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 2021

Industry: banking

18 Interests in associates and joint ventures

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

A list of all associates and joint ventures is set out in Note 38.

Bank of Communications Co., Limited

The Group’s investment in Bank of Communications Co., Limited (‘BoCom’) is classified as an associate. Significant influence in BoCom was established with consideration of all relevant factors, including representation on BoCom’s Board of Directors and participation in a resource and experience sharing agreement (‘RES’). Under the RES, HSBC staff have been seconded to assist in the maintenance of BoCom’s financial and operating policies. Investments in associates are recognised using the equity method of accounting in accordance with IAS 28, whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the Group’s share of BoCom’s net assets. An impairment test is required if there is any indication of impairment.

Impairment testing

At 31 December 2021, the fair value of the Group’s investment in BoCom had been below the carrying amount for approximately 10 years. As a result, the Group performed an impairment test on the carrying amount, which confirmed that there was no impairment at 31 December 2021 as the recoverable amount as determined by a value-in-use (‘VIU’) calculation was higher than the carrying value.

Compared with 31 December 2020, the extent to which the VIU exceeds the carrying value (‘headroom’) increased by $0.6bn. The increase in headroom was principally due to the impact on the VIU from BoCom’s actual performance, which was better than earlier estimates, revisions to management’s best estimates of BoCom’s future earnings in the short to medium term, and the net impact of revisions to certain long-term assumptions.

In future periods, the VIU may increase or decrease depending on the effect of changes to model inputs. The main model inputs are described below and are based on factors observed at period-end. The factors that could result in a change in the VIU and an impairment include a short-term underperformance by BoCom, a change in regulatory capital requirements or an increase in uncertainty regarding the future performance of BoCom resulting in a downgrade of the forecast of future asset growth or profitability. An increase in the discount rate could also result in a reduction of VIU and an impairment. At the point where the carrying value exceeds the VIU, impairment would be recognised.

If the Group did not have significant influence in BoCom, the investment would be carried at fair value rather than the current carrying value.

Basis of recoverable amount

The impairment test was performed by comparing the recoverable amount of BoCom, determined by a VIU calculation, with its carrying amount. The VIU calculation uses discounted cash flow projections based on management’s best estimates of future earnings available to ordinary shareholders prepared in accordance with IAS 36. Significant management judgement is required in arriving at the best estimate.

There are two main components to the VIU calculation. The first component is management’s best estimate of BoCom’s earnings, which is based on explicit forecasts over the short to medium term. This results in forecast earnings growth that is lower than recent historical actual growth and also reflects the uncertainty arising from the current economic outlook. Reflecting management’s intent to continue to retain its investment, earnings beyond the short to medium term are then extrapolated into perpetuity using a long-term growth rate to derive a terminal value, which comprises the majority of the VIU. The second component is the capital maintenance charge (‘CMC’), which is management’s forecast of the earnings that need to be withheld in order for BoCom to meet capital requirements over the forecast period, meaning that CMC is deducted when arriving at management’s estimate of future earnings available to ordinary shareholders. The principal inputs to the CMC calculation include estimates of asset growth, the ratio of risk-weighted assets to total assets and the expected capital requirements. An increase in the CMC as a result of a change to these principal inputs would reduce VIU. Additionally, management considers other qualitative factors, to ensure that the inputs to the VIU calculation remain appropriate.

Key assumptions in value-in-use calculation

We used a number of assumptions in our VIU calculation, in accordance with the requirements of IAS 36:

  • Long-term profit growth rate: 3% (2020: 3%) for periods after 2025, which does not exceed forecast GDP growth in mainland China and is consistent with forecasts by external analysts.
  • Long-term asset growth rate: 3% (2020: 3%) for periods after 2025, which is the rate that assets are expected to grow to achieve long-term profit growth of 3%.
  • Discount rate: 10.03% (2020: 11.37%) based on a capital asset pricing model (‘CAPM’), using market data. The discount rate used is within the range of 8.7% to 10.1% (2020 equivalent range: 10.9% to 11.9%) indicated by the CAPM. The lower rate reflects the impact of a relative reduction in the volatility of Chinese banks’ equity prices and a decrease in mainland China’s credit risk due to its relatively quick recovery from the impact of the Covid-19 outbreak. While the CAPM range sits at the lower end of the range adopted by selected external analysts of 9.9% to 13.5% (2020: 10.3% to 15.0%), we continue to regard the CAPM range as the most appropriate basis for determining this assumption.
  • Expected credit losses as a percentage of customer advances (‘ECL’): ranges from 0.98% to 1.12% (2020: 0.98% to 1.22%) in the short to medium term, reflecting reported credit experience through the ongoing Covid-19 pandemic in mainland China followed by an expected reversion to recent historical levels. For periods after 2025, the ratio is 0.97% (2020: 0.88%), which is higher than BoCom’s average ECL in recent years prior to the Covid-19 outbreak.
  • Risk-weighted assets as a percentage of total assets: ranges from 61.0% to 62.4% (2020: 61.0% to 62.0%) in the short to medium term, reflecting reductions that may arise from a subsequent lowering of ECL and a continuation of the trend of strong retail loan growth. For periods after 2025, the ratio is 61.0% (2020: 61.0%). These rates are similar to BoCom’s actual results in recent years and forecasts disclosed by external analysts.
  • Operating income growth rate: ranges from 5.1% to 6.2% (2020: 3.5% to 6.7%) in the short to medium term, and is lower than BoCom’s actual results in recent years and the forecasts disclosed by external analysts, reflecting BoCom’s most recent actual results, global trade tensions and industry developments in mainland China.
  • Cost-income ratio: ranges from 35.5% to 36.1% (2020: 36.3% to 36.8%) in the short to medium term. These ratios are similar to BoCom’s actual results in recent years and forecasts disclosed by external analysts.
  • Effective tax rate (‘ETR’): ranges from 6.8% to 15.0% (2020: 7.8% to 16.5%) in the short to medium term, reflecting BoCom’s actual results and an expected increase towards the long-term assumption through the forecast period. For periods after 2025, the rate is 15.0% (2020: 16.8%), which is higher than the recent historical average, and aligned to the minimum tax rate as proposed by the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting.
  • Capital requirements: capital adequacy ratio (‘CAR’) of 12.5% (2020: 11.5%) and tier 1 capital adequacy ratio of 9.5% (2020: 9.5%), based on BoCom’s capital risk appetite and capital requirements respectively. The CAR assumption was updated to 12.5% from 11.5% following the approval of BoCom’s capital management plan in March 2021.

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

The following table further illustrates the impact 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 may occur at the same time. The selected rates of reasonably possible changes to key assumptions are largely based on external analysts’ forecasts, which can change period to period.

1 The reasonably possible ranges of the long-term profit growth rate and long-term asset growth rate assumptions reflect the close relationship between these assumptions, which would result in offsetting changes to each assumption.

2 The unfavourable change in the reasonably possible ranges of the discount rate assumption reflects the impact of adopting the average of the rates adopted by selected external analysts.

Considering the interrelationship of the changes set out in the table above, management estimates that the reasonably possible range of VIU is $19.0bn to $29.3bn (2020 equivalent range: $17.2bn to $25.7bn). The range is based on impacts set out in the table above arising from the favourable/unfavourable change in the earnings in the short to medium term, the long-term expected credit losses as a percentage of customer advances, and a 50bps increase/decrease in the discount rate. The discount rate has been included this year, reflecting the relative materiality of movements in this assumption. All other long-term assumptions and the basis of the CMC have been kept unchanged when determining the reasonably possible range of the VIU.

Selected financial information of BoCom

The statutory accounting reference date of BoCom is 31 December. For the year ended 31 December 2021, HSBC included the associate’s results on the basis of the financial statements for the 12 months ended 30 September 2021, taking into account changes in the subsequent period from 1 October 2021 to 31 December 2021 that would have materially affected the results.

The Saudi British Bank

The Group’s investment in The Saudi British Bank (‘SABB’) is classified as an associate. HSBC is the largest shareholder in SABB with a shareholding of 31%. Significant influence in SABB is established via representation on the Board of Directors. Investments in associates are recognised using the equity method of accounting in accordance with IAS 28, as described previously for BoCom.

Impairment testing

There were no indicators of impairment at 31 December 2021. The fair value of the Group’s investment in SABB of $5.6bn was above the carrying amount of $4.4bn.