HSBC 2015 Annual Report Download - page 246

Report of the Directors: Capital (continued)
Appendix to Capital
HSBC HOLDINGS PLC
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our investment and capital allocation decisions and seek to ensure that returns on investment meet the Group’s management
objectives. Our strategy is to allocate capital to businesses and entities on the basis of their ability to achieve established
RoRWA objectives and their regulatory and economic capital requirements.
Risk-weighted asset plans
RWA plans form part of the Annual Operating Plan that is approved by the Board. Revised forecasts are submitted to the GMB
on a monthly basis and reported RWAs are monitored against plan.
Our global businesses are set targets in line with the priorities outlined in last June’s strategy update including RWA efficiency
and return on RWAs. Business performance against RWA targets is monitored through regular reporting to the Holding
Company ALCO as well as the GMB. Performance measures are aligned to the Group’s strategic actions. The management of
regulatory capital deductions is also addressed in the RWA monitoring framework through additional notional charges for
these items.
Analysis is undertaken within the RWA monitoring framework to identify the key drivers of movements. Particular attention is
paid to identifying and segmenting items within the day-to-day control of the business and those items that are driven by
changes in risk models or regulatory methodology. Analysis is also undertaken to recognise and report specific actions that are
targeted RWA reduction initiatives.
Capital generation
HSBC Holdings is the primary provider of equity capital to its subsidiaries and also provides them with non-equity capital where
necessary. 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 its investment in subsidiaries.
Capital measurement and allocation
The PRA 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. Our capital at Group level is calculated under CRD IV
and supplemented by the PRA’s rules to effect the transposition of directive requirements.
Our policy and practice in capital measurement and allocation at Group level is underpinned by the CRD IV rules. In most
jurisdictions, non-banking financial subsidiaries are also subject to the supervision and capital requirements of local regulatory
authorities.
The Basel III framework, similarly to Basel II, is structured around three ‘pillars’: minimum capital requirements, supervisory
review process and market discipline. The CRD IV legislation implemented Basel III in the EU and, in the UK, the ‘PRA Rulebook’
for CRR Firms transposed the various national discretions under the CRD IV legislation into UK requirements. CRDIV also
introduces a number of capital buffers, including the CCB, CCyB, and other systemic buffers such as the G-SII buffer.
Regulatory capital
For regulatory purposes, our capital base is divided into three main categories, namely CET1, additional tier 1 and tier 2,
depending on their characteristics.
• CET1 capital is the highest quality form of capital, comprising shareholders’ equity and related non-controlling interests
(subject to limits). Under CRD IV various capital deductions and regulatory adjustments are made to these items which are
treated differently for the purposes of capital adequacy – these include deductions for goodwill and intangible assets,
deferred tax assets that rely on future profitability, negative amounts resulting from the calculation of expected loss
amounts under IRB, holdings of capital securities of financial sector entities and surplus defined benefit pension fund
assets.
• Additional tier 1 capital comprises eligible non-common equity capital securities and any related share premium; it also
includes qualifying securities issued by subsidiaries subject to certain limits. Holdings of additional tier 1 securities of
financial sector entities are deducted.
• Tier 2 capital comprises eligible capital securities and any related share premium and qualifying tier 2 capital securities
issued by subsidiaries subject to limits. Holdings of tier 2 capital securities of financial sector entities are deducted.
Pillar 1 capital requirements
Pillar 1 is comprised of the capital resources requirements for credit risk, market risk and operational risk. Credit risk includes
counterparty credit risk and securitisation requirements. These requirements are expressed in terms of RWAs.
Credit risk capital requirements
CRD IV applies three approaches of increasing sophistication to the calculation of Pillar 1 credit risk capital requirements. The
most basic, the standardised approach, requires banks to use external credit ratings to determine the risk weightings applied