IFRS 12 paras 20, 21, B12, B16, IAS 28 paras 40-43, disclosure on associates, and details of impairment review

HSBC Holdings plc – Annual report – 31 December 2017

Industry: banking

17 Interests in associates and joint ventures

Associates

At 31 December 2017, the carrying amount of HSBC’s interests in associates was $22,577m (2016: $19,874m).

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A list of all associates and joint ventures is set out on page 258. 

Bank of Communications Co., Limited

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. Under this programme, a number of HSBC staff have been seconded to assist in the maintenance of BoCom’s financial and operating policies.

Impairment testing

At 31 December 2017, the fair value of HSBC’s investment in BoCom had been below the carrying amount for approximately 68 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 2017.

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Basis of recoverable amount

The impairment test was performed by comparing the recoverable amount of BoCom, determined by a value in use (‘VIU’) calculation, with its carrying amount. The VIU calculation uses discounted cash flow projections based on management’s estimates of earnings. Cash flows beyond the short to medium term are extrapolated in perpetuity using a long-term growth rate to derive a terminal value, which comprises the majority of VIU. 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 minimum regulatory capital requirements. An increase in the CMC as a result of a change to these principal inputs would reduce VIU. Additionally, management considers other factors (including qualitative factors) to ensure that the inputs to the VIU calculation remain appropriate. Significant management judgement is required in estimating the future cash flows of BoCom.

Key assumptions in value in use calculation

We used a number of assumptions in our VIU calculation:

  • Long-term profit growth rate of 3% (2016: 5%) for periods after 2020, which does not exceed forecast GDP growth in mainland China and is within the range forecast by external analysts.
  • Long-term asset growth rate of 3% (2016: 4%) for periods after 2020, which is the rate that assets are expected to grow to achieve long-term profit growth of 3%.
  • Discount rate of 11.85% (2016: 13.0%), which is based on 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. The discount rate used was within the range of 10.2% to 13.4% (2016: 10.2% to 15.0%) indicated by external sources.
  • Loan impairment charge as a percentage of customer advances: a range from 0.66% to 0.82% (2016: 0.72% to 0.87%) in the short to medium term, largely based on forecasts disclosed by external analysts. For periods after 2020, the ratio is 0.70% (2016: 0.70%), slightly higher than the historical average.
  • Risk-weighted assets as a percentage of total assets: 62% (2016: 62%) for all forecast periods. This is consistent with the forecasts disclosed by external analysts.
  • Cost-income ratio: ranges from 37.1% to 38.0% (2016: 40.0%) in the short to medium term. This is slightly higher than the forecasts disclosed by external analysts.

The long-term profit growth rate, long-term asset growth rate and discount rate assumptions were updated in 2017 to better align with market practice when setting long-term assumptions in VIU calculations. The long-term profit growth rate was set at the lower end of the range forecast by external analysts and there was a corresponding change to the long-term asset growth rate. These changes reduced management’s uncertainty in respect of estimated future cash flows and accordingly the discount rate was set based on CAPM with no adjustment for uncertainty in future cash flows.

The following table shows the change to each key assumption in the VIU calculation that on its own would reduce the headroom to nil.

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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. The selected rates of reasonably possible changes to key assumptions is largely based on external analysts’ forecasts which can change period to period.

 

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Considering the interrelationship of the changes set out in the table above, management estimates that the reasonably possible range of VIU is $14.7bn to $21.1bn (2016: $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 2017, HSBC included the associate’s results on the basis of financial statements for the 12 months ended 30 September 2017, taking into account changes in the subsequent period from 1 October 2017 to 31 December 2017 that would have materially affected the results.

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