Brexit and other economic and political risks, banking

HSBC Holdings plc – Annual report – 31 December 2017

Industry: banking

Report of the Directors (extract)

Risk (extract)

Top and emerging risks (extract 1)

Our approach to identifying and monitoring top and emerging risks is described on page 69. During 2017, there have been a number of developments in our top and emerging risks analysis to reflect our assessment of the issues facing HSBC. Our current top and emerging risks are as follows.

Externally driven

Economic outlook and capital flows

Although global economic activity strengthened in 2017, growth was weak in many countries and headwinds remain in both developed and emerging economies. Global central banks have initiated a gradual tightening of monetary policy that will likely continue into 2018. Sharper than expected interest rate rises, or economic and/or geopolitical shocks, could lead to an increase in capital flows volatility, especially for emerging markets, potentially impacting economic growth.

Protectionism is on the rise in many parts of the world, driven by both populist sentiment and structural challenges facing developed economies. This rise could contribute to weaker global trade, potentially affecting HSBC’s traditional lines of business.

The ongoing uncertainty regarding the terms of the UK’s exit from the EU, the UK’s future relationship with the EU, and its trading relationship with the rest of the world, may lead to market volatility, which could affect both the Group and its customers.

The level of indebtedness in mainland China remains high. Any policy action to restrain credit growth could have wider ramifications for regional and global economic growth, trade and capital flows.

Increased tensions in the Middle East may have significant regional economic and political consequences which could impact the Group’s operations within the region.

Oil prices have staged a partial recovery since mid-2017, returning to levels last seen in late 2014. Nevertheless, certain producers, exporters and oil services companies are still under financial strain, which could negatively affect their investment budgets and thus business prospects for HSBC.

Mitigating actions

  • We actively assess the impact of economic developments in key markets on specific customer segments and portfolios and take appropriate mitigating actions. These actions include revising risk appetite and/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. Our approach to stress testing is described on page 69.
  • We have carried out detailed reviews and stress tests of our wholesale credit and trading portfolios to determine those sectors and customers most vulnerable to the UK’s exit from the EU, in order to proactively manage and mitigate this risk.

Geopolitical risk

Our operations and portfolios are exposed to risks associated with political instability, civil unrest and military conflict, which could lead to disruption to our operations, physical risk to our staff and/or physical damage to our assets. In addition, rising protectionism and the increasing trend of using trade and investment policies as diplomatic tools may also adversely affect global trade flows.

Geopolitical risk remained heightened throughout 2017. While elections across the EU during 2017 have temporarily stemmed a populist tide, political uncertainty remains high in the UK as negotiations progress towards an exit from the EU (see ‘Process of UK withdrawal from the European Union’ in Areas of special interest on page 66). In addition, the threat of terrorism within the region remains high.

In the Middle East, a number of countries severed diplomatic and transport ties with Qatar, a leading exporter of liquefied natural gas and a significant global investor. Further sanctions may be imposed on Iran outside the guidelines laid out in the Joint Comprehensive Plan of Action, which was decertified, rather than dismantled, by the Trump administration. The tensions between Saudi Arabia, the US and Iran may remain.

In Asia, tensions continue to rise between North Korea and the US as a result of North Korean progress in its missile and nuclear programmes. The stronger Chinese enforcement of UN sanctions on North Korea may not halt further missile and nuclear tests. Any escalation could have a significant impact on regional and global trade.

Mitigating actions

  • We continually monitor the geopolitical outlook, in particular in countries where we have material exposures and/or a physical presence. We have also established dedicated forums to monitor geopolitical developments.
  • We use internal stress tests and scenario analysis as well as regulatory stress test programmes, to adjust limits and exposures to reflect our risk appetite and mitigate risks as appropriate. Our internal credit risk ratings of sovereign counterparties take into account geopolitical developments that could potentially disrupt our portfolios and businesses.
  • Contingency planning for the UK’s exit from the EU continues and we are assessing the potential impact on our portfolios, operations and staff.
  • We have taken steps to enhance physical security in those geographical areas deemed to be at high risk from terrorism and military conflicts.

Top and emerging risks (extract 2)

Impact of organisational change and regulatory demands on employees

Our success in delivering the Group’s strategic priorities, as well as significant regulatory change programmes, depends in part on the retention of key members of our management team and wider employee base. The ability to continue to attract, train, motivate and retain highly qualified professionals in an employment market where expertise is often mobile and in short supply is critical. This may depend on factors beyond our control, including economic, market and regulatory conditions. In addition, the impact of the UK’s exit from the EU on our employees and the scale of the resultant organisational change is yet to be fully understood.

Mitigating actions

  • 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, development and extensive relocation support to existing employees in the UK ring-fenced bank.
  • Through dedicated work streams, we continue to develop succession plans using a broad array of talent-sourcing channels for key management roles, which are reviewed on a regular basis.
  • Contingency planning to address the potential impacts of the UK’s exit from the EU on our staff is underway with regular updates provided to the UK authorities.

Top and emerging risks (extract 3)

Areas of special interest

During 2017, we considered a number of areas because of the effect they may have on the Group. While these areas have been identified and considered as part of our top and emerging risks, we have placed particular focus on the UK withdrawal from the European Union in this section. 

Process of UK withdrawal from the European Union

The UK is due to formally leave the EU in March 2019. Before this can happen, the UK and the EU have to finalise the Article 50 Withdrawal Agreement, which will then need to be approved by their respective Parliaments. Concluding negotiations on a comprehensive trade deal within this time frame could be challenging. A period of transition is therefore possible but the scope and length of any such arrangement would need to be agreed between the UK and the EU. Uncertainty therefore continues and with it the risk of significant market volatility.

Our objective in all scenarios is to continue to meet customers’ needs and minimise disruption. This is likely to require adjustments to our cross-border banking model, with impacted business transferring from the UK to our existing subsidiary in France or other European subsidiaries, as appropriate.

Given the tight time frame and the complexity of the negotiations, we have put in place a robust contingency plan. It is based on a scenario whereby the UK exits the EU in March 2019, without access to the single market or customs union, and without a transitional arrangement. When negotiation positions and timelines become clearer, we will update our contingency plan.