57HB Hsbc Frn Var3

TIDM57HB

RNS Number : 0769A

Hongkong & Shanghai Banking Corp Ld

21 March 2017

   1    Basis of preparation and significant accounting policies 
   a    Basis of preparation 
   (i)    Compliance with Hong Kong Financial Reporting Standards 

The consolidated financial statements of The Hongkong and Shanghai Banking Corporation Limited ('the Bank') and its subsidiaries (together 'the group') have been prepared in accordance with Hong Kong Financial Reporting Standards ('HKFRSs') as issued by the Hong Kong Institute of Certified Public Accountants ('HKICPA')

and accounting principles generally accepted in Hong Kong. These financial statements also comply with

the requirements of the Hong Kong Companies Ordinance (Cap. 622) which are applicable to the preparation of financial statements.

Standards adopted during the year ended 31 December 2016

There were no new standards applied during the year ended 31 December 2016. During 2016, the group adopted

a number of amendments to standards which had an insignificant effect on the consolidated financial statements

of the group.

   (ii)   Future accounting developments 

Minor amendments to HKFRSs

The group has not early applied any of the amendments effective after 31 December 2016 and it expects they will have an insignificant effect, when applied, on the consolidated financial statements of the group.

Major new HKFRSs

The HKICPA has published HKFRS 9 'Financial Instruments', HKFRS 15 'Revenue from Contracts with Customers' and HKFRS 16 'Leases'.

HKFRS 9 'Financial Instruments'

In September 2014, the HKICPA issued HKFRS 9 'Financial Instruments', which is the comprehensive standard

to replace HKAS 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 (i.e 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 HKAS 39. However, based on an assessment of financial assets performed to date and expectations around changes to balance sheet composition, the group 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. The impact of this change is not expected to

be significant.

   1    Basis of preparation and significant accounting policies (continued) 

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 12-month ECL is recognised are considered to be 'stage 1'; financial assets which 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 which is 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 HKAS 39 and the resulting impairment charge will tend to be more volatile. It 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 HKAS 39.

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, but do not explicitly address macro hedge accounting strategies, which are particularly important for banks. As a result, HKFRS 9 includes an accounting policy choice to remain with HKAS 39 hedge accounting.

Based on the analysis performed to date, the group expects to exercise the accounting policy choice to continue HKAS 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 HKFRS 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. The group 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. If this presentation was applied at 31 December 2016, the effect would be to decrease profit before tax with the opposite effect on other comprehensive income based on the change in fair value attributable to changes in the group'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 the group's credit risk, is disclosed in note 21. The group is assessing the impact that the impairment requirements will have on the financial statements.

The group intends to quantify the potential impact of HKFRS 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.

   1    Basis of preparation and significant accounting policies (continued) 

HKFRS 15 'Revenue from Contracts with Customers'

In July 2014, the HKICPA issued HKFRS 15 'Revenue from Contracts with Customers'. The original effective date of HKFRS 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. HKFRS 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. The group has assessed the impact of HKFRS 15 and it expects that the standard will have no significant effect, when applied, on the consolidated financial statements of the group.

HKFRS 16 'Leases'

In May 2016, the HKICPA issued HKFRS 16 'Leases' with an effective date of annual periods beginning on or after 1 January 2019. HKFRS 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 HKAS 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 in HKAS 17. The group is currently assessing the impact of HKFRS 16 and it is not practicable to quantify the effect as at the date of the publication of these financial statements. Existing operating lease commitments are set out in note 35.

(iii) Foreign currencies

Items included in each of the group's entities are measured using the currency of the primary economic environment in which the entity operates (the 'functional currency'). The group's consolidated financial statements are presented in Hong Kong dollars.

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 Hong Kong 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.

(iv) Presentation of information

Certain disclosures required by HKFRSs have been included in the audited sections of the Annual Report and Accounts as follows:

-- Disclosures concerning the nature and extent of risks relating to banking and insurance activities are included in the 'Risk Report' on pages 15 to 49.

   --    Capital disclosures are included in the 'Capital' section on page 50. 

In accordance with the group's policy to provide disclosures that help other stakeholders to understand the group's performance, financial position and changes thereto, the information provided in the Notes on the Financial Statements, the Risk Report and the Capital section goes beyond the minimum levels required by accounting standards, statutory and regulatory requirements. In addition, the group 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.

   1    Basis of preparation and significant accounting policies (continued) 
   (v)    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 note 1(b) 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 the 2016 Financial Statements. Management's selection of the group'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.

(vi) Segmental analysis

The group's chief operating decision-maker is the Executive Committee 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 Executive Committee.

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.

   (vii)   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, capital resources and risks facing the group including those associated with the Deferred Prosecution Agreement as described in note 43.

   b    Summary of significant accounting policies 
   (i)   Consolidation and related policies 

Investments in subsidiaries

Where an entity is governed by voting rights, the group 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.

The Bank's investments in subsidiaries are stated at cost less impairment losses.

Goodwill

Goodwill is allocated to cash-generating units for the purpose of impairment testing. Impairment testing is performed at least annually, or whenever there is an indication of impairment.

Interests in associates

The group classifies investments in entities over which it has significant influence, and that are neither subsidiaries nor joint arrangements, as associates.

Investments in associates are recognised using the equity method. The attributable share of the results and reserves of associates are included in the consolidated financial statements of the group 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 of financial statements available and 31 December.

   1    Basis of preparation and significant accounting policies (continued) 

Investments in associates 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 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 ('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 15. 
---------------------------------------------------- 
 
   (ii)   Income and expenses 

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 the group 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 the group 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 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 the group 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(b)(vi).

   1    Basis of preparation and significant accounting policies (continued) 

(iii) 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, the group 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 the group enters into an offsetting transaction.

The fair value of financial instruments is generally measured on an individual basis. However, in cases where the group 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 HKFRSs offsetting criteria.

 
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, 
 where the measurement of fair value is more 
 judgemental. 
------------------------------------------------------ 
 

(iv) 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 for some leveraged finance and syndicated lending activities, the difference is deferred and recognised over the life of the loan (as described in paragraph (iii) above) through the recognition of interest income, unless the loan becomes impaired.

The group may commit to underwrite 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 the group intends to hold the loan, a provision on the loan commitment is only recorded where it is probable that the group 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, the group 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.

   1    Basis of preparation and significant accounting policies (continued) 

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 the group has incurred as a result of events occurring before the balance sheet date which the group 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 that are used to calculate collective allowances are:

-- When appropriate empirical information is available, the group 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 through 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, the group 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 explicitly estimated by local management, and is typically between six and twelve months.

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.

   1    Basis of preparation and significant accounting policies (continued) 

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' and reported in 'Other assets'.

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 have 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 determine 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. 
 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.

   1    Basis of preparation and significant accounting policies (continued) 
   (v)    Financial instruments measured at fair value 

Available-for-sale financial assets

Available-for sale financial assets are recognised on the trade date when the groupenters into contractual arrangements to purchase those instruments, and are normally derecognised when either the securities are 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, the group 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. Under this criterion, the main classes of financial instruments designated by the group 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.

   1    Basis of preparation and significant accounting policies (continued) 

Financial assets and financial liabilities under unit-linked and non-linked investment contracts

A contract under which the group 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(b)(vi) for investment contracts with DPF and contracts where the group 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 standalone 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 from financial instruments designated at fair value' together with the gains and losses on the economically hedged items. Where the derivatives are managed with debt securities issued by the group 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. The group 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.

   1    Basis of preparation and significant accounting policies (continued) 

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, 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.

(vi) Insurance contracts

A contract is classified as an insurance contract where the group 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, the group issues investment contracts with discretionary participation features which are also accounted for as insurance contracts as required by HKFRS 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.

   1    Basis of preparation and significant accounting policies (continued) 

Future profit participation on insurance contracts with Discretionary Participation Features ('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. This benefit may arise from 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 HKFRS 4. The group therefore recognises the premiums for those contracts as revenue and recognises as an expense the resulting increase in the carrying amount of the liability.

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

The value placed on insurance contracts that are classified as long-term insurance business or long-term investment contracts with DPF and are in force at the balance sheet date is recognised as an asset. The asset represents the present value of the equity holders' interest in the issuing insurance companies' profits expected to emerge from these contracts written at the balance sheet date. The PVIF 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.

 
Critical accounting estimates and judgements 
----------------------------------------------------- 
The value of PVIF depends upon assumptions regarding 
 future events. The 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 assumptions are reassessed at 
 each reporting date and changes in the estimates 
 which affect the value of PVIF are reflected 
 in the income statement. 
----------------------------------------------------- 
 

(vii) Property

Land and buildings

Land and buildings held for own use are carried at their revalued amount, being the fair value at the date of the revaluation less any subsequent accumulated depreciation and impairment losses.

Revaluations are performed by professional qualified valuers, on a market basis, with sufficient regularity to ensure that the net carrying amount does not differ materially from the fair value. Surpluses arising on revaluation are credited firstly to the income statement, to the extent of any deficits arising on revaluation previously charged to

the income statement in respect of the same land and buildings, and are thereafter taken to the 'Property

revaluation reserve'. Deficits arising on revaluation are first set off against any previous revaluation surpluses included in the 'Property revaluation reserve' in respect of the same land and buildings, and are thereafter recognised in the income statement.

   1    Basis of preparation and significant accounting policies (continued) 

Buildings held for own use which are situated on leasehold land where it is possible to reliably separate the value of the building from the value of the leasehold land at inception of the lease are revalued by professional qualified valuers, on a depreciated replacement cost basis or surrender value, with sufficient regularity to ensure that the net carrying amount does not differ materially from the fair value.

Leasehold land and buildings are depreciated over the shorter of the unexpired terms of the leases or the remaining useful lives.

The Government of Hong Kong owns all the land in Hong Kong and permits its use under leasehold arrangements. Similar arrangements exist in mainland China. At inception of the lease, where the cost of land is known or can be reliably determined and the term of the lease is not less than 50 years, the group records its interests in leasehold land and land use rights as land and buildings held for own use. Where the term is less than 50 years, the group records its interests as operating leases.

Where the cost of the land is unknown or cannot be reliably determined, and the leasehold land and land use rights are not clearly held under an operating lease, they are accounted for as land and buildings held for own use.

Investment properties

The group holds certain properties as investments to earn rentals or for capital appreciation, or both, and those investment properties are included on balance sheet at fair value with changes in fair value being recognised in the income statement.

(viii) Employee compensation and benefits

Post-employment benefit plans

The group 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.

(ix) 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 it is recognised in the same statement in which 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. The group 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.

   1    Basis of preparation and significant accounting policies (continued) 
   (x)   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 which has arisen as a result of past events and for which a reliable estimate can be made.

 
Critical accounting estimates and judgements 
------------------------------------------------------- 
Provisions 
 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. 
------------------------------------------------------- 
 

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.

The Bank has issued financial guarantees and similar contracts to other group entities. The groupelects to account for certain guarantees

as insurance contracts in the Bank 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.

`

This information is provided by RNS

The company news service from the London Stock Exchange

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March 21, 2017 07:52 ET (11:52 GMT)