HSBC 2009 Annual Report Download - page 288

HSBC HOLDINGS PLC
Report of the Directors: Risk (continued)
Capital management and allocation > Capital measurement and allocation
286
financial system during the past two years have been
used to inform the capital planning process and
further develop the stress scenarios employed by the
Group.
The responsibility for global capital allocation
principles and decisions rests with GMB. Through
its structured internal governance processes, HSBC
maintains discipline over its investment and capital
allocation decisions and seeking to ensure that
returns on investment are adequate after taking
account of capital costs. HSBC’s strategy is to
allocate capital to businesses on the basis of their
economic profit generation, regulatory and economic
capital requirements and cost of capital.
HSBC’s capital management process is
articulated in an annual Group capital plan which is
approved by the Board. The plan is drawn up with
the objective of maintaining both the appropriate
amount of capital and the optimal mix between the
different components of capital. When HSBC
Holdings and its major subsidiaries raise non-equity
tier 1 capital and subordinated debt, this is done in
accordance with the Group’s guidelines on market
and investor concentration, cost, market conditions,
timing, effect on composition and maturity profile.
Each subsidiary manages its own capital to support
its planned business growth and meet its local
regulatory requirements within the context of the
approved annual Group capital plan. In accordance
with HSBC’s Capital Management Framework,
capital generated by subsidiaries in excess of
planned requirements is returned to HSBC Holdings,
normally by way of dividends.
HSBC Holdings is primarily the provider of
equity capital to its subsidiaries and 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 that of its
investment in subsidiaries.
During 2009, the Group targeted a tier 1 ratio
within the range 7.5 to 10.0 per cent for the purposes
of its long-term capital planning. This was an
increase on the 2008 range of 7.5 to 9.0 per cent, and
reflected revised market expectations on capital
strength and the higher volatility of capital
requirements which resulted from pro-cyclicality
embedded within the Basel II rules. The tier 1 ratio
increased to 10.8 per cent at 31 December 2009
(2008: 8.3 per cent) and notwithstanding that this
lies outside the target range noted above, HSBC is
satisfied that, in light of the current evolution of the
regulatory framework, this is appropriate.
Capital measurement and allocation
The FSA supervises HSBC on a consolidated basis
and therefore receives information on the capital
adequacy of, and sets capital requirements for, the
Group as a whole. Individual banking subsidiaries
are directly regulated by their local banking
supervisors, who set and monitor their capital
adequacy requirements.
HSBC calculates capital at a Group level using
the Basel II framework of the Basel Committee on
Banking Supervision; local regulators are at different
stages of implementation and local rules may still
be on a Basel I basis, notably in the US. In most
jurisdictions, non-banking financial subsidiaries
are also subject to the supervision and capital
requirements of local regulatory authorities.
Basel II is structured around three ‘pillars’:
minimum capital requirements, supervisory review
process and market discipline. The Capital
Requirements Directive (‘CRD’) implemented
Basel II in the EU and the FSA then gave effect
to the CRD by including the requirements of the
CRD in its own rulebooks.
Capital
HSBC’s capital is divided into two tiers:
• tier 1 capital is divided into core tier 1 and other
tier 1 capital. Core tier 1 capital comprises
shareholders’ equity and related minority
interests. The book values of goodwill and
intangible assets are deducted from core tier 1
capital and other regulatory adjustments are
made for items reflected in shareholders’ equity
which are treated differently for the purposes of
capital adequacy. Qualifying hybrid capital
instruments such as non-cumulative perpetual
preference shares and innovative tier 1 securities
are included in other tier 1 capital;
• tier 2 capital comprises qualifying subordinated
loan capital, related minority interests, allowable
collective impairment allowances and unrealised
gains arising on the fair valuation of equity
instruments held as available-for-sale. Tier 2
capital also includes reserves arising from the
revaluation of properties.
To ensure the overall quality of the capital base,
the FSA’s rules set limits on the amount of hybrid
capital instruments that can be included in tier 1
capital relative to core tier 1 capital, and also limits
overall tier 2 capital to no more than tier 1 capital.
The basis of consolidation for financial
accounting purposes is described on page 367 and