Company Announcements

Independent auditors' report to the members of HSBC Holdings plc

Report on the audit of the financial statements

Opinion

In our opinion, HSBC Holdings plc's ('HSBC') group financial statements¹ and company financial statements (the 'financial statements'):

•    give a true and fair view of the state of the group's and of the company's affairs as at 31 December 2020 and of the group's and company's profit and the group's and company's cash flows for the 12 month period (the "year") then ended;

•    have been properly prepared in accordance with international accounting standards in conformity with the requirements of the Companies Act 2006; and

•    have been prepared in accordance with the requirements of the Companies Act 2006.

Our opinion is consistent with our reporting to the Group Audit Committee ('GAC').

Separate opinion in relation to international financial reporting standards adopted pursuant to Regulation (EC) No 1606/2002 as it applies in the European Union

As explained in note 1.1(a) to the financial statements, the group, in addition to applying international accounting standards in conformity with the requirements of the Companies Act 2006, has also applied international financial reporting standards adopted pursuant to Regulation (EC) No 1606/2002 as it applies in the European Union.

In our opinion, the group financial statements have been properly prepared in accordance with international financial reporting standards adopted pursuant to Regulation (EC) No 1606/2002 as it applies in the European Union.

Separate opinion in relation to IFRSs as issued by the IASB

As explained in note 1.1(a) to the financial statements, the group, in addition to applying international accounting standards in conformity with the requirements of Companies Act 2006, has also applied IFRSs as issued by the International Accounting Standards Board (IASB).

In our opinion, the group financial statements have been properly prepared in accordance with IFRSs as issued by the IASB.

Basis for opinion

We conducted our audit in accordance with International Standards on Auditing (UK) ('ISAs (UK)') and applicable law. Our responsibilities under ISAs (UK) are further described in the Auditors' responsibilities for the audit of the financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Independence

We remained independent of the group in accordance with the ethical requirements that are relevant to our audit of the financial statements in the UK, which includes the FRC's Ethical Standard, as applicable to listed public interest entities, and we have fulfilled our other ethical responsibilities in accordance with these requirements.

To the best of our knowledge and belief, we declare that non-audit services prohibited by the FRC's Ethical Standard were not provided to the group.

Other than those disclosed in note 6 to the financial statements, we have provided no non-audit services to the group in the period under audit.

Our audit approach

Overview

This was the second year that it has been my responsibility to form this opinion on behalf of PricewaterhouseCoopers LLP ('PwC'), who you first appointed on 31 March 2015 in relation to that year's audit. In addition to forming this opinion, in this report we have also provided information on how we approached the audit, how it changed from the previous year and details of the significant discussions that we had with the GAC.

Given the impact of Covid-19, substantially all of our interactions were undertaken virtually, including those between the engagement team, with the teams for Significant Subsidiaries and Operations Centres, and with HSBC Board members and management. Similarly, substantially all of our audit testing was performed remotely. For further details around the impact of Covid-19 on our audit, please see the 'Impact of Covid-19' key audit matter below.

Materiality

•    Overall group materiality: $900m (2019: $1,000m) based on 5% of an adjusted profit before tax for the last three years.

•    Overall company materiality: $855m (2019: $900m) being an amount capped below the overall group materiality.

1   We have audited the financial statements, included within the Annual Report and Accounts (the 'Annual Report'), which comprise: the consolidated and company balance sheets as at 31 December 2020, the consolidated and company income statements and the consolidated and company statements of comprehensive income for the year then ended, the consolidated and company statements of cash flows for the year then ended, the consolidated and company statements of changes in equity for the year then ended, and the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. Certain notes to the financial statements have been presented elsewhere in the Annual Report and Accounts 2020, rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as '(Audited)'. The relevant disclosures are included in the Risk review section on pages 113 to 194 and the Directors' remuneration report disclosures on pages 239 to 249.

 

 

Audit scope

The scope of our audit and the nature, timing and extent of audit procedures performed were determined based on our risk assessment, taking into account changes from the prior year, the financial significance of subsidiaries and other qualitative factors. We executed the planned approach and concluded based on the results of our testing, ensuring that sufficient audit evidence had been obtained to support our opinion.

 

Key audit matters

•    Impact of Covid-19 (group and company)

•    Expected credit losses - Impairment of loans and advances (group)

•    Investment in associate - Bank of Communications Company, Limited ('BoCom') (group)

•    Impairment of goodwill and intangible assets (group)

•    Valuation of financial instruments (group)

•    Impairment of investments in subsidiaries (company)

•    Valuation of defined benefit pensions obligations (group)

•    IT access management (group)

 

The scope of our audit

As part of designing our audit, we determined materiality and assessed the risks of material misstatement in the financial statements. In particular, we looked at where the directors made subjective judgements, for example in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain.

 

Capability of the audit in detecting irregularities, including fraud

Irregularities, including fraud, are instances of non-compliance with laws and regulations. We design procedures in line with our responsibilities, outlined in the Auditors' responsibilities for the audit of the financial statements section, to detect material misstatements in respect of irregularities, including fraud. The extent to which our procedures are capable of detecting irregularities, including fraud, is detailed below.

Based on our understanding of the group and industry, we identified that the principal risks of non-compliance with laws and regulations related to breaches of financial crime laws & regulations and regulatory compliance, including conduct of business, and we considered the extent to which non-compliance might have a material effect on the financial statements. We also considered those laws and regulations that have a direct impact on the preparation of the financial statements, such as the Companies Act 2006 and the UK and Hong Kong listing rules. We evaluated management's incentives and opportunities for fraudulent manipulation of the financial statements (including the risk of override of controls), and determined that the principal risks were related to posting inappropriate journal entries to increase revenue or reduce costs, creating fictitious trades to hide losses or to improve financial performance, and management bias in accounting estimates. The group engagement team shared this risk assessment with the component auditors so that they could include appropriate audit procedures in response to such risks in their work. Audit procedures performed by the group engagement team and/or component auditors included:

•    Review of correspondence with and reports to the regulators, including the Prudential Regulation Authority ('PRA') and Financial Conduct Authority ('FCA');

•    Reviewed reporting to the GAC and GRC in respect of compliance and legal matters;

•    Review a sample of legal correspondence with legal advisors;

•    Enquiries of management and review of internal audit reports in so far as they related to the financial statements;

•    Obtain legal confirmations from legal advisors relating to material litigation and compliance matters;

•    Assessment of matters reported on the group's whistleblowing and 'Speak up' programmes and the results of management's investigation of such matters; in so far as they related to the financial statements;

•    Challenging assumptions and judgements made by management in its significant accounting estimates, in particular in relation to the determination of expected credit losses, and the impairment assessments of goodwill, intangible assets, the investment in BoCom, valuation of financial instruments, valuation of defined benefit pensions obligations and investment in subsidiaries (see related key audit matters below);

•    Obtaining confirmations from third parties to confirm the existence of a sample of transactions; and

•    Identifying and testing journal entries, including those posted with certain descriptions, posted and approved by the same individual, backdated journals or posted by infrequent and unexpected users.

There are inherent limitations in the audit procedures described above. We are less likely to become aware of instances of non-compliance with laws and regulations that are not closely related to events and transactions reflected in the financial statements. Also, the risk of not detecting a material misstatement due to fraud is higher than the risk of not detecting one resulting from error, as fraud may involve deliberate concealment by, for example, forgery or intentional misrepresentations, or through collusion.

 

Key audit matters

Key audit matters are those matters that, in the auditors' professional judgement, were of most significance in the audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by the auditors, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. These matters, and any comments we make on the results of our procedures thereon, were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. This is not a complete list of all risks identified by our audit.

The impact of Covid-19 and valuation of financial instruments are new key audit matters this year. Otherwise, the key audit matters below are consistent with last year.

Impact of Covid-19 (group and company)

The impact of the Covid-19 pandemic has resulted in unprecedented economic conditions and resulting government support programmes and regulatory interventions to support businesses and people. The Covid-19 pandemic has also changed the way that companies operate their businesses, with one of the most substantial impacts being the transition to remote working. A substantial proportion of HSBC's employees have been working remotely during 2020, with some consequential changes on their processes and the control environment, some of which were relevant for financial reporting purposes. Our audit team has also been working remotely for most of 2020, as have most of our teams auditing the Significant Subsidiaries and operational centres. The impact of the Covid-19 pandemic and resulting uncertainty has impacted a number of the estimates in the group financial statements and company financial statements. The impact on the most significant accounting judgements and our audit is set out in the following other key audit matters in this opinion: •      Expected credit losses - Impairment on loans and advances to customers; •      Investment in associate - BoCom; •      Impairment of goodwill and intangible assets; •      Valuation of financial instruments; and •      Impairment of investment in subsidiaries.

We discussed our assessment of the impact of Covid-19 on HSBC's operations and control environment with the GAC. We also explained how we planned to execute our audit with substantially all of our audit team working remotely.

We engaged with the Board and management at HSBC in a manner consistent with our previous audits, albeit remotely using video and telephone calls. Substantially all of the information and audit evidence we need for the HSBC audit is provided in electronic format. We shared information, including the audit evidence provided to us by HSBC, using share-screen functionality in video calls and our secure encrypted information sharing software. Where we would have previously inspected physical evidence, for example our stock counts of precious metals, these audit procedures were performed virtually. We understood and assessed the transition of HSBC employees to working remotely on the control environment relevant to financial reporting, and reflected this in our audit approach for new or changed processes and controls. Where the group undertook new business activities as a result of Covid-19, for example, the government sponsored lending programmes, we assessed the audit risks and designed appropriate audit procedures. We were not able to visit any of the audit teams for the Significant Subsidiaries and operational centres during our 2020 audit. However, consistent with our experience with HSBC, we engaged with and directed these teams in a manner consistent with our previous audits using video conferencing and telephone calls. This included 'virtual visits' to certain locations, in which we met with both the audit teams and local management. To ensure we were satisfied with the audits performed by the audit teams for the Significant Subsidiaries, we evaluated and reviewed audit evidence by remotely reviewing electronic audit files or using share-screen functionality in video conferencing.

GAC Report, page 218.

 

Expected credit losses - Impairment of loans and advances (group)

Determining expected credit losses ('ECL') involves management judgement and is subject to a high degree of estimation uncertainty, both of which have significantly increased as a result of Covid-19. Management makes various assumptions when estimating ECL. The significant assumptions that we focus on in our audit included those with greater levels of management judgement and for which variations had the most significant impact on ECL. Specifically these included, •      forward looking economic scenarios and their likelihoods; •      customer risk ratings ('CRRs'), and probability of defaults; and •      the recoverability of credit impaired wholesale exposures. The modelling methodologies that use these assumptions, as well as other data, to estimate ECL are complex and not standardised. The modelling methodologies are developed using historical experience, which can result in limitations in their reliability to appropriately estimate ECL. These limitations are often addressed with adjustments, which are inherently judgemental and subject to estimation uncertainty. The impact of the Covid-19 pandemic has resulted in unprecedented economic conditions that vary across countries and industry sectors. Covid-19 related government support programmes and regulatory interventions have impacted economic factors such as GDP and unemployment, and consequently the extent and timing of customer defaults. These factors have increased the uncertainty around judgements made in determining the severity and likelihood of macroeconomic variable ('MEV') forecasts across the different economic scenarios used in ECL models. Furthermore, these conditions are outside the bounds of historical experience used to develop the models and where models produce plausible results, resulting in significantly greater limitations in their reliability to estimate ECLs. Management has made significant adjustments to ECL to address these limitations through management judgemental adjustments to modelled outcomes. The nature and extent of these limitations and the resulting changes to ECL varies across retail and wholesale portfolios globally. In addition, certain models have been redeveloped during 2020. The determination of CRRs is based on quantitative scorecards, with qualitative adjustments for relevant factors. The extent of qualitative adjustments has increased due to Covid-19. The uncertainty caused by Covid-19 also increases judgement involved in estimating expected cash flows and collateral valuations for specific impairments on credit impaired wholesale exposures.

We held discussions with the GAC covering governance and controls over ECL, with a significant focus on the impact of Covid-19. We also discussed a number of other areas, including: •      the severity and likelihood of MEV forecasts in economics scenarios, across countries for the impact of Covid-19, and specifically for the UK and Hong Kong in relation to the geopolitical risks relating to the UK's withdrawal from the EU and US-China relations; •      the determination and migration of customer risk ratings; •      assumptions around the recoverability of significant wholesale exposures; •      the identification and assessment of model limitations and resulting changes and adjustments to ECL, in particular for approaches adopted in response to Covid-19; •      models that were redeveloped during the year; •      model validation and monitoring; and •      the disclosures made to explain ECL, in particular the impact of Covid-19 on determining ECL and the resulting estimation uncertainty.

We assessed the design of governance and controls over the estimation of ECLs, as well as testing how effectively they operated. We observed management's review and challenge governance forums for (1) the determination of MEV forecasts and their likelihood for different economic scenarios, and (2) the assessment of ECL for Retail and Wholesale portfolios, including the assessment of model limitations and approval of any resulting adjustments to modelled outcomes. We also tested controls over: •      model validation and monitoring; •      credit reviews that determine CRRs for wholesale customers; •      the input of critical data into source systems and the flow and transformation of critical data from source systems to the impairment models; and •      the calculation and approval of management judgemental adjustments to modelled outcomes. We involved our economic experts in assessing the reasonableness of the severity and likelihood of MEV forecasts. These assessments considered the sensitivity of ECLs to variations in the severity and likelihood of MEVs for different economic scenarios. We involved our modelling experts in assessing the appropriateness of modelling methodologies that were redeveloped during the year, and for a sample of those models, we independently reperformed the modelling for certain aspects of the ECL calculation. We also assessed the appropriateness of modelling methodologies that did not change during the year, giving specific consideration to Covid-19 and whether management judgemental adjustments were needed. In addition, we performed testing over: •      the compliance of ECL methodologies and assumptions with the requirements of IFRS9; •      a sample of critical data used in the year end ECL calculation and to estimate management judgemental adjustments; •      critical data, assumptions and discounted cash flows for a sample of credit impaired wholesale exposures; and •      a sample of CRRs applied to wholesale exposures, including our credit experts assessing a sample by comparing to external sources. We evaluated and tested the Credit Risk disclosures made in the Annual Report and Accounts 2020.

•      Credit risk disclosures, page 119. •      GAC Report, page 220. •      Note 1.2(d): Financial instruments measured at amortised cost, page 292. •      Note 1.2(i): Impairment of amortised cost and FVOCI financial assets, page 293.

 

 

 

Investment in associate - BoCom (group)

At 31 December 2020, the market value of the investment in BoCom, based on the share price, was $13.7bn lower than the carrying value of $21.2bn. This is an indicator of potential impairment. An impairment test was performed by management, with supporting sensitivity analysis, using a value in use ('VIU') model. The VIU was $0.6bn in excess of the carrying value. On this basis, management concluded no impairment was required and the share of BoCom's profits has been recognised in the consolidated income statement. The methodology in the VIU model is dependent on various assumptions, both short term and long term in nature. These assumptions, which are subject to estimation uncertainty, are derived from a combination of management's judgement, analysts' forecasts and market data. The significant assumptions that we focused our audit on were those with greater levels of management judgement and for which variations had the most significant impact on the VIU. Specifically, these included •      discount rates; •      forecast operating income; •      long term growth rates; •      future expected credit losses; •      effective tax rates; and •      regulatory capital requirements.

We discussed the appropriateness of the VIU methodology and significant assumptions with the GAC, giving consideration to the macroeconomic environment, as well as Covid-19 and the outlook for the Chinese banking market. We considered reasonably possible alternatives for the significant assumptions. We also discussed the disclosures made in relation to BoCom, including the use of sensitivity analysis to explain estimation uncertainty and the conditions that would result in an impairment being recognised.

We tested controls in place over significant assumptions and the model used to determine the VIU. We assessed the appropriateness of the methodology used, and the mathematical accuracy of the calculations, to estimate the VIU. In respect of the significant assumptions, our testing included the following: •      Challenging the basis for determining significant assumptions and, where relevant, their interrelationships; •      Obtaining and evaluating evidence where available for critical data relating to significant assumptions, from a combination of historic experience, external market information, third-party sources including analyst reports, information from BoCom management and historical publicly available BoCom financial information; •      Assessing the sensitivity of the VIU to reasonable variations in significant assumptions, both individually and in aggregate; and •      Determining a reasonable range for the discount rate used within the model, with the assistance of our valuation experts, and comparing it to the discount rate used by management. We observed meetings in April, May, September and November 2020 between management and senior BoCom executive management, held specifically to identify facts and circumstances impacting assumptions relevant to the determination of the VIU. We evaluated and tested the disclosures made in the Annual Report and Accounts 2020 in relation to BoCom.

•      GAC Report, page 221. •      Note 1.2(a): Critical accounting estimates and judgements, page 291. •      Note 18 Interests in associates and joint ventures, page 331.

 

Impairment of goodwill and intangible assets (group)

The impact of the Covid-19 pandemic has resulted in unprecedented economic conditions, impacting the performance of HSBC in both 2020 and the outlook into 2021 and beyond. This is considered by management to be an indicator of impairment. An impairment test was performed by management, with supporting sensitivity analysis, using the higher of value in use ('VIU') and fair value less cost to sell. Management predominantly used VIU in its impairment tests, unless it believed that fair value less cost to sell would result in a higher recoverable amount for any cash generating unit ('CGU'). The impairment test resulted in impairment charges of $1.3bn and $41m for software intangibles and goodwill being recognised respectively for certain CGUs. For the remaining CGUs, where the recoverable amount was higher than the carrying value, no impairment was recorded. The remaining goodwill and software intangibles on the balance sheet at 31 December 2020 are $5.9bn and $4.5bn respectively. The methodology in the models is dependent on various assumptions, both short term and long term in nature. These assumptions, which are subject to estimation uncertainty, are derived from a combination of management's judgement, experts engaged by management and market data. The significant assumptions that we focused our audit on were those with greater levels of management judgement and for which variations had the most significant impact on the recoverable amount. Specifically, these included HSBC's annual operating plan (AOP) for 2021 to 2025 including revenue forecasts and cost reduction targets, regulatory capital requirements, long term growth rates and discount rates.

We discussed the appropriateness of methodologies used and significant assumptions with the GAC, giving consideration to the macroeconomic environment, as well as Covid-19 and HSBC's strategy. We considered reasonably possible alternatives for significant assumptions. We also discussed the disclosures made in relation to goodwill and software intangibles, including the use of sensitivity analysis to explain estimation uncertainty and the conditions that would result in an impairment being recognised.

We tested controls in place over significant assumptions and the model used to determine VIUs and fair values. We assessed the appropriateness of the CGUs and the methodology used, and the mathematical accuracy of the calculations, to estimate the recoverable amounts. In respect of the significant assumptions, our testing included the following: •      challenging the achievability of management's AOP and the prospects for HSBC's businesses; •      obtaining and evaluating evidence where available for critical data relating to significant assumptions, from a combination of historic experience and external market and other financial information; •      assessing whether the cash flows included in the model were in accordance with the relevant accounting standard; •      assessing the sensitivity of the VIU to reasonable variations in significant assumptions, both individually and in aggregate; and •      determining a reasonable range for the discount rate used within the model, with the assistance of our valuation experts, and comparing it to the discount rate used by management. We evaluated and tested the disclosures made in the Annual Report and Accounts 2020 in relation to goodwill and software intangibles.

•      GAC Report, page 221. •      Note 1.2(a): Critical accounting estimates and judgements, page 290. •      Note 1.2(n): Critical accounting estimates and judgements, page 299. •      Note 21: Goodwill and intangible assets, page 338.

 

Valuation of financial instruments (group)

The financial instruments held by the group range from those that are traded daily on active markets with quoted prices, to more complex and bespoke positions. The valuation of financial instruments can require the use of prices or inputs which are not readily observable in the market. Where significant pricing inputs are unobservable, the financial instruments are classified as Level 3 (L3), per the IFRS 13 fair value hierarchy. Determining unobservable inputs in fair value measurement involves management judgement and is subject to a high degree of estimation uncertainty. The most material L3 financial instruments which are dependent on unobservable inputs are the group's holding of $11.0bn of private equity (PE) investments held by the Global Banking and Markets and the Insurance businesses. The group also holds $758m of similar investments in the pension scheme assets for HSBC (UK) Bank plc. Covid-19 has resulted in markets being more volatile.  The level of judgement surrounding the valuation of PE investments increases in times of heightened market volatility. Fair value of the group's PE investments is estimated using commonly accepted valuation methodologies, which are set out in the International Private Equity and Venture Capital Valuation Guidelines and includes the use of net asset value (NAV) statements from fund managers, the price of recent investments, the use of market comparables or discounted cash flow models. The fair value of most PE investments are based on NAV statements provided by fund managers.

We discussed with the GAC the appropriateness of the PE valuation approaches for PE investments. We also discussed the governance and controls over determining fair values, in particular, when markets are more volatile.

We tested controls in place, including those relating to the assessment of valuations based on NAV statements and the fund managers that provide them. For fair values based on NAV statements from fund managers, we inspected NAV statements and engaged our valuation experts to test management's assessment of the reliability of those valuations. For these valuations, we also: •      compared fair value movements to movements in relevant market information, such as industry indices; •      agreed NAV statements from fund managers to audited fund financial statements where they were available; and •      performed back testing of fair values to any recent transactions. We evaluated the adequacy and extent of disclosures made in the Annual Report and Accounts 2020 in relation to valuation of L3 financial instruments.

•      GAC Report, page 221. •      Note 1.2(c): Critical accounting estimates and judgements, page 292. •      Note 12: Fair values of financial instruments carried at fair value, page 314.

 

Impairment of investments in subsidiaries (company)

The impact of the Covid-19 pandemic has resulted in unprecedented economic conditions, impacting the performance of HSBC in both 2020 and the outlook into 2021 and beyond. This is considered by management to be an indicator of impairment on the investment in subsidiaries. Management compared the net assets to the carrying value of each subsidiary. Where the net assets did not support the carrying value or the subsidiary made a loss during the period, management estimated the recoverable amount using the higher of value in use ('VIU') or fair value less cost to sell. Management predominantly used VIU in its impairment tests, unless it believed that fair value would result in a higher recoverable amount for any subsidiary. The impairment test resulted in impairment charges of $435m in relation to HSBC Overseas Holdings (UK) limited. The remaining investment in subsidiaries was $158bn at 31 December 2020. The methodology in the models used to estimate the recoverable amount is dependent on various assumptions, both short term and long term in nature. These assumptions, which are subject to estimation uncertainty, are derived from a combination of management's judgement, experts engaged by management and market data. The significant assumptions that we focused our audit on were those with greater levels of management judgement and for which variations had the most significant impact on the recoverable amount. Specifically, these included HSBC's AOP for 2021 to 2025 including revenue forecasts and cost reduction targets, regulatory capital requirements, long term growth rates and discount rates.

We discussed the appropriateness of methodologies used and significant assumptions with the GAC, giving consideration to the macroeconomic environment, as well as Covid-19 and HSBC's strategy. We considered reasonably possible alternatives for significant assumptions. We also discussed the disclosures made in relation to investment in subsidiaries, including the use of sensitivity analysis to explain estimation uncertainty and the conditions that would result in an impairment being recognised.

We tested controls in place over significant assumptions and the model used to determine the recoverable amounts. We assessed the appropriateness of the methodology used, and the mathematical accuracy of the calculations, to estimate the recoverable amounts. In respect of the significant assumptions, our testing included the following: •      challenging the achievability of management's AOP and the prospects for HSBC's businesses; •      obtaining and evaluating evidence where available for critical data relating to significant assumptions, from a combination of historic experience and external market and other financial information; •      assessing whether the cash flows included in the model were in accordance with the relevant accounting standard; •      assessing the sensitivity of the VIU to reasonable variations in significant assumptions, both individually and in aggregate; and •      determining a reasonable range for the discount rate used within the model, with the assistance of our valuation experts, and comparing it to the discount rate used by management. We evaluated and tested the disclosures made in the Annual Report and Accounts 2020 in relation to investment in subsidiaries.

•    Note 19: Investments in subsidiaries, page 335.

 

Valuation of defined benefit pensions obligations (group)

The group has a defined benefit obligation of $44bn, of which $33bn relates to HSBC Bank (UK) pension scheme.  The valuation of the defined benefit obligation for HSBC Bank (UK) is dependent on a number of actuarial assumptions. Management uses an actuarial expert to determine the valuation of the defined benefit obligation. The expert uses a valuation methodology that requires a number of market based inputs and other financial and demographic assumptions. The significant assumptions that we focused our audit on were those with greater levels of management judgement and for which variations had the most significant impact on the liability. Specifically, these included the discount rate, inflation rate and mortality rate.

We discussed with the GAC the methodologies and significant assumptions used by management to determine the value of the defined benefit obligation.

We tested controls in place over the methodologies and the significant assumptions. We also evaluated the objectivity and competence of management's expert involved in the valuation of the defined benefit obligation. We assessed the appropriateness of the methodology used, and the mathematical accuracy of the calculations, to estimate the liability. In respect of the significant assumptions, our actuarial experts understood the judgements made by management and management's actuarial expert in determining the significant assumptions, and compared these assumptions to our independently compiled expected ranges based on market observable indices and our market experience. We also tested the members data used in calculating the obligation. We evaluated and tested the disclosures made in the Annual Report and Accounts 2020 in relation to defined benefit pension obligation.

•      GAC Report, page 221. •      Note 1.2(k): Critical accounting estimates and judgements, page 298. •      Note 5: Employee compensation and benefits, page 301.

 

IT access management (group)

HSBC has operations across a number of countries supporting a wide range of products and services, resulting in an IT environment that is large, complex and increasingly reliant on third parties. HSBC's financial reporting processes rely upon a significant element of this IT environment, both within Finance and the business and operations more broadly. Access management controls are an important part of the IT environment to ensure both access and changes made to systems and data are appropriate. Our audit approach planned to rely extensively on the effectiveness of IT access management controls. As part of our audit work in prior periods, control deficiencies were identified in relation to IT access management for systems and data relevant to financial reporting. Management has an ongoing remediation programme to address these matters.

The significance of IT access management to our audit was discussed at GAC meetings during the year, as well as progress on management's remediation programme, control deficiencies identified and our related audit responses.

IT access management controls were tested for systems and data relevant to financial reporting that we planned to rely upon as part of our audit. Specifically we tested controls over: •      authorising new access requests; •      the timely removal of access rights; •      periodic monitoring of the appropriateness of access rights to systems and data; •      restricting highly privileged access to appropriate personnel; •      the accuracy of information about IT users to facilitate access management; •      segregation of access across IT and business functions; •      changes made to systems and data; and •      understanding and assessing reliance on third parties, including Service Organisation controls reports.  We also independently assessed password policies and system configurations, and performed substantive audit procedures in relation to access right removal, privileged access, IT user information and segregation of duties. We performed further testing where control deficiencies were identified, including: •      where inappropriate access was identified, we understood and assessed the nature of the access, and obtained additional evidence on the appropriateness of activities performed; and, •      we identified and tested compensating business controls and performed other audit procedures where IT compensating controls were not sufficient to address the audit risk.

•    Effectiveness of internal controls, page 260.

 

Materiality

The scope of our audit was influenced by our application of materiality. We set certain quantitative thresholds for materiality. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures on the individual financial statement line items and disclosures and in evaluating the effect of misstatements, both individually and in aggregate on the financial statements as a whole.

 

Based on our professional judgement, we determined materiality for the financial statements as a whole as follows:

Overall materiality	$900m (2019: $1,000m).	$855m (2019: $900m).
How we determined it	5% of a three year average of adjusted profit before tax.	0.75% of total assets. This would result in an overall materiality of $1.9bn and was therefore reduced below this materiality for the group.
Rationale for benchmark applied	We believe a standard benchmark of 5% of adjusted profit before tax is an appropriate quantitative indicator of materiality, although certain items could also be material for qualitative reasons. This benchmark is standard for listed entities and consistent with the wider industry. We selected adjusted profit because, as discussed on page 77, management believes it better reflects the performance of the group. We excluded the adjustments made by management on page 311 for certain customer redress programmes and fair value movements of financial instruments, as in our opinion they are recurring items that form part of ongoing business performance.Whilst adjusted profit before tax is still considered the most suitable benchmark, we have used a three year average to reflect the significant impact Covid-19 has had on performance in 2020.	A benchmark of total assets has been used as the company's primary purpose is to act as a holding company with investments in the group's subsidiaries, not to generate operating profits and therefore a profit based measure is not relevant.

 

We use performance materiality to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds overall materiality. Specifically, we use performance materiality in determining the scope of our audit and the nature and extent of our testing of account balances, classes of transactions and disclosures, for example in determining sample sizes. Our performance materiality was 75% of overall materiality, amounting to $675m (2019: $750m) for the group financial statements and $641m (2019: $675m) for the company financial statements. In determining the performance materiality, we considered a number of factors - the history of misstatements, our risk assessment and aggregation risk, and the effectiveness of controls.

For each component in the scope of our group audit, we allocated a materiality that is less than our overall group materiality. The range of materiality allocated across components was between $60m and $855m. Certain components were audited to a local statutory audit materiality that was less than the materiality we allocated them.

We agreed with the GAC that we would report to them misstatements identified during our group and company audit above $45m (2019: $50m), as well as misstatements below those amounts that, in our view, warranted reporting for qualitative reasons.

How we tailored the audit scope

We tailored the scope of our audit to ensure that we performed enough work to be able to give an opinion on the financial statements as a whole, reflecting the structure of the group and the company, the processes and controls relevant to financial reporting, and the industry in which they operate. Our audit approach incorporated a number of key aspects:

(1) Audit approach to HSBC's global businesses

We designed audit approaches for the products and services that substantially make up HSBC's global businesses, such as lending, deposits and derivatives. These global business approaches were designed by partners and team members who are specialists in the relevant businesses. These approaches were provided to the audit partners and teams around the world that contributed to the group audit.

(2) Audit work for Significant Subsidiaries:

Through our risk assessment and scoping we identified certain entities (collectively the Significant Subsidiaries) for which we obtained audit opinions. We obtained full scope audit opinions for Hongkong and Shanghai Banking Corporation Limited, HSBC Bank plc, HSBC UK Bank plc, HSBC North America Holdings Ltd, HSBC Bank Canada and HSBC Mexico S.A. We obtained audit opinions over specific balances for HSBC Global Services (UK) Limited and HSBC Group Management Services Limited and HSBC Bank Middle East Limited - UAE Operations. The audits for HSBC Bank plc, HSBC UK Bank plc, HSBC Global Services (UK) Limited and HSBC Group Management Services Limited were performed by other PwC teams in the UK. All other audits were performed by other PwC network firms.

We worked with the Significant Subsidiaries in 2020 to develop an approach for rotating certain smaller locations in and out of scope over a number of reporting periods. These locations, which are subject to local external audits, are individually relatively small compared to the group. Notwithstanding their size, the rotational approach is designed to ensure that over time these locations are subject to audit work as part of the group audit. India was removed from the scope of the Hongkong and Shanghai Banking Corporation audit for 2020 and Singapore was included.

We asked the partners and teams reporting to us on the Significant Subsidiaries to work to assigned materiality levels reflecting the size of the operations they audited. The performance materiality levels ranged from $45m to $641m. Certain Significant Subsidiaries were audited to a local statutory audit materiality that was less than our overall group materiality.

We were in active dialogue throughout the year with the partners and teams responsible for the audits of the Significant Subsidiaries. This included consideration of how they planned and performed their work, including their use of the global business approaches. We attended Audit Committee meetings for some of Significant Subsidiaries. We also attended meetings with management in each of these Significant Subsidiaries at the year-end.

The audit of The Hongkong and Shanghai Banking Corporation in Hong Kong relied upon work performed by other teams in Hong Kong and the PwC network firms in Malaysia, mainland China and Singapore. Similarly, the audit of HSBC Bank plc and HSBC UK Bank plc in the UK relied upon work performed by other teams in the UK and the PwC network firms in France and Germany. We considered how the audit partners and teams for the Significant Subsidiaries instructed and provided oversight to the work performed in these locations. Collectively, PwC network firms completed audit procedures covering 88% of assets and 73% of total operating income.

(3) Audit work performed at Operations Centres

A significant amount of the operational processes and controls which are critical to financial reporting are undertaken in operations centres run by Digital Business Services ('DBS') across 12 different locations. Financial reporting processes are performed in HSBC's four Finance Operations Centres. We coordinated and provided oversight on the audit work performed by PwC teams in the UK, Poland, China, Sri Lanka, Malaysia, India and the Philippines. This work was relied upon by us, as well as the PwC teams auditing the Significant Subsidiaries.

(4)  Audit procedures undertaken at a group level and on the company

We ensured that appropriate further work was undertaken for the HSBC group and company. This work included auditing, for example, the impairment assessment of goodwill and intangible assets, the consolidation of the group's results, the preparation of the financial statements, certain disclosures within the Directors' remuneration report, litigation provisions and exposures, taxation, and management's entity level and oversight controls relevant to financial reporting. Subsidiaries' balances that were not identified as part of a Significant Subsidiary were subject to procedures which mitigated the risk of material misstatement, including testing of entity level controls, information technology general controls, testing at the Operations Centre, analytical review procedures and understanding and assessing the outcome of local external audits.

(5) Using the work of others

We continued to make use of evidence provided by others. This included testing of controls performed by Global Internal Audit and management themselves in some low risk areas. We used the work of PwC experts, for example, valuation experts for our work around the assumptions used in the impairment assessment over goodwill and actuaries on the estimates used in determining pension liabilities. An increasing number of controls are operated on behalf of HSBC by third parties. We rely on audit evidence that is scoped and provided by other auditors that are engaged by those third parties. For example, we obtain a report evidencing the testing of external systems and controls supporting HSBC's payroll and HR processes.

Conclusions relating to going concern

Our evaluation of the directors' assessment of the group's and the company's ability to continue to adopt the going concern basis of accounting included:

•    Performing a risk assessment to identify factors that could impact the going concern basis of accounting, including the impact of Covid-19 and geopolitical risks.

•    Understanding and evaluating the group's financial forecasts and the group's stress testing of liquidity and regulatory capital, including the severity of the stress scenarios that were used.

•    Reading and evaluating the adequacy of the disclosures made in the financial statements in relation to going concern.

Based on the work we have performed, we have not identified any material uncertainties relating to events or conditions that, individually or collectively, may cast significant doubt on the group's and the company's ability to continue as a going concern for a period of at least twelve months from when the financial statements are authorised for issue.

In auditing the financial statements, we have concluded that the directors' use of the going concern basis of accounting in the preparation of the financial statements is appropriate.

However, because not all future events or conditions can be predicted, this conclusion is not a guarantee as to the group's and the company's ability to continue as a going concern.

In relation to the group's and the company's reporting on how they have applied the UK Corporate Governance Code, we have nothing material to add or draw attention to in relation to the directors' statement in the financial statements about whether the directors considered it appropriate to adopt the going concern basis of accounting.

Our responsibilities and the responsibilities of the directors with respect to going concern are described in the relevant sections of this report.

Reporting on other information

The other information comprises all of the information in the Annual Report other than the financial statements and our auditors' report thereon. The directors are responsible for the other information. Our opinion on the financial statements does not cover the other information and, accordingly, we do not express an audit opinion or, except to the extent otherwise explicitly stated in this report, any form of assurance thereon.

In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If we identify an apparent material inconsistency or material misstatement, we are required to perform procedures to conclude whether there is a material misstatement of the financial statements or a material misstatement of the other information. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report based on these responsibilities.

With respect to the Strategic Report and Report of the Directors', we also considered whether the disclosures required by the UK Companies Act 2006 have been included.

Based on our work undertaken in the course of the audit, the Companies Act 2006 requires us also to report certain opinions and matters as described below.

Strategic Report and Report of the Directors

In our opinion, based on the work undertaken in the course of the audit, the information given in the Strategic Report and Report of the Directors' for the year ended 31 December 2020 is consistent with the financial statements and has been prepared in accordance with applicable legal requirements.

In light of the knowledge and understanding of the group and company and their environment obtained in the course of the audit, we did not identify any material misstatements in the Strategic Report and Report of the Directors.

Directors' Remuneration

In our opinion, the part of the Directors' Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006.

 Corporate governance statement

The Listing Rules require us to review the directors' statements in relation to going concern, longer-term viability and that part of the corporate governance statement relating to the company's compliance with the provisions of the UK Corporate Governance Code specified for our review. Our additional responsibilities with respect to the corporate governance statement as other information are described in the Reporting on other information section of this report.

Based on the work undertaken as part of our audit, we have concluded that each of the following elements of the corporate governance statement is materially consistent with the financial statements and our knowledge obtained during the audit and we have nothing material to add or draw attention to in relation to:

•    The directors' confirmation that they have carried out an assessment of the emerging and principal risks;

•    The disclosures in the Annual Report and Accounts that describe those principal risks, what procedures are in place to identify emerging risks and an explanation of how these are being managed or mitigated;

•    The directors' statement in the financial statements about whether they considered it appropriate to adopt the going concern basis of accounting in preparing them, and their identification of any material uncertainties to the group's and company's ability to continue to do so over a period of at least twelve months from the date of approval of the financial statements;

•    The directors' explanation as to their assessment of the group's and company's prospects, the period this assessment covers and why the period is appropriate; and

•    The directors' statement as to whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of its assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions.

Our review of the directors' statement regarding the longer-term viability of the group was substantially less in scope than an audit and only consisted of making inquiries and considering the directors' process supporting their statement; checking that the statement is in alignment with the relevant provisions of the UK Corporate Governance Code; and considering whether the statement is consistent with the financial statements and our knowledge and understanding of the group and company and their environment obtained in the course of the audit.

In addition, based on the work undertaken as part of our audit, we have concluded that each of the following elements of the corporate governance statement is materially consistent with the financial statements and our knowledge obtained during the audit:

•    The directors' statement that they consider the Annual Report, taken as a whole, is fair, balanced and understandable, and provides the information necessary for the members to assess the group's and company's position, performance, business model and strategy;

•    The section of the Annual Report that describes the review of effectiveness of risk management and internal control systems; and

•    The section of the Annual Report describing the work of the GAC.

We have nothing to report in respect of our responsibility to report when the directors' statement relating to the company's compliance with the Code does not properly disclose a departure from a relevant provision of the Code specified under the Listing Rules for review by the auditors.

Responsibilities for the financial statements and the audit

Responsibilities of the directors for the financial statements

As explained more fully in the Directors' responsibilities statement, the directors are responsible for the preparation of the financial statements in accordance with the applicable framework and for being satisfied that they give a true and fair view. The directors are also responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the financial statements, the directors are responsible for assessing the group's and the company's ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the group or the company or to cease operations, or have no realistic alternative but to do so.

Auditors' responsibilities for the audit of the financial statements

Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors' report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.

Our audit testing might include testing complete populations of certain transactions and balances, possibly using data auditing techniques. However, it typically involves selecting a limited number of items for testing, rather than testing complete populations. We will often seek to target particular items for testing based on their size or risk characteristics. In other cases, we will use audit sampling to enable us to draw a conclusion about the population from which the sample is selected.

A further description of our responsibilities for the audit of the financial statements is located on the FRC's website at: www.frc.org.uk/auditorsresponsibilities. This description forms part of our auditors' report.

Use of this report

This report, including the opinions, has been prepared for and only for the company's members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.

Other required reporting

 Companies Act 2006 exception reporting

Under the Companies Act 2006 we are required to report to you if, in our opinion:

•    we have not obtained all the information and explanations we require for our audit; or

•    adequate accounting records have not been kept by the company, or returns adequate for our audit have not been received from branches not visited by us; or

•    certain disclosures of directors' remuneration specified by law are not made; or

•    the financial statements and the part of the Directors' Remuneration Report to be audited are not in agreement with the accounting records and returns.

We have no exceptions to report arising from this responsibility.

 

Appointment

Following the recommendation of the GAC, we were appointed by the members on 31 March 2015 to audit the financial statements for the year ended 31 December 2015 and subsequent financial periods. The period of total uninterrupted engagement is six years, covering the years ended 31 December 2015 to 31 December 2020.

 

 

 

 

 

Scott Berryman (Senior Statutory Auditor)

for and on behalf of PricewaterhouseCoopers LLP

Chartered Accountants and Statutory Auditors

London

23 February 2021