 1, 107 1, 94 114 Keyser Ullmann Limited Kings Meadow Nominees Limited Legend Estates Limited Lemasco Nominees Limited Lion Corporate Services Limited Lion International Corporate Services Limited Lion International Management Limited Lion Management (Hong Kong) Limited Lyndholme Limited MAGIM Client HSBC GIS Nominee (UK) Limited Marks and Spencer Financial Services plc Marks and Spencer Retail Financial Services Holdings Limited Marks and Spencer Savings and Investments Limited Marks and Spencer Unit Trust Management Limited 100.00 1, 201 Mercantile Company Limited Maxima S.A. AFJP 100.00 1, 201 Midcorp Limited Mexicana de Fomento, S.A. de C.V. 100.00 1, 201 Midland Bank (Branch Nominees) Limited Midland Australia Pty Limited 100.00 1, 201 Midland Nominees Limited MIL (Cayman) Limited MM Mooring #2 Corp. 100.00 1, 201 MW Gestion SA Oakwood Holdings, Inc. 100.00 1, 201 Promocion en Bienes Raices, S.A. de C.V. 100.00 1, 201 Prudential Client HSBC GIS Nominee (UK) Limited ProServe Bermuda Limited 100.00 1, 201 PT HSBC Securities Indonesia PT Bank HSBC Indonesia HSBC-DL, S. A. de C. V., Sociedad de Inversion en Instrumentos de Deuda 100.00 1, 201 PTC New LLC R/CLIP Corp. HSBC-E2, S.A. de C. V., Sociedad de Inversion de Renta Variable HSBC-E3, S.A. de C.V., Sociedad de Inversion en Instrumentos de Deuda HSBC-FF, S.A. de C.V., Sociedad de Inversion de Renta Variable HSBC-V2, S.A. de C.V., Sociedad de Inversion de Renta Variable HSBC-V3, S.A. de C.V., Sociedad de Inversion de Renta Variable HSI Asset Securitization Corporation HSI International Limited HSIL Investments Limited Hubei Macheng HSBC Rural Bank Company Limited Hubei Suizhou Cengdu HSBC Rural Bank Company Limited Hubei Tianmen HSBC Rural Bank Company Limited Hunan Pingjiang HSBC Rural Bank Company Limited Imenson Limited INKA Internationale Kapitalanlagegesellschaft mbH Inmobiliaria Banci, S.A. de C.V. Inmobiliaria Bisa, S.A. de C.V. Inmobiliaria Grufin, S.A. de C.V. Inmobiliaria Guatusi, S.A. de C.V. IRERE Property Investments (French Offices) Sarl James Capel & Co. Limited James Capel (Channel Islands) Nominees Limited Real Estate Collateral Management Company 100.00 1, 201 Republic Nominees Limited 100.00 1, 201 S.A.P.C. - Ufipro Recouvrement Republic Overseas Capital Corporation 100.00 1, 201 100.00 1, 201 Saf Baiyun Saf Chang Jiang Saf Chang Jiang Shi Liu Saf Chang Jiang Shi Wu Saf Chang Jiang Shi'Er 100.00 100.00 62.14 100.00 100.00 100.00 100.00 100.00 62.14 80.65 99.99 99.99 99.99 99.99 100.00 100.00 100.00 1, 201 Saf Chang Jiang Shiyi 127 96 94 Saf Guangzhou Saf Zhu Jiang Saf Zhu Jiang Yi 22, 197 Saf Zhu Jiang Ba 22, 194 22, 99 22, 213 96 238 201 201 201 201 1, 88 94 168 Saf Zhu Jiang Er Saf Zhu Jiang Jiu Saf Zhu Jiang Liu Saf Zhu Jiang Qi Saf Zhu Jiang San Saf Zhu Jiang Shi Saf Zhu Jiang Shi Ba Saf Zhu Jiang Shi Er Saf Zhu Jiang Shi Jiu Saf Zhu Jiang Shi Liu Saf Zhu Jiang Shi Qi Saf Zhu Jiang Shi Wu Saf Zhu Jiang Shiyi 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 99.99 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 50.00 100.00 98.94 85.00 100.00 100.00 100.00 100.00 100.00 99.98 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 94 94 94 94 94 94 101 94 175 94 168 1, 27 208 208 1, 27 27 1, 94 175 175 175 175 150 14, 94 201 2, 16, 94 182 1, 94 1, 94 166 101 150 101 16, 201 125 1, 94 236 83 10, 127 127 127 200 80 20, 74 4, 89 4, 89 4, 89 1, 4, 89 4, 89 1, 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 4, 89 HSBC Holdings plc Annual Report and Accounts 2016 269 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Subsidiaries Saf Zhu Jiang Wu Samada Limited Samuel Montagu & Co. Limited SAS Bosquet -Audrain SAS Cyatheas Pasteur SAS Orona SCI Hervet Mathurins SCI HSBC Assurances Immo Secondary Club Deal I GP Limited Secondary Club Deal II GP Limited SFSS Nominees (Pty) Limited Shandong Rongcheng HSBC Rural Bank Company Limited Shenfield Nominees Limited Sico Limited SNC Dorique SNC Kerouan SNC Les Mercuriales SNC Les Oliviers D'Antibes SNC Makala SNC Nuku-Hiva Bail SNCB/M6 - 2008 A SNCB/M6-2007 A SNCB/M6-2007 B Societe CCF Finance Moyen-Orient S.A.L. (in liquidation) Société Financière et Mobilière Société Française et Suisse Societe Immobiliere Atlas S.A. Somers & Co Somers Dublin DAC Somers Nominees (Far East) Limited Sopingest South Yorkshire Light Rail Limited SPE 1 2005 Manager Inc. St Cross Trustees Limited Sterling Credit Limited Sun Hung Kai Development (Lujiazui III) Limited Swan National Leasing (Commercials) Limited Swan National Limited Tasfiye Halinde HSBC Internet ve Telekomunikasyon Hizmetleri Anonim Sirketi Tayside Holdings Limited (In liquidation) Group interest % Footnotes Subsidiaries Group interest % Footnotes 100.00 100.00 100.00 94.90 94.93 94.93 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 60.00 100.00 100.00 100.00 100.00 100.00 99.90 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 4, 89 167 1, 94 1, 4, 43 1, 4, 74 1,4,28 20,89 Tempus Management AG Thasosfin The Hongkong and Shanghai Banking Corporation Limited The Venture Catalysts Limited Timberlink Settlement Services (USA) Inc. TKM International Limited 1, 20, 44 Tooley Street View Limited 108 108 56 22, 198 1, 94 235 1, 20, 78 1, 20, 89 1, 20, 89 20, 89 1, 20, 89 1, 20, 89 1, 4, 89 1, 4, 89 1, 4, 89 1, 220 4, 29 4, 89 210 Tower Investment Management Trinkaus Australien Immobilien Fonds Nr. 1 Brisbane GmbH & Co. KG Trinkaus Australien Immobilien-Fonds Nr. 1 Treuhand- GmbH Trinkaus Canada Immobilien-Fonds Nr. 1 Verwaltungs-GmbH Trinkaus Europa Immobilien-Fonds Nr.3 Objekt Utrecht Verwaltungs-GmbH Trinkaus Immobilien-Fonds Geschaeftsfuehrungs- GmbH Trinkaus Immobilien-Fonds Verwaltungs-GmbH Trinkaus Private Equity Management GmbH Trinkaus Private Equity Verwaltungs GmbH Tropical Nominees Limited Trumball Management, Inc. Turnsonic (Nominees) Limited Vadep Holding AG Valeurs Mobilières Elysées Vintage 2016 HV GP Limited Vintage 2016 KKR GP Limited 19, 121 Vintage 2017 Athyrium GP Limited 26 87 4, 89 1, 94 36 1, 94 131 Vintage I Secondary GP Limited Vintage III Special Situations GP Limited Wardley Limited Wayfoong Credit Limited Wayfoong Finance Limited Wayfoong Nominees Limited Wayhong (Bahamas) Limited 22, 212 Westminster House, LLC 94 94 Woodex Limited Yan Nin Development Company Limited 96.00 12, 116 100.00 1, 12, 187 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 109 4, 44 13, 27 94 127 94 1, 94 32 80.65 176 80.65 6, 176 80.65 80.65 80.65 80.65 80.65 80.65 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 62.14 176 176 6, 176 6, 176 176 6, 176 166 101 1, 94 203 4, 30 108 108 1, 108 108 108 27 27 27 27 187 10, 127 87 96 270 HSBC Holdings plc Annual Report and Accounts 2016 Joint Ventures Associates The undertakings below are Joint Ventures and equity accounted. The undertakings below are associates and equity accounted. Joint Ventures GSI Retail Property Holdings Limited HCM Holdings Limited HOUSe Network Sdn Bhd HSBC Jintrust Fund Management Company Limited HSBC Kingdom Africa Investments (Cayman) Limited Vaultex UK Limited Vaultex Isle of Man Insurance Limited Group interest % 50.00 51.00 25.00 Footnotes 1, 217 153 1, 225 49.00 1, 22, 50 50.00 50.00 50.00 1, 186 60 55 Associates AREIT Management Ltd Ashwood Energy Limited Bank of Communications Co., Ltd. Barrowgate Limited Business Growth Fund plc Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited CFAC Payment Scheme Limited Chemi & Cotex (Rwanda) Limited Chemi & Cotex Kenya Limited Chemi and Cotex Industries Limited Electronic Payment Services Company (Hong Kong) Limited EPS Company (Hong Kong) Limited GIE GNIFI GZHS Research Co Ltd Hang Seng Qianhai Fund Management Company Limited HSBC Amanah Takaful (Malaysia) Berhad HSBC Middle East Securities L.L.C HSBC Mortgage LLP HSBC TFS II 2005 LLC Icon Brickell LLC Intercede Holdco Limited Jeppe Star Limited MENA Infrastructure Fund (GP) Ltd NAS Holding Limited NAS United Healthcare Services LLC Northstar Trade Finance Inc. Novo Star Limited SABB Takaful SCI Karuvefa sino AG The Headland Asian Ventures Fund 3 Limited The London Gold Market Fixing Limited The Saudi British Bank Trinkaus Europa Immobilien-Fonds Nr. 7 Frankfurt Mertonviertel KG Group interest % Footnotes 41.90 25.00 19.03 15.31 24.31 26.00 33.33 33.33 34.00 34.00 19.33 38.66 25.00 20.51 43.50 49.00 49.00 33.30 20.00 24.90 29.92 34.00 33.33 22.13 22.13 17.89 34.00 45.50 33.33 20.16 32.59 25.00 40.00 1, 206 1, 129 193 81 37 232 1, 21, 47 173 185 1, 204 1, 27 1, 27 1, 7, 73 1, 10, 33 22, 62 31 154 1, 19, 72 10, 36 1, 10, 117 1, 106 1, 129 1, 180 1, 129 1, 10, 39 97 1, 172 209 1, 20, 184 5, 145 1, 16, 166 1, 8, 120 104 33.22 1, 9, 176 HSBC Holdings plc Annual Report and Accounts 2016 271 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Notes on the Financial Statements Footnotes for Note 38 1 Management has determined that these undertakings are excluded from consolidation in the Group accounts as these entities do not meet the definition of subsidiaries in accordance with IFRSs. HSBC’s consolidation policy is described in Note 1.2(a). 2 Directly held by HSBC Holdings plc 3 Entity is incorporated in The Netherlands Description of shares 4 Actions shares 5 Aktiengesellschaft (AG) shares 6 GmbH Anteil 7 Groupement D'intérêt Economique shares 8 Guarantee shares 9 Kommanditgesellschaft (KG) shares 10 11 Limited Liability Company – no shares Liquidating shares 12 Nominal shares 13 Ordinary and Cumulative Irredeemable and Non-cumulative Irredeemable Preference shares 14 Ordinary and Deferred shares 15 Ordinary and Non-Voting Redeemable shares 16 Ordinary and Preference shares 17 Ordinary Non-Participating, Non Voting shares 18 Ordinary Redeemable Non Participating shares 19 Partnership shares 20 Parts shares 21 Preference shares 22 Registered Capital shares 23 Russian limited liability company shares 24 Stückaktien Registered Offices 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 (Liquidator's address) 62/F One Island East 18 Westlands Road, Island East Hong Kong 1 Grand Canal Square, Grand Canal Harbour, Dublin 2, D02 P820, Ireland 1 Queen's Road Central, Hong Kong 10, Rue Jean Jaurès BP Q5 Noumea 98845 Nouvelle Calédonie 103, Avenue des Champs-Elysées, 75008, Paris, France 109, Avenue des Champs-Elysees, 75008, Paris, France 10th Floor, North Tower 2, Leboh Ampang 50100, Kuala Lumpur, Malaysia 11 Dr. Roy’s Drive PO Box 694GT Grand Cayman KY1-1107 Cayman Islands 1101-J46, 11/F, Nansha Financial Building 171 Haibin Road, Nansha District Guangzhou China 11-17, Ludwig-Erhard-Str., 20459, Hamburg, Germany 116 Archbishop Street Valletta Malta 1209 Orange Street, Wilmington, Delaware 19899, United States 13-15 York Buildings, London, Great Britain, WC2N 6JU, United Kingdom 13F-14F, 333 Keelung Road, Sec.1 Taipei 110 Taiwan, Province of China 13th Floor, Lulu Center Building, Salam Street, PO Box 44505, Abu Dhabi, United Arab Emirates 13th Floor, South Tower 2, Leboh Ampang, 50100 Kuala Lumpur, Malaysia 1441 Brickell Avenue, Miami FL 33131, United States 15 Canada Square, London E14 5GL, United Kingdom 15 Rue Guynemer BP 412 Noumea 98845 Nouvelle Calédonie 15, Rue Vernet, 75008, Paris France 16 Boulevard d'Avranches, L-1160, Luxembourg 16F, 369 Zhongxiao East Road, Section 7 Nangang District, Taipei 115, Taiwan 17 Rochester Row, London SW1P 1QT, United Kingdom 17, Avenue d'Ostende, 98000, Monaco 171, Old Bakery Street, Valletta VLT 1455, Malta 17F, HSBC Building, Shanghai IFC, 8 Century Avenue, Pudong, Shanghai, China 18/F, HSBC Building, 8 Century Avenue, China (Shanghai) Pilot Free Trade Zone, 200120, China 1800 Tysons Boulevard, Suite 50, McLean, Virginia 22102, United States 18th Floor, Tower 1, HSBC Centre, 1 Sham Mong Road, Kowloon, Hong Kong 192 Old Bakery Street, Valletta, Malta 1st Floor Rose House, 51-59 Circular Road, Douglas IM1 1RE, Isle of Man 2 Exchange Square, 85 Maude Street, Sandown, Sandton 2196, South Africa 2 Paveletskaya square, building 2, 115054 Moscow, Russia 21 Collyer Quay, #13-02, HSBC Building, 49320, Singapore 21 Farncombe Road, Worthing, Sussex BN11 2BW, England 21, Garlick Hill, London, EC4V 2AU, United Kingdom 2156 Horse Prairie Drive, Henderson, NV 89052, United States 272 HSBC Holdings plc Annual Report and Accounts 2016 2-3/F, Unit 21A, Qianhai Enterprise Dream Park, No. 63 Qian Wan Yi Road, Qianhai Shenzhen-Hongkong Cooperation Zone, Shenzhen China 24th Fl., 99, Sec.2, Tunhwa S. Rd., Taipei, Taiwan, R.O.C. 2910 Virtual Way, Vancouver BC, V5M 0B2, Canada 3, Aboul Feda Street, Zamalek, Cairo Egypt 300 Delaware Avenue, Suite 1400, Wilmington, DE 19801, United States 300 Delaware Avenue, Suite 1401, Wilmington, DE 19801, United States 300, 885 West Georgia Street Vancouver BC V6C 3E9 Canada 306 Corniche El Nil Maadi, Cairo 11728, Egypt 3303 Express Drive North Islandia NY 11749 United States 34/F and 36/F, Hang Seng Bank Tower, 1000 Lujiazui Ring Road 27/F, Shanghai Stock Exchange Bldg, 528 Pudong South Road Shanghai 200120 China 35 Great St Helens, London EC3A 6AP, United Kingdom 37 Avenue Henri Lafleur Nouméa, BP K3 98849, New Caledonia 39, Rue de Bassano, 75008, Paris, France 3rd Floor, HSBC Bank Middle East Limited Building Al Souq Road, Bur Dubai PO Box 4604, Dubai United Arab Emirates 3rd Floor, Merchantile Bank Chamber 16, Veer Nariman Road Fort Mumbai Maharashtra 400001 India 4-17/F, Office Tower 2 TaiKoo Hui, No. 381 Tian He Road, Tian He District Guangzhou Guangdong China 43, Rue de Paris, Saint Denis 97400, Reunion 439, Sri Jayawardenapura Mawatha Welikada, Rajagiriya, Colombo, Sri Lanka 452 Fifth Avenue, New York, NY10018, United States 49/F, The Lee Gardens, 33 Hysan Avenue Hong Kong 4th Floor, Harbour Place 103 South Church Street George Town Grand Cayman KY1-1002 Cayman Islands 4th Floor, World Trade Center, J1, Jend. Sudirman Kav. 29-31 Jakarta 12920 Indonesia 5 Donegal Square South Belfast BT1 5JP Northern Ireland 52/60, M G Road Fort, Mumbai, Maharashtra 400 001 India 545 Washington Blvd., 11th Floor Jersey City NJ 07310 United States 6 Front Street, Hamilton HM 11, Bermuda 6, Rue Adolphe Grand-Duchy of Luxembourg L-1116 Luxembourg 64, Rue Galilée, 75008, Paris, France 66 Teryan street Yerevan 9 Armenia 6th Floor, HSBC Centre, 18, Cybercity, Ebene Mauritius 7/F The Enterprise Centre - Tower I, 6766 Ayala Avenue corner Paseo De Roxas, Makati City, Philippines 70 York Street, 7th Floor, Toronto ON, M5J 1S9 Canada 8 Canada Square, London E14 5HQ, United Kingdom 80, Mill Street, Qormi, QRM 3101, Malta 83 Des Voeux Road, Central, Hong Kong SAR 833 Three Bentall Centre, 595 Burrard Street, Vancouver BC V7X 1C4, Canada 885 West Georgia Street, Suite 300, Vancouver BC, V6C 3E9, Canada 89 Jingling Hongjian Avenue Tianmen Hubei Province 431700 China 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 9-11 Floors, NESCO IT Park Building No. 3, Western Express Highway, Goregaon (East), Mumbai, Maharashtra 400063, India 101 95 Washington Street, Buffalo NY, 14203, United States 102 9th Floor, HSBC Centre 3058 Fifth Avenue West, Bonifacio Global City Taguig City Philippines 103 Akara Bldg. 24 De Castro Street Wickhams Cay I, Road Town Tortola Virgin Islands, British 104 Al Amir Abdulaziz Ibn Mossaad Ibn Jalawi Street Riyadh Saudi Arabia 105 Al Khuwair Office PO Box 1727 PC111 CPO Seeb Muscat Oman 106 Alderflat Drive, Newstead Industrial Estate, Trentham Stoke on Trent, ST4 8HX, United Kingdom 107 Amot Atrium Tower, 30th Floor, 2 Jabotinsky St,. Ramat Gan 5250501, Israel 108 Arnold House, St Julians Avenue, St Peter Port, GY1 3NF, Guernsey 109 Bederstrasse 49, CH-8002, Zurich, Switzerland 110 Bouchard 680, 11° Ciudad de Buenos Aires 1106 Argentina 111 Bouchard 680, 9° Ciudad de Buenos Aires 1106 Argentina 112 Breite Str. 29/31 40213 Düsseldorf Germany 113 Bufete Tapia, PO Box 7412 Panama 5 Panama 114 Büyükdere Cad. No.128 D Blok Esentepe, Sisli Istanbul, Turkey 115 Büyükdere Cad. No:124 B Blok Kat 9 Oda:1, Esentepe, Sisli, I Turkey 116 Buyukdere Cad. No:124 B Blok Kat 9 Oda:2 34394 , Sisli / Ese Turkey 117 C T Corporation System 1200 South Pine Island Road Plantation FL 33324 United States 118 119 C/O Bank of Bermuda (Cayman) Limited, PO Box 513, HSBC House, 68 West Bay Road, Grand Cayman KY1-1106, Cayman Islands C/O Corporation Trust Incorporated, 351 West Camden Street, Baltimore MD 21201, United States 120 C/O Hackwood Secretaries Limited, One Silk Street, London EC2Y 8HQ, United Kingdom 121 C/O HSBC AFS (USA) LLC, 452 Fifth Avenue, New York, NY 10018, United States 122 C/O HSBC Bank (Mauritius) Limited 6th Floor, HSBC Centre, 18 Cyber City, Ebene, Mauritius 123 C/O Kross Border Trust Services Limited, St. Louis Business Centre, Cnr Desroches & St Louis Streets, Port Louis, Mauritius 124 125 126 127 128 C/O Morrison & Foerster (UK) LLP, City Point, 1 Ropemake Street, London EC2Y 9AW, United Kingdom C/O MUFG Fund Services (Bermuda) Limited The Belvedere Building 69 Pitts Bay Road Pembroke HM08 Bermuda C/O The Corporation Trust Company 100 S. 5th Street-Suite 1075 Minneapolis MN 55401 United States C/O The Corporation Trust Company, 1209 Orange Street, Wilmington DE 19801, United States C/O The Corporation Trust Incorporated 351 West Camden Street Baltimore MD 21201 United States 129 C/O Trident Trust Company, Trident Chambers, PO Box 146, Tortola, British Virgin Islands 130 C/O Walkers SPV Limited, Walker House 87 Mary Street, PO Box 908GT George Town Grand Cayman Cayman Islands 131 Camden House West, The Parade, Birmingham, B1 3PY, United Kingdom 132 City Gate House 22 Southwark Bridge Road London SE1 9HB 133 Corporation Service Company 2711 Centerville Road Suite 400 Wilmington DE 19808 United States 134 Corporation Service Company 830 Bear Tavern Road West Trenton NJ 08628 United States 135 CT Corporation System 1515 Market Street Registered Office Philadelphia PA 19102 United States 136 CT Corporation System 1720 Carey Avenue Cheyenne WY 82001 United States 137 CT Corporation System 2 North Jackson Street Suite 605 Montgomery AL 36104 United States 138 CT Corporation System 2222 Grand Avenue Des Moines IA 50312 United States 139 CT Corporation System 225 Hillsborough Street Raleigh NC 27603 United States 140 CT Corporation System Kentucky Home Life Building Louisville KY 40202 United States 141 CT Corporation System, 530 Gay Street, Knoxville, TN 37902, United States 142 CT Corporation System, 800 S. Figueroa, Los Angeles, California 90017, United States 143 144 CT Corporation System, Secretary of State, 707 Virginia Street, East Charleston, WV 25301, United States Drake House, Three Rivers Court, Homestead Road, Rickmansworth, Hertfordshire, WD3 1FX, United Kingdom 145 Ernst-Schneider-Platz 1 40212 Duesseldorf Germany 146 Esentepe Mah. Büyükdere Caddesi No.128 Istanbul 34394 Turkey 147 First & Second Floor, No.3 Nanshan Road, Pulandian Dalian Liaoning Province China 148 First Floor, Xinhua Bookstore Xindong Road (SE of roundabout) Miyun District Beijing China 149 Florida 201 10°, Ciudad de Buenos Aires C1005AAE Argentina 150 Florida 229, 10° Ciudad de Buenos Aires, C1005AAE, Argentina 151 Harneys Corporate Services Limited, Craigmuir Chambers, PO Box 71, Road Town, Tortola, British Virgin Islands 152 Herrengasse 1-3 1010 Wien Austria 153 Hill House, 1 Little New Street, London EC4A 3TR, United Kingdom 154 HSBC Bank Middle East Building - level 5, building 5, Emaar Dubai 502601 United Arab Emirates 155 HSBC Building 11-1, Nihonbashi 3-Chome Chuo-ku Tokyo 103-0027 Japan 156 HSBC Building 7267 Olaya - Al Murrooj Riyadh 12283 - 2255 Saudi Arabia 157 HSBC Building Shanghai IFC 8 Century Avenue, Pudong Shanghai 200120 China 158 HSBC Building, Minet El Hosn, Riad el Solh Beirut 1107-2080, PO Box 11-1380, Lebanon 159 HSBC Centre River Side, West Avenue, 25B Raheja woods Kalyaninagar Pune Maharashtra 411006 India 160 HSBC Centre, Eighteen Cybercity Ebene, Mauritius 161 HSBC Chambers, Corner of Jalan Sultan and Jalan Pemancha Bandar Seri Begawan BS8811 Brunei Darussalam 162 HSBC House Esplanade, St. Helier, JE1 1HS, Jersey 163 HSBC House Esplanade, St. Helier, JE4 8UB, Jersey 164 HSBC House, Level 9, One Queen Street, Auckland 1010, New Zealand 165 166 HSBC House Plot No.8, Survey No.64 (Part) Hightec City Layout Madhapur Hyderabad Andhra Pradesh 500081 India HSBC House, 68 West Bay Road, PO Box 1109, George Town, Grand Cayman KY1-1102, Cayman Islands 167 HSBC House, Esplanade, St. Helier, JE1 1GT, Jersey 168 HSBC House, Esplanade, St. Helier, JE4 8WP, Jersey HSBC, Filinvest One Bldg, Northgate Cyberzone, Filinvest Corporate City Alabang, Muntinlupa City Philippines Immeuble Coeur Défense 110, Esplanade du Général de Gaulle- La Défense 4 92400 Courbevoie France 169 170 171 Isidora Goyenechea 2800, 23rd Floor, Las Condes, Santiago 7550647, Chile 172 Jayla Place Wickhams Cay I PO Box 3190 Road Town Tortola British Virgin Islands 173 Kacyiru BP 3094 Kigali Rwanda 174 Kapelanka 42A 30-347 Krakow Poland Level 36, Tower 1, International Towers Sydney, 100 Barangaroo Avenue, Sydney, NSW 2000, Australia Level 4, Building 4, The Gate Dubai International Financial Centre PO Box 506553 Dubai United Arab Emirates 182 183 184 Lot n°5, la Rocade , Grand Camp LES ABYMES 97142 Guadeloupe 185 LR No. 1758/13 Grevella Grove Road Kalamu House PO Box 47323-00100 Nairobi Kenya 186 Maples Corporate Services Limited, PO Box 309, Ugland House, South Church Street, George Town, Grand Cayaman, KY1-1104, Cayman Islands 187 Mareva House, 4 George Street, Nassau, Bahamas MB&H Corporate Services Ltd, Mareva House, 4 George Street, Nassau, New Providence, Bahamas 188 189 MMG Tower, 23 Floor Ave. Paseo del Mar Urbanizacion Costa del Este Panama 190 No 1, Bei Huan East Road Dazu County Chongqing China 191 No 107, Ping Du Avenue (E), Sanhe Town, Fengdu County Chongqing China 192 No. 1 1211 Yanjiang Zhong Road Yongan Fujian China 193 No. 188 Yincheng Zhong Lu, Pudong New District Shanghai 200120 China 194 No. 205, Lie Shan Road Suizhou Hubei China 195 No. 3, 5, 7, Haitang Erzhi Road Changyuan, Rongchang Chongqing 402460 China 196 No. 44, Xin Ping Road Central, Encheng, Enping Guangdong 529400 China 197 No. 56, Yu Rong Street Macheng Hubei Province 438300 China 198 No.198-2, Chengshan Avenue (E) Rongcheng Shangdong 264300 China 199 Palm Grove House PO Box 438 Road Town Tortola British Virgin Islands 200 Park Place, Park Street, St Peter Port, GY1 1EE, Guernsey 201 Paseo de la Reforma 347, Col. Cuauhtemoc, 6500, Mexico 202 Paseo de la Reforma 359, 6th Floor, D.F. 6500, Mexico 203 Philippe Kaiser Baarerstrasse 8 6300 Zug Switzerland 204 Plot No. 89-90 Mbezi Industrial Area Box 347 Dar es Salaam City United Republic of Tanzania 205 PO Box 1109, HSBC House 68 West Bay Road Grand Cayman KY1-1102 Cayman Islands 206 207 PO Box 309 Ugland House, South Church Street George Town Grand Cayman KY1 - 1104 Cayman Islands PO Box 484, Ground Floor, HSBC House 68 West Bay Road Grand Cayman, KY1-1106 Cayman Islands 208 PO Box 71, Craigmuir Chambers, Road Town, Tortola, British Virgin Islands 209 PO Box 9086 Riyadh 11413 Saudi Arabia 210 Quai des Bergues 9-17, 1201, Geneva, Switzerland 211 Rincon 391 Montevideo 11000 Uruguay 212 213 RM 2112, HSBC Building, Shanghai IFC No. 8 Century Road, Pudong Shanghai 200120 China RM101, 102 & 106 Sunshine Fairview, Sunshine Garden Pedestrian Walkway Pingjiang Hunan China 214 Rondo ONZ 1 00-124 Warsaw Poland 215 Room 305 No.886 Tianhe Bei Road, Tianhe District, Guangzhou Guangdong China 216 Rua Funchal, nº 160, SP Corporate Towers, Torre Norte, 19° Andar, cj 191A - Parte, São Paulo 04551-060, Brazil 217 Second Floor, St Peters House, Le Bordage, St Peter Port, GY1 1B, Guernsey 218 Shop 4 & 5 Ground Floor & Mezzanine, Bldg. of Hilal Salim Bin Tarraf Al Wasel Area, Sheikh Zayed Road PO Box 1956 Dubai United Arab Emirates 219 Smart Village 28th Km Cairo- Alexandria Desert Road Building Cairo Egypt 220 Solidere - Rue Saad Zaghloul Immeuble - 170 Marfaa, PO Box 17, 5476 Mar Michael, 11042040 Beyrouth, Lebanon 221 St Nicholas House, 10th Floor Catholic Mission St Lagos Nigeria 222 Suite 1005, 10th Floor, Wisma Hamzah Kwong Hing No. 1, Leboh Ampang 50100, Kuala Lumpur, Malaysia 223 Suite 2400, 745 Thurlow Street, Vancouver BC V6E 0C5 Canada 224 Suite 300, 3381 Steeles Avenue East Toronto ON M2H 3S7 Canada 225 226 Suite 8-3A, Menara RA, No. 18, Jalan Dataran SD2, Dataran SD, PJU 9, Bandar Sri Damansara 52200 Wilayah Persekutuan Malaysia The Corporation Trust Company of Nevada 311 S. Division Street Carson City NV 89703 United States 227 The Metropolitan 235 Dong Khoi Street District 1, Ho Chi Minh City Viet Nam 228 The R&H Trust Co. Ltd. Windward 1, Regatta Office Park PO Box 897 Grand Cayman KY1-1103 Cayman Islands 229 Tour Crystal 1 10EME Etage BD Al Mohades 20000 Casablanca, ANFA Morocco 230 231 232 Unit 04A-04B, 1F, Bangunan Gadong Properties Jalan Gadong Bandar Seri Begawan BE4119 Brunei Darussalam Unit 1 GF The Commercial Complex Madrigal Avenue Ayala Alabang Village Muntinlupa City 1770 Philippines Unit No. 208, 2nd Floor, Kanchenjunga Building, 18 Barakhamba Road, New Delhi - 110001, India 175 Kings Meadow, Chester Business Park, Chester, Cheshire CH99 9FB, United Kingdom 233 Unsoeldstrasse 2, 80538, Munich, Germany 176 Königsallee 21/23, 40212, Düsseldorf Germany 177 Level 1, Building No. 8, Gate Village Dubai International Financial Centre PO Box 502601 United Arab Emirates 178 Level 12, HSBC Building 37, Chilpae-ro Jung-gu Seoul Korea, Republic of 179 Level 19, HSBC Building, Shanghai IFC 8 Century Avenue Pudong Shanghai China 180 Level 3 Building 4, Gate District Dubai International Financial Centre Dubai MENA United Arab Emirates 181 Level 32, HSBC Main Building 1 Queen's Road Central Hong Kong SAR Hong Kong 234 Walkers Corporate Services Limited, Walker House, 87 Mary Street, George Town, Grand Cayman KY1-9005, Cayman Islands 235 Woodbourne Hall, Road Town, PO Box 916, Tortola, British Virgin Islands 236 237 World Trade Center 1, Floor 8-9 Jalan Jenderal Sudirman Kavling 29 - 31 Jakarta 12920 Indonesia World Trade Center Montevideo Avenida Luis Alberto de Herrera 1248 Torre 1, Piso 15, Oficina 1502 Montevideo CP 11300 Uruguay 238 Yorckstraße 21 - 23, 40476, Duesseldorf, Germany HSBC Holdings plc Annual Report and Accounts 2016 273 Strategic ReportFinancial Review Corporate Governance Shareholder Information Financial Statements Shareholder information Shareholder information Fourth interim dividend for 2016 Interim dividends for 2017 2016 Annual General Meeting Earnings Releases and Interim Results Shareholder enquiries and communications Stock symbols Investor relations Where more information about HSBC is available Taxation of shares and dividends Cautionary statement regarding forward-looking statements Certain defined terms Abbreviations Page 274 274 274 274 275 276 276 276 277 279 279 280 A glossary of terms used in this Annual Report and Accounts can be found in the Investor Relations section of www.hsbc.com Fourth interim dividend for 2016 The Directors have declared a fourth interim dividend for 2016 of $0.21 per ordinary share. Information on the scrip dividend scheme and currencies in which shareholders may elect to have the cash dividend paid will be sent to shareholders on or about 8 March 2017. The timetable for the dividend is: Announcement American Depositary Shares (‘ADSs’) quoted ex-dividend in New York Shares quoted ex-dividend in London, Hong Kong, Paris and Bermuda Record date – London, Hong Kong, New York, Paris, Bermuda Mailing of Annual Report and Accounts 2016 and/or Strategic Report 2016 and dividend documentation Final date for receipt by registrars of forms of election, Investor Centre electronic instructions and revocations of standing instructions for scrip dividends Exchange rate determined for payment of dividends in sterling and Hong Kong dollars Payment date: dividend warrants, new share certificates or transaction advices and notional tax vouchers mailed and shares credited to stock accounts in CREST 1 Removals to and from the Overseas Branch register of shareholders in Hong Kong will not be permitted on this date. Footnote 21 February 2017 22 February 2017 23 February 2017 1 24 February 2017 8 March 2017 23 March 2017 27 March 2017 6 April 2017 Interim dividends for 2017 The Board has adopted a policy of paying quarterly interim dividends on ordinary shares. Under this policy it is intended to have a pattern of three equal interim dividends with a variable fourth interim dividend. It is envisaged that the first interim dividend in respect of 2017 will be $0.10 per ordinary share. Dividends are declared in US dollars and, at the election of the shareholder, paid in cash in one of, or in a combination of, US dollars, sterling and Hong Kong dollars, or, subject to the Board’s determination that a scrip dividend is to be offered in respect of that dividend, may be satisfied in whole or in part by the issue of new shares in lieu of a cash dividend. 2016 Annual General Meeting All resolutions considered at the 2016 Annual General Meeting held at 11.00am on 22 April 2016 at the Queen Elizabeth II Conference Centre, London SW1P 3EE were passed on a poll. Earnings Releases and Interim Results Earnings Releases are expected to be issued on or around 4 May 2017 and 30 October 2017. The Interim Results for the six months to 30 June 2017 are expected to be issued on 31 July 2017. 274 HSBC Holdings plc Annual Report and Accounts 2016 Shareholder enquiries and communications Enquiries Any enquiries relating to shareholdings on the share register (for example, transfers of shares, changes of name or address, lost share certificates or dividend cheques) should be sent to the Registrars at the address given below. The Registrars offer an online facility, Investor Centre, which enables shareholders to manage their shareholding electronically. Principal Register: Hong Kong Overseas Branch Register: Bermuda Overseas Branch Register: Computershare Investor Services PLC Computershare Hong Kong Investor Investors Relations Team The Pavilions Bridgwater Road Bristol BS99 6ZZ United Kingdom Telephone: +44 (0) 370 702 0137 Services Limited Rooms 1712-1716, 17th Floor Hopewell Centre 183 Queen’s Road East Hong Kong SAR HSBC Bank Bermuda Limited 6 Front Street Hamilton HM 11 Bermuda Telephone: +1 441 299 6737 Email via website: Telephone: +852 2862 8555 Email: hbbm.shareholder.services@hsbc.bm www.investorcentre.co.uk/contactus Email: hsbc.ecom@computershare.com.hk Investor Centre: www.investorcentre.co.uk Investor Centre: Investor Centre: www.investorcentre.com/hk www.investorcentre.com/bm Any enquiries relating to ADSs should be sent to the depositary: The Bank of New York Mellon Depositary Receipts PO Box 30170 College Station, TX 77842-3170 USA Telephone (US): +1 877 283 5786 Telephone (International): +1 201 680 6825 Email: shrrelations@bnymellon.com Website: www.computershare.com/us/contact/Pages/default.aspx Any enquiries relating to shares held through Euroclear France, the settlement and central depositary system for NYSE Euronext Paris, should be sent to the paying agent: HSBC France 103, avenue des Champs Elysées 75419 Paris Cedex 08 France Telephone: +33 1 40 70 22 56 Website: www.hsbc.fr If you have elected to receive general shareholder communications directly from HSBC Holdings, it is important to remember that your main contact for all matters relating to your investment remains the registered shareholder, or custodian or broker, who administers the investment on your behalf. Therefore any changes or queries relating to your personal details and holding (including any administration of it) must continue to be directed to your existing contact at your investment manager or custodian or broker. HSBC Holdings cannot guarantee dealing with matters directed to it in error. Further copies of this Annual Report and Accounts 2016 may be obtained by writing to the following departments: For those in Europe, the Middle East and Africa: For those in Asia: For those in the Americas: External Affairs HSBC Holdings plc 8 Canada Square London E14 5HQ United Kingdom Electronic communications Communications (Asia) The Hongkong and Shanghai Banking Corporation Limited 1 Queen’s Road Central Hong Kong US Communications HSBC Bank USA, N.A. 1 West 39th Street, 9th Floor New York, NY 10018 USA Shareholders may at any time choose to receive corporate communications in printed form or to receive notifications of their availability on HSBC’s website. To receive notifications of the availability of a corporate communication on HSBC’s website by email, or revoke or amend an instruction to receive such notifications by email, go to www.hsbc.com/ecomms. If you provide an email address to receive electronic communications from HSBC, we will also send notifications of your dividend entitlements by email. If you received a notification of the availability of this document on HSBC’s website and would like to receive a printed copy, or if you would like to receive future corporate communications in printed form, please write or send an email (quoting your shareholder reference number) to the appropriate Registrars at the address given above. Printed copies will be provided without charge. HSBC Holdings plc Annual Report and Accounts 2016 275 Strategic ReportFinancial Review Corporate Governance Financial Statements Shareholder Information Shareholder information Chinese translation A Chinese translation of this Annual Report and Accounts 2016 will be available upon request after 8 March 2017 from the Registrars: Computershare Hong Kong Investor Services Limited Computershare Investor Services PLC Rooms 1712-1716, 17th Floor Hopewell Centre 183 Queen’s Road East Hong Kong The Pavilions Bridgwater Road Bristol BS99 6ZZ United Kingdom Please also contact the Registrars if you wish to receive Chinese translations of future documents, or if you have received a Chinese translation of this document and do not wish to receive them in future. Stock symbols HSBC Holdings ordinary shares trade under the following stock symbols: London Stock Exchange Hong Kong Stock Exchange New York Stock Exchange (ADS) Investor relations HSBA 5 HSBC Euronext Paris Bermuda Stock Exchange HSB HSBC.BH Enquiries relating to HSBC’s strategy or operations may be directed to: Richard O’Connor, Global Head of Investor Relations Hugh Pye, Head of Investor Relations Asia-Pacific HSBC Holdings plc 8 Canada Square London E14 5HQ United Kingdom Email: investorrelations@hsbc.com The Hongkong and Shanghai Banking Corporation Limited 1 Queen’s Road Central Hong Kong Telephone: 852 2822 4908 Where more information about HSBC is available This Annual Report and Accounts 2016, and other information on HSBC, may be viewed on HSBC’s website: www.hsbc.com. Reports, statements and information that HSBC Holdings files with the Securities and Exchange Commission are available at www.sec.gov. Investors can also request hard copies of these documents upon payment of a duplicating fee by writing to the SEC at the Office of Investor Education and Advocacy, 100 F Street N.E., Washington, DC 20549-0213 or by emailing PublicInfo@sec.gov. Investors should call the Commission at (1) 202 551 8090 if they require further assistance. Investors may also obtain the reports and other information that HSBC Holdings files at www.nyse.com (telephone number (1) 212 656 3000). HM Treasury has transposed the requirements set out under CRD IV and issued the Capital Requirements Country-by-Country Reporting Regulations 2013. The legislation requires HSBC Holdings to publish additional information in respect of the year ended 31 December 2016 by 31 December 2017. This information will be available on HSBC’s website: www.hsbc.com/tax. 276 HSBC Holdings plc Annual Report and Accounts 2016 Taxation of shares and dividends Taxation – UK residents The following is a summary, under current law, of certain UK tax considerations that are likely to be material to the ownership and disposition of HSBC Holdings ordinary shares. The summary does not purport to be a comprehensive description of all the tax considerations that may be relevant to a holder of shares. In particular, the summary deals with shareholders who are resident solely in the UK for UK tax purposes and only with holders who hold the shares as investments and who are the beneficial owners of the shares, and does not address the tax treatment of certain classes of holders such as dealers in securities. Holders and prospective purchasers should consult their own advisers regarding the tax consequences of an investment in shares in light of their particular circumstances, including the effect of any national, state or local laws. Taxation of dividends Currently, no tax is withheld from dividends paid by HSBC Holdings. UK resident individuals With effect for the tax year beginning 6 April 2016, UK resident individuals are given an annual tax-free allowance of £5,000 on dividend income. To the extent that dividend income received by an individual in the relevant tax year does not exceed the allowance, a nil tax rate will apply. Dividend income in excess of this allowance will be taxed at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. UK resident companies Shareholders that are within the charge to UK corporation tax should generally be entitled to an exemption from UK corporation tax on any dividends received from HSBC Holdings. However, the exemptions are not comprehensive and are subject to anti-avoidance rules. If the conditions for exemption are not met or cease to be satisfied, or a shareholder within the charge to UK corporation tax elects for an otherwise exempt dividend to be taxable, the shareholder will be subject to UK corporation tax on dividends received from HSBC Holdings at the rate of corporation tax applicable to that shareholder. Scrip dividends Information on the taxation consequences of the HSBC Holdings scrip dividends offered in lieu of the 2015 fourth interim dividend and the first, second and third interim dividends for 2016 was set out in the Secretary’s letters to shareholders of 18 March, 3 June, 25 August and 3 November 2016. In no case was the difference between the cash dividend forgone and the market value of the scrip dividend in excess of 15% of the market value. Accordingly, for individual shareholders, the amount of the dividend income chargeable to tax, and, the acquisition price of the HSBC Holdings ordinary shares for UK capital gains tax purposes, was the cash dividend forgone. Taxation of capital gains The computation of the capital gains tax liability arising on disposals of shares in HSBC Holdings by shareholders subject to UK tax on capital gains can be complex, partly depending on whether, for example, the shares were purchased since April 1991, acquired in 1991 in exchange for shares in The Hongkong and Shanghai Banking Corporation Limited, or acquired subsequent to 1991 in exchange for shares in other companies. For capital gains tax purposes, the acquisition cost for ordinary shares is adjusted to take account of subsequent rights and capitalisation issues. Any capital gain arising on a disposal by a UK company may also be adjusted to take account of indexation allowance. If in doubt, shareholders are recommended to consult their professional advisers. Stamp duty and stamp duty reserve tax Transfers of shares by a written instrument of transfer generally will be subject to UK stamp duty at the rate of 0.5% of the consideration paid for the transfer (rounded up to the next £5), and such stamp duty is generally payable by the transferee. An agreement to transfer shares, or any interest therein, normally will give rise to a charge to stamp duty reserve tax at the rate of 0.5% of the consideration. However, provided an instrument of transfer of the shares is executed pursuant to the agreement and duly stamped before the date on which the stamp duty reserve tax becomes payable, under the current practice of UK HM Revenue and Customs (‘HMRC’) it will not be necessary to pay the stamp duty reserve tax, nor to apply for such tax to be cancelled. Stamp duty reserve tax is generally payable by the transferee. Paperless transfers of shares within CREST, the UK’s paperless share transfer system, are liable to stamp duty reserve tax at the rate of 0.5% of the consideration. In CREST transactions, the tax is calculated and payment made automatically. Deposits of shares into CREST generally will not be subject to stamp duty reserve tax, unless the transfer into CREST is itself for consideration. Following the case HSBC pursued before the European Court of Justice (Case C-569/07 HSBC Holdings plc and Vidacos Nominees Ltd v The Commissioners for HM Revenue & Customs) and a subsequent case in relation to depositary receipts, HMRC now accepts that the charge to stamp duty reserve tax at 1.5% on the issue of shares to a depositary receipt issuer or a clearance service is prohibited. Taxation – US residents The following is a summary, under current law, of the principal UK tax and US federal income tax considerations that are likely to be material to the ownership and disposition of shares or American Depositary Shares (‘ADS’s) by a holder that is a resident of the US for US federal income tax purposes (a ‘US holder’) and who is not resident in the UK for UK tax purposes. The summary does not purport to be a comprehensive description of all of the tax considerations that may be relevant to a holder of shares or ADSs. In particular, the summary deals only with US holders that hold shares or ADSs as capital assets, and does not address the tax treatment of holders that are subject to special tax rules, such as banks, tax-exempt entities, insurance companies, dealers in securities or currencies, persons that hold shares or ADSs as part of an integrated investment (including a ‘straddle’) comprised of a share or ADS and one or more other positions, and persons that own, directly or indirectly, 10% or more of the voting stock of HSBC Holdings. This discussion is based on laws, treaties, judicial decisions and regulatory interpretations in effect on the date hereof, all of which are subject to change. Holders and prospective purchasers should consult their own advisers regarding the tax consequences of an investment in shares or ADSs in light of their particular circumstances, including the effect of any national, state or local laws. Any US federal tax advice included in this Annual Report and Accounts is for informational purposes only; it was not intended or written to be used, and cannot be used, for the purpose of avoiding US federal tax penalties. Taxation of dividends Currently, no tax is withheld from dividends paid by HSBC Holdings. For US tax purposes, a US holder must include cash dividends paid on the shares or ADSs in ordinary income on the date that such holder or the ADS depositary receives them, translating dividends paid in UK pounds sterling into US dollars using the exchange rate in effect on the date of receipt. A US holder that elects to receive shares in lieu of a cash dividend must include in ordinary income the fair market value of such HSBC Holdings plc Annual Report and Accounts 2016 277 Strategic ReportFinancial Review Corporate Governance Financial Statements Shareholder Information No stamp duty will be payable on the transfer of, or agreement to transfer, an ADS, provided that the ADR and any separate instrument of transfer or written agreement to transfer remain at all times outside the UK, and provided further that any such transfer or written agreement to transfer is not executed in the UK. No stamp duty reserve tax will be payable on a transfer of, or agreement to transfer, an ADS effected by the transfer of an ADR. US backup withholding tax and information reporting Distributions made on shares or ADSs and proceeds from the sale of shares or ADSs that are paid within the US, or through certain financial intermediaries to US holders, are subject to information reporting and may be subject to a US ‘backup’ withholding tax unless, in general, the US holder complies with certain certification procedures or is a corporation or other person exempt from such withholding. Holders that are not US persons generally are not subject to information reporting or backup withholding tax, but may be required to comply with applicable certification procedures to establish that they are not US persons in order to avoid the application of such information reporting requirements or backup withholding tax to payments received within the US or through certain financial intermediaries. Shareholder information shares on the dividend payment date, and the tax basis of those shares will equal such fair market value. Subject to certain exceptions for positions that are held for less than 61 days or are hedged, and subject to a foreign corporation being considered a ‘qualified foreign corporation’ (which includes not being classified for US federal income tax purposes as a passive foreign investment company), certain dividends (‘qualified dividends’) received by an individual US holder generally will be subject to US taxation at preferential rates. Based on the company’s audited financial statements and relevant market and shareholder data, HSBC Holdings does not anticipate being classified as a passive foreign investment company. Accordingly, dividends paid on the shares or ADSs generally should be treated as qualified dividends. Taxation of capital gains Gains realised by a US holder on the sale or other disposition of shares or ADSs normally will not be subject to UK taxation unless at the time of the sale or other disposition the holder carries on a trade, profession or vocation in the UK through a branch or agency or permanent establishment and the shares or ADSs are or have been used, held or acquired for the purposes of such trade, profession, vocation, branch or agency or permanent establishment. Such gains will be included in income for US tax purposes, and will be long- term capital gains if the shares or ADSs were held for more than one year. A long- term capital gain realised by an individual US holder generally will be subject to US tax at preferential rates. Inheritance tax Shares or ADSs held by an individual whose domicile is determined to be the US for the purposes of the United States- United Kingdom Double Taxation Convention relating to estate and gift taxes (the ‘Estate Tax Treaty’) and who is not for such purposes a national of the UK will not, provided any US federal estate or gift tax chargeable has been paid, be subject to UK inheritance tax on the individual’s death or on a lifetime transfer of shares or ADSs except in certain cases where the shares or ADSs (i) are comprised in a settlement (unless, at the time of the settlement, the settlor was domiciled in the US and was not a national of the UK), (ii) are part of the business property of a UK permanent establishment of an enterprise, or (iii) pertain to a UK fixed base of an individual used for the performance of independent personal services. In such cases, the Estate Tax Treaty generally provides a credit against US federal tax liability for the amount of any tax paid in the UK in a case where the shares or ADSs are subject to both UK inheritance tax and to US federal estate or gift tax. Stamp duty and stamp duty reserve tax – ADSs If shares are transferred to a clearance service or American Depositary Receipt (‘ADR’) issuer (which will include a transfer of shares to the Depositary) under the current HMRC practice UK stamp duty and/or stamp duty reserve tax will be payable. The stamp duty or stamp duty reserve tax is generally payable on the consideration for the transfer and is payable at the aggregate rate of 1.5%. The amount of stamp duty reserve tax payable on such a transfer will be reduced by any stamp duty paid in connection with the same transfer. 278 HSBC Holdings plc Annual Report and Accounts 2016 consumer markets; expropriation, nationalisation, confiscation of assets and changes in legislation relating to foreign ownership; changes in bankruptcy legislation in the principal markets in which we operate and the consequences thereof; general changes in government policy that may significantly influence investor decisions; extraordinary government actions as a result of current market turmoil; other unfavourable political or diplomatic developments producing social instability or legal uncertainty which in turn may affect demand for our products and services; the costs, effects and outcomes of product regulatory reviews, actions or litigation, including any additional compliance requirements; and the effects of competition in the markets where we operate including increased competition from non-bank financial services companies, including securities firms. • Factors specific to HSBC, including our success in adequately identifying the risks we face, such as the incidence of loan losses or delinquency, and managing those risks (through account management, hedging and other techniques). Effective risk management depends on, among other things, our ability through stress testing and other techniques to prepare for events that cannot be captured by the statistical models it uses; and our success in addressing operational, legal and regulatory, and litigation challenges, notably compliance with the US DPA; and other risks and uncertainties we identify in ‘top and emerging risks’ on pages 64 and 67. Certain defined terms Unless the context requires otherwise, ‘HSBC Holdings’ means HSBC Holdings plc and ‘HSBC’, the ‘Group’, ‘we’, ‘us’ and ‘our’ refer to HSBC Holdings together with its subsidiaries. Within this document the Hong Kong Special Administrative Region of the People’s Republic of China is referred to as ‘Hong Kong’. When used in the terms ‘shareholders’ equity’ and ‘total shareholders’ equity’, ‘shareholders’ means holders of HSBC Holdings ordinary shares and those preference shares and capital securities issued by HSBC Holdings classified as equity. The abbreviations ‘$m’, ‘$bn’ and ‘$tn’ represent millions, billions (thousands of millions) and trillions of US dollars, respectively. Cautionary statement regarding forward-looking statements The Annual Report and Accounts 2016 contains certain forward- looking statements with respect to HSBC’s financial condition, results of operations and business. Statements that are not historical facts, including statements about HSBC’s beliefs and expectations, are forward-looking statements. Words such as ‘expects’, ‘targets’, ‘anticipates’, ‘intends’, ‘plans’, ‘believes’, ‘seeks’, ‘estimates’, ‘potential’ and ‘reasonably possible’, variations of these words and similar expressions are intended to identify forward-looking statements. These statements are based on current plans, estimates and projections, and therefore undue reliance should not be placed on them. Forward-looking statements speak only as of the date they are made. HSBC makes no commitment to revise or update any forward-looking statements to reflect events or circumstances occurring or existing after the date of any forward-looking statements. Written and/or oral forward-looking statements may also be made in the periodic reports to the US Securities and Exchange Commission, summary financial statements to shareholders, proxy statements, offering circulars and prospectuses, press releases and other written materials, and in oral statements made by HSBC’s Directors, officers or employees to third parties, including financial analysts. Forward-looking statements involve inherent risks and uncertainties. Readers are cautioned that a number of factors could cause actual results to differ, in some instances materially, from those anticipated or implied in any forward- looking statement. These include, but are not limited to: • Changes in general economic conditions in the markets in which we operate, such as continuing or deepening recessions and fluctuations in employment beyond those factored into consensus forecasts; changes in foreign exchange rates and interest rates; volatility in equity markets; lack of liquidity in wholesale funding markets; illiquidity and downward price pressure in national real estate markets; adverse changes in central banks’ policies with respect to the provision of liquidity support to financial markets; heightened market concerns over sovereign creditworthiness in over-indebted countries; adverse changes in the funding status of public or private defined benefit pensions; and consumer perception as to the continuing availability of credit and price competition in the market segments we serve. • Changes in government policy and regulation, including the monetary, interest rate and other policies of central banks and other regulatory authorities; initiatives to change the size, scope of activities and interconnectedness of financial institutions in connection with the implementation of stricter regulation of financial institutions in key markets worldwide; revised capital and liquidity benchmarks which could serve to deleverage bank balance sheets and lower returns available from the current business model and portfolio mix; imposition of levies or taxes designed to change business mix and risk appetite; the practices, pricing or responsibilities of financial institutions serving their HSBC Holdings plc Annual Report and Accounts 2016 279 Strategic ReportFinancial Review Corporate Governance Financial Statements Shareholder Information Other Information Abbreviations Currencies CA$ EGP € HK$ MXN RMB S$ $ A ABS1 ADR ADS AFS AGM AIEA ALCM ALCO AML ARM1 ARS AT1 B Barion Basel Basel II1 Basel III1 BBA BEPS BoCom BoE Bps1 BSA BSM BVI C Capm CCAR CDOs CDS1 CEA CET11 CGUs CIUs CMB CMC CML1 COSO CP1 CRD1 CRR1 CRR/CRD IV CSA CVA1 CVC D Canadian dollar Egyptian pound Euro Hong Kong dollar Mexican peso Chinese renminbi Singapore dollar United States dollar Asset-backed security American Depositary Receipt American Depositary Share Available for sale Annual General Meeting Average interest-earning assets Asset, Liability and Capital Management Asset and Liability Management Committee Anti-money laundering Adjustable-rate mortgage Argentine peso Additional tier 1 Barion Funding Limited, a term-funding vehicle Basel Committee on Banking Supervision 2006 Basel Capital Accord Basel Committee’s reforms to strengthen global capital and liquidity rules British Bankers’ Association The OECD Base Erosion and Profit Shifting initiative Bank of Communications Co., Limited, one of China’s largest banks Bank of England Basis points. One basis point is equal to one-hundredth of a percentage point Bank Secrecy Act (US) Balance Sheet Management British Virgin Islands Capital asset pricing model Federal Reserve Comprehensive Capital Analysis and Review Collaterised debt obligations Credit default swap Commodities Exchange Act (US) Common equity tier 1 Cash-generating units Collective investment undertakings Commercial Banking, a global business Capital maintenance charge Consumer and Mortgage Lending (US) 2013 Committee of the Sponsors of the Treadway Commission (US) Commercial paper Capital Requirements Directive Customer risk rating Capital Requirements Regulation and Directive Credit Support Annex Credit valuation adjustment Conduct & Values Committee Decision One Decision One Mortgage Company LLC Deferred Shares Awards of deferred shares define the number of HSBC Holdings ordinary shares to which the employee will become entitled, generally between one and three years from the date of the award, and normally subject to the individual remaining in employment 280 HSBC Holdings plc Annual Report and Accounts 2016 Dodd-Frank Dodd-Frank Wall Street Reform and Consumer Protection Act (US) DoJ DPA DPF DVA1 E EBA EC ECB ECL EL1 EU Department of Justice (US) Deferred Prosecution Agreement (US) Discretionary participation feature of insurance and investment contracts Debit valuation adjustment European Banking Authority European Commission European Central Bank Expected credit losses Expected loss European Union Euribor Euro interbank offered rate EVE F FCA FCR FFVA Economic value of equity Financial Conduct Authority (UK) Financial Crime Risk function Funding fair value adjustment estimation methodology on derivative contracts Fintech Financial technology FRB FSCS FSVC FTE FTSE FuM FOVCI FVPL G GAAP GAC GB&M GCC GDP GLCM Federal Reserve Board (US) Financial Services Compensation Scheme Financial System Vulnerabilities Committee Full-time equivalent staff Financial Times – Stock Exchange index Funds under management Fair value through other comprehensive income Fair value through profit or loss Generally accepted accounting principles Group Audit Committee Global Banking and Markets, a global business The Group Change Committee Gross domestic product Global Liquidity and Cash Management Global Markets HSBC’s capital markets services in Global Banking and Markets GMB GPB GPSP GRC Group G-SIB1 GSM GTRF H Group Management Board Global Private Banking, a global business Group Performance Share Plan Group Risk Committee HSBC Holdings together with its subsidiary undertakings Global systemically important bank The Group’s Global Standards Manual Global Trade and Receivables Finance Hang Seng Bank Hang Seng Bank Limited, one of Hong Kong’s largest HKEx HKMA HMRC HNAH banks The Stock Exchange of Hong Kong Limited Hong Kong Monetary Authority HM Revenue and Customs HSBC North America Holdings Inc. Holdings ALCO HSBC Holdings Asset and Liability Management Committee Hong Kong Hong Kong Special Administrative Region of the People’s Republic of China HQLA HSBC HSBC Bank HSBC Bank Middle East High-quality liquid assets HSBC Holdings together with its subsidiary undertakings HSBC Bank plc HSBC Bank Middle East Limited HSBC Bank USA HSBC Bank USA, N.A., HSBC’s retail bank in the US HSBC Canada The sub-group, HSBC Bank Canada, HSBC Trust Company Canada, HSBC Mortgage Corporation Canada and HSBC Securities Canada, consolidated for liquidity purposes HSBC Colombia HSBC Bank (Colombia) S.A. HSBC Finance HSBC Finance Corporation, the US consumer finance company (formerly Household International, Inc.) HSBC France HSBC’s French banking subsidiary, formerly CCF S.A. HSBC Holdings HSBC Holdings plc, the parent company of HSBC HSBC Private Bank (Suisse) HSBC Private Bank (Suisse) SA, HSBC’s private bank in Switzerland HSBC USA The sub-group, HSBC USA Inc (the holding company of HSBC Bank USA) and HSBC Bank USA, consolidated for liquidity purposes HSI HSSL HTIE HTM I IAS IASB ICAAP IFRSs ILAA ILR HSBC Securities (USA) Inc. HSBC Securities Services (Luxembourg) HSBC International Trust Services (Ireland) Limited Held to maturity International Accounting Standards International Accounting Standards Board Internal capital adequacy assessment process International Financial Reporting Standards Individual liquidity adequacy assessment Inherent liquidity risk Industrial Bank Industrial Bank Co. Limited, a national joint-stock bank in mainland China in which Hang Seng Bank Limited has a shareholding Investor Update IRB1 IRRBB The Investor Update in June 2015 Internal ratings-based Interest rate risk in the banking book ISDA K KPMG L LCR LFRF LGBT+ LGD1 Libor LICs LTI LTV1 M International Swaps and Derivatives Association KPMG Audit Plc and its affiliates Liquidity coverage ratio Liquidity and funding risk management framework Lesbian, gay, bisexual and transgender. The plus sign denotes other non-mainstream groups on the spectrums of sexual orientation and gender identity Loss given default London interbank offered rate Loan impairment charges and other credit risk provisions Long-term incentive Loan-to-value ratio Madoff Bernard L. Madoff Investment Securities LLC Mainland China People’s Republic of China excluding Hong Kong Malachite Mazarin MBS MENA MOCs Malachite Funding Limited, a term-funding vehicle Mazarin Funding Limited, an asset-backed CP conduit US mortgage-backed security Middle East and North Africa Model Oversight Committees Monoline Monoline insurance company MRT N NII NSFR NYSE O OCC OCI ORMF OTC1 P PD1 Material risk taker Net interest income Net stable funding ratio New York Stock Exchange Office of the Comptroller of the Currency (US) Other comprehensive income Operational risk management framework Over-the-counter Probability of default Performance shares1 Awards of HSBC Holdings ordinary shares under employee share plans that are subject to corporate performance conditions Ping An PPI PRA PRC Ping An Insurance (Group) Company of China, Ltd, the second-largest life insurer in the PRC Payment protection insurance Prudential Regulation Authority (UK) People’s Republic of China Principal plan HSBC Bank (UK) Pension Scheme PVIF PwC R RAS RBWM RC Repo1 Reverse repo RMBS RMM RNIV RoE Present value of in-force long-term insurance business and long-term investment contracts with DPF The member firms of the PwC network, including PricewaterhouseCoopers LLP Risk appetite statement Retail Banking and Wealth Management, a global business The Regulatory Compliance sub-function Sale and repurchase transaction Security purchased under commitments to sell Residential mortgage-backed securities Risk Management Meeting of the Group Management Board Risk not in VaR Return on equity RoRWA Return on risk-weighted assets RQFII RRCS RWA1 S SE1 SEC Renminbi qualified foreign institutional investor Reputational Risk and Client Selection team Risk-weighted asset Structured entity Securities and Exchange Commission (US) ServCo group Separately incorporated group of service companies planned in response to UK ring-fencing proposals SIC SID SME Solitaire SPE1 T T1 T2 TLAC1 TSR U UAE UK US US DPA US run-off portfolio V VaR1 VIU Securities investment conduit Senior Independent Director Small and medium-sized enterprise Solitaire Funding Limited, a special purpose entity managed by HSBC Special purpose entity Tier 1 Tier 2 Total loss-absorbing capacity Total shareholder return United Arab Emirates United Kingdom United States of America Five-year deferred prosecution agreement with the Department of Justice and others (US) Includes our CML, vehicle finance and Taxpayer Financial Services businesses and insurance, commercial, corporate and treasury activities in HSBC Finance on an IFRSs management basis Value at risk Value in use 1 A full definition is included in the glossary to the Annual Report and Accounts 2016 which is available at www.hsbc.com/investor-relations. HSBC Holdings plc Annual Report and Accounts 2016 281 Strategic ReportFinancial Review Corporate Governance Financial Statements Shareholder Information ADR Depositary The Bank of New York Mellon Depositary Receipts PO Box 30170 College Station, TX 77842-3170 USA Telephone (US): 1 877 283 5786 Telephone (International): 1 201 680 6825 Email: shrrelations@bnymellon.com Web: www.computershare.com/us/contact/ Pages/ default.aspx Paying Agent (France) HSBC France 103 avenue des Champs Elysées 75419 Paris Cedex 08 France Telephone: 33 1 40 70 22 56 Email: ost-agence-des-titres-hsbc-reims.hbfr-do@hsbc.fr Web: www.hsbc.fr STOCKBROKERS Goldman Sachs International Peterborough Court 133 Fleet Street London EC4A 2BB United Kingdom Credit Suisse Securities (Europe) Limited 1 Cabot Square London E14 4QT United Kingdom HSBC Bank plc 8 Canada Square London E14 5HQ United Kingdom Other Information HSBC HOLDINGS PLC Incorporated in England on 1 January 1959 with limited liability under the UK Companies Act Registered in England: number 617987 REGISTERED OFFICE AND GROUP HEAD OFFICE 8 Canada Square London E14 5HQ United Kingdom Telephone: 44 020 7991 8888 Facsimile: 44 020 7992 4880 Web: www.hsbc.com REGISTRARS Principal Register Computershare Investor Services PLC The Pavilions Bridgwater Road Bristol BS99 6ZZ United Kingdom Telephone: 44 0370 702 0137 Email: via website Web: www.investorcentre.co.uk/contactus Hong Kong Overseas Branch Register Computershare Hong Kong Investor Services Limited Rooms 1712-1716, 17th floor Hopewell Centre 183 Queen’s Road East Hong Kong Telephone: 852 2862 8555 Email: hsbc.ecom@computershare.com.hk Web: www.computershare.com/hk/investors Bermuda Overseas Branch Register Investor Relations Team HSBC Bank Bermuda Limited 6 Front Street Hamilton HM11 Bermuda Telephone: 1 441 299 6737 Email: hbbm.shareholder.services@hsbc.bm Web: www.computershare.com/investor/bm 282 HSBC Holdings plc Annual Report and Accounts 2016 Photography Cover: courtesy of Dragages-China Harbour-VSL JV Inside front cover: Huynh Nguyen Minh Thu, HSBC Bank (Vietnam) Ltd Pages 2–3, 10–11, 12–13, 18–19, 20–21, 26–27: Getty Images Pages 4 (Group Chairman), 7 (Group Chief Executive), 22–23: Charles Best Pages 133–137: Directors by Charles Best, except Laura Cha and Paul Walsh by Patrick Leung Inside back cover: Nurwata Yuda Pradana, The Hongkong and Shanghai Banking Corporation Limited, Indonesia © Copyright HSBC Holdings plc 2017 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of HSBC Holdings plc. Published by Global Finance, HSBC Holdings plc, London Designed by Addison Group, London (Strategic Report) and by Global Finance with Addison Group (rest of Annual Report and Accounts) Printed by Park Communications Limited, London, on Revive 100 Offset board and paper using vegetable oil-based inks. Made in Austria, the stocks comprise 100% de-inked post-consumer waste. Pulps used are totally chlorine-free. The FSC® logo identifies products which contain wood from well- managed forests certified in accordance with the rules of the Forest Stewardship Council®. HSBC Holdings plc 8 Canada Square London E14 5HQ United Kingdom Telephone: 44 020 7991 8888 www.hsbc.com

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