HSBC Holdings Regulatory News (HSBA)

Liquidity and funding

Liquidity and funding

Liquidity risk is the risk that the Group will not have sufficient financial resources to meet its obligations as they fall due, or will have to do so at an excessive cost. The risk arises from mismatches in the timing of cash flows.

The risk arises when the funding needed for illiquid asset positions cannot be obtained at the expected terms and when required.

A summary of our current policies and practices regarding liquidity and funding is provided in the Appendix to Risk on page 204.

The objective of our liquidity framework is to allow us to withstand very severe liquidity stresses. It is designed to be adaptable to changing business models, markets and regulations.

Our Liquidity and Funding Risk Management Framework ('LFRF') requires:

· liquidity to be managed by operating entities on a stand-alone basis with no implicit reliance on the Group or central banks;

· all operating entities to comply with their limits for the advances to core funding ratio; and

· all operating entities to maintain a positive stressed cash flow position out to three months under prescribed Group stress scenarios.

Liquidity and funding in 2015

The liquidity position of the Group remained strong in 2015. Our ratio of customer advances to customer deposits was 72% (2014: 72%). Both customer loans and customer accounts fell on a reported basis with these movements including:

· the transfer to 'Assets held for sale' and 'Liabilities of disposal groups held for sale' of balances relating to the planned disposal of our operations in Brazil;

· a reduction in corporate overdraft and current account balances relating to a small number of clients in our Payments and Cash Management business in the UK who settled their overdraft and deposit balances on a net basis, with customers increasing the frequency with which they settled their positions; and

· movements in currency markets, which changed the value of our customer loans and customer accounts when translated from their local currency into US dollars.

The HSBC UK liquidity group recorded an increase in its advances to core funding ('ACF') ratio to 101% at 31 December 2015 (2014: 97%), mainly because of higher wholesale lending while core funding remained unchanged.

The Hongkong and Shanghai Banking Corporation recorded a decrease in its ACF ratio to 69% at 31 December 2015 (2014: 75%), mainly because of an increase in core deposits coupled with a decrease in corporate loans.

HSBC USA recorded a decrease in its ACF ratio to 89% at 31 December 2015 (2014: 100%), mainly because of growth in core funding, which was partially offset by higher loans to customers.

The HSBC UK liquidity group, The Hongkong and Shanghai Banking Corporation and HSBC USA are defined in footnotes 19 to 21 on page 191. The ACF ratio is discussed on page 205.

Wholesale senior funding markets

Conditions in the bank wholesale debt markets were generally positive in 2015. Periods of volatility remained, however, particularly during the latter months of the year when concerns over the decline in oil prices and economic growth in Europe and mainland China combined with a variety of other factors to leave the outlook uncertain, affecting market confidence.

In 2015, a number of Group entities issued the equivalent of $22bn (2014: $20bn) of long-term debt securities in the public capital markets in a range of currencies and maturities.

Liquidity regulation

Under European Commission ('EC') Delegated Regulation 2015/61, the consolidated liquidity coverage ratio ('LCR') became a minimum regulatory standard from 1 October 2015.

The European calibration of the net stable funding ratio ('NSFR') is still pending following the Basel Committee's final recommendation in October 2014, and therefore external disclosure of this metric is currently on hold.

Non-EU regulators are expected to apply the LCR and NSFR reporting requirement locally and there is the potential for local requirements to diverge from the rules applicable to the Group.

Liquidity coverage ratio - EC LCR Delegated Regulation

The calculation of the EC LCR metric involves two key assumptions: the definition of operational deposits and the ability to transfer liquidity from non-EU legal entities.

· We define operational deposits as transactional (current) accounts arising from the provision of custody services by HSBC Security Services or Payments and Cash Management services, where the operational component is assessed to be the lower of the current balance and the separate notional values of debits and credits across the account in the previous calculation period.

· No transferability of liquidity from non-EU entities is assumed other than to the extent currently permitted. This results in $94bn of high-quality liquid assets ('HQLA') being excluded from the Group's LCR.

On the basis of these assumptions, we reported to the PRA a Group EC LCR at 31 December 2015 (on the basis of the Delegated Regulation) of 116%.

The ratio of total consolidated HQLAs to the EC LCR denominator at 31 December 2015 was 142%, reflecting the additional $94bn of HQLAs excluded from the Group LCR.

The liquidity position of the Group can also be represented by the stand-alone ratios of each of our principal operating entities. The table below displays the individual LCR levels for the principal HSBC operating entities on an EC LCR Delegated Regulation basis. The ratios shown for operating entities in non-EU jurisdictions can vary from their local LCR measures due to differences in the way non-EU regulators have implemented the Basel III recommendations.

Operating entities' LCRs

For footnotes, see page 191.

At 31 December 2015, all the Group's operating entities were individually within the risk tolerance level established by the Board and applicable under the new internal framework which took effect from 1 January 2016.

Management of liquidity and funding risk

Forward-looking framework

From 1 January 2016, the Group implemented a new internal LFRF, using the external LCR and NSFR regulatory framework as a foundation, but adding extra metrics/limits and overlays to address the risks that we consider are not adequately reflected by the external regulatory framework.

The key aspects of the new internal LFRF are:

i. stand-alone management of liquidity and funding by operating entity;

ii. operating entity classification by inherent liquidity risk ('ILR') categorisation;

iii. minimum operating entity EC LCR requirement depending on ILR categorisation (EC LCR Delegated Regulation basis);

iv. minimum operating entity NSFR requirement depending on ILR categorisation (on the basis of the Basel 295 publication, pending finalisation of the EC NSFR delegated regulation);

v. legal entity depositor concentration limit;

vi. operating entity three-month and twelve-month cumulative rolling term contractual maturity limits covering deposits from banks, deposits from non-bank financials and securities issued;

vii. annual individual liquidity adequacy assessment ('ILAA') by operating entity; and

viii. during 2016, we will also introduce a minimum operating entity LCR requirement by currency.

The new internal LFRF and the risk tolerance (limits) were approved by the RMM and the Board on the basis of recommendations made by the Group Risk Committee.

Our ILAA process has been designed to identify risks that are not reflected in the Group framework and where additional limits are assessed to be required locally, and to validate the risk tolerance at the operating entity level.

The decision to create an internal framework modelled around the external regulatory framework was driven by the need to ensure that the external and internal frameworks are directionally aligned and that the Group's internal funds transfer pricing framework incentivises the global businesses within each operating entity to collectively comply with both the external (regulatory) and the internal risk tolerance.

Current framework

The 2015, LFRF employed two key measures to define, monitor and control the liquidity and funding risk of each of our operating entities. The ACF ratio was used to monitor the structural long-term funding position, and the stressed coverage ratio, incorporating Group-defined stress scenarios, was used to monitor the resilience to severe liquidity stresses. Although in place before and during 2015, this framework and its accompanying metrics will be demised as the new framework outlined above is implemented.

The three principal entities listed in the tables below represented 65% (2014: 66%) of the Group's customer accounts. Including the other principal entities, the percentage was 88% (2014: 88%).

Advances to core funding ratio

The table overleaf shows the extent to which loans and advances to customers in our principal banking entities were financed by reliable and stable sources of funding.

ACF limits set for principal operating entities at 31 December 2015 ranged between 80% and 120%.

Core funding represents the core component of customer deposits and any term professional funding with a residual contractual maturity beyond one year. Capital is excluded from our definition of core funding.

Advances to core funding ratios23

For footnotes, see page 191.

Stressed coverage ratios

The ratios tabulated below express stressed cash inflows as a percentage of stressed cash outflows over both one-month and three-month time horizons. Operating entities are required to maintain a ratio of 100% or more out to three months.

Inflows included in the numerator of the stressed coverage ratio are generated from liquid assets (net of assumed haircuts) and cash inflows relating to assets contractually maturing within the time period.

In general, customer loans and advances are assumed to be renewed on maturity and as a result do not generate a cash inflow.

The stressed coverage ratios for The Hongkong and Shanghai Banking Corporation increased due to higher deposits and lower advances year-on-year. The ratios for HSBC USA increased due to a growth in core funding.

The stressed coverage ratios for the other entities remained broadly unchanged.

Stressed one-month and three-month coverage ratios23

For footnotes, see page 191.

Liquid assets of HSBC's principal operating entities

The table below shows the estimated liquidity value (before assumed haircuts) of assets categorised as liquid and used for the purposes of calculating the three-month stressed coverage ratios, as defined under the LFRF.

The level of liquid assets reported reflects the stock of unencumbered liquid assets at the reporting date adjusted for the effect of reverse repo, repo and collateral swaps maturing within three months as the liquidity value of these transactions is reflected as a contractual cash flow reported in the net contractual cash flow table. Repos are sale and repurchase transactions while reverse repos are transactions under which securities are purchased under commitments to sell.

Like reverse repo transactions with residual contractual maturities within three months, unsecured interbank loans maturing within three months are not included in liquid assets, but are treated as contractual cash inflows.

Liquid assets are held and managed on a stand-alone operating entity basis. Most of the liquid assets shown are held directly by each operating entity's Balance Sheet Management ('BSM') department, primarily for the purpose of managing liquidity risk, in line with the LFRF.

The liquid asset buffer may also include securities held in held-to-maturity portfolios. In order to qualify as part of the liquid asset buffer, all held-to-maturity portfolios must have a deep and liquid repo market in the underlying security.

Liquid assets also include any unencumbered liquid assets held outside BSM for any other purpose. The LFRF gives ultimate control of all unencumbered assets and sources of liquidity to BSM.

For a summary of our liquid asset policy and definitions of the classifications shown in the table below, see the Appendix to Risk on page 206.

Liquid assets of HSBC's principal entities

For footnotes, see page 191.

All assets held within the liquid asset portfolio are unencumbered.

· The quantum of liquid assets held by the HSBC UK liquidity group on a constant currency basis was broadly unchanged.

· Liquid assets held by The Hongkong and Shanghai Banking Corporation increased due to added holdings of government securities and higher regulatory reserves. This was driven by the investment of surplus deposits.

· Liquid assets held by HSBC USA decreased, mainly due to a switch from regulatory reserves to reverse repo placements. A corresponding improvement can be seen in HSBC USA's net repo cash flow shown in the net contractual cash flow table.

Net contractual cash flows

The following table quantifies the contractual cash flows from interbank and intra-Group loans and deposits, and reverse repo, repo (including intra-Group transactions) and short positions for the principal entities shown. These contractual cash inflows and outflows are reflected gross in the numerator and denominator, respectively, of the one and three-month stressed coverage ratios and should be considered alongside the level of liquid assets.

Outflows included in the denominator of the stressed coverage ratios include the principal outflows associated with the contractual maturity of wholesale debt securities reported in the table headed 'Wholesale funding cash flows payable by HSBC under financial liabilities by remaining contractual maturities' on page 161.

For a summary of our policy and definitions of the classifications shown in the table on page 159, see the Appendix to Risk on page 206.

Net cash inflows/(outflows) for interbank and intra-Group loans and deposits and reverse repo, repo and short positions

For footnotes, see page 191.

Contingent liquidity risk arising from committed lending facilities

The Group's operating entities provide commitments to various counterparties. The most significant liquidity risk relates to committed lending facilities which, whilst undrawn, give rise to contingent liquidity risk as they could be drawn during a period of liquidity stress. Commitments are given to customers and committed lending facilities are provided to consolidated multi-seller conduits established to enable clients to access flexible market-based sources of finance (see page 442), consolidated securities investment conduits and third-party sponsored conduits.

The consolidated securities investment conduits include Solitaire Funding Limited ('Solitaire') and Mazarin Funding Limited ('Mazarin'). They issue asset-backed commercial paper secured against the portfolio of securities held by them. At 31 December 2015, the HSBC UK liquidity group had undrawn committed lending facilities to these conduits of $8.2bn (2014: $11bn), of which Solitaire represented $7.7bn (2014: $9.5bn) and the remaining $0.5bn (2014: $1.6bn) pertained to Mazarin. Although the HSBC UK liquidity group provides a liquidity facility, Solitaire and Mazarin have no need to draw on it so long as HSBC purchases the commercial paper issued, which it intends to do for the foreseeable future. At 31 December 2015, the commercial paper issued by Solitaire and Mazarin was entirely held by the HSBC UK liquidity group. Since HSBC controls the size of the portfolio of securities held by these conduits, no contingent liquidity risk exposure arises as a result of these undrawn committed lending facilities.

The table below shows the level of undrawn commitments to customers outstanding for the five largest single facilities and the largest market sector, and the extent to which they are undrawn.

The Group's contractual undrawn exposures at 31 December monitored under the contingent liquidity risk limit structure

(Audited)

For footnotes, see page 191.

Sources of funding

(Audited)

Our primary sources of funding are customer current accounts and customer savings deposits payable on demand or at short notice. We issue wholesale securities (secured and unsecured) to supplement our customer deposits and change the currency mix, maturity profile or location of our liabilities.

The 'Funding sources and uses' table below, which provides a consolidated view of how our balance sheet is funded, should be read in light of the LFRF, which requires operating entities to manage liquidity and funding risk on a stand-alone basis.

The table analyses our consolidated balance sheet according to the assets that primarily arise from operating activities and the sources of funding primarily supporting these activities. The assets and liabilities that do not arise from operating activities are presented as a net balancing source or deployment of funds.

The level of customer accounts continued to exceed the level of loans and advances to customers. The positive funding gap was predominantly deployed in liquid assets (cash and balances with central banks and financial investments) as required by the LFRF.

Loans and other receivables due from banks continued to exceed deposits taken from banks. The Group remained a net unsecured lender to the banking sector.

For a summary of sources and utilisation of repos and stock lending, see the Appendix to Risk on page 208.

Funding sources and uses28

For footnote, see page 191.

Cross-border, intra-Group and cross-currency liquidity and funding risk

The stand-alone operating entity approach to liquidity and funding mandated by the LFRF restricts the exposure of our operating entities to the risks that can arise from extensive reliance on cross-border funding. Operating entities manage their funding sources locally, focusing predominantly on the local customer deposit base. The RBWM, CMB and GPB customer relationships that give rise to core deposits within an operating entity generally reflect a local customerrelationship with that operating entity. Access to public debt markets is coordinated globally by the Global Head of Balance Sheet Management and the Group Treasurer with Group ALCO monitoring all planned public debt issuance on a monthly basis. As a general principle, operating entities are only permitted to issue in their local currency and are encouraged to focus on local private placements. The public issuance of debt instruments in foreign currency is tightly controlled and generally restricted to HSBC Holdings plc and HSBC Bank plc.

A central principle of our stand-alone approach to LFRF is that operating entities place no future reliance on other Group entities. However, operating entities may, at their discretion, utilise their respective committed facilities from other Group entities if necessary. In addition, intra-Group large exposure limits are applied by national regulators to individual legal entities locally, which restrict the unsecured exposures of legal entities to the rest of the Group to a percentage of the lender's regulatory capital.

Our LFRF also considers the ability of each entity to continue to access foreign exchange markets under stress when a surplus in one currency is used to meet a deficit in another currency, for example, by using the foreign currency swap markets. Where appropriate, operating entities are required to monitor stressed coverage ratios and ACF ratios for non-local currencies and set limits for them. Foreign currency swap markets in currency pairs settled through the Continuous Link Settlement Bank are considered to be extremely deep and liquid and it is assumed that capacity to access these markets is not exposed to idiosyncratic risks. The table below shows the ACF ratios by material currencies for the year ended 31 December 2015.

Advances to core funding ratios by material currency23

For footnotes, see page 191.

For all HSBC's operating entities, the only material currencies (those that exceed 5% of Group balance sheet liabilities) are the Hong Kong dollar, euro, sterling and US dollar.

Wholesale funding cash flows payable by HSBC under financial liabilities by remaining contractual maturities

Wholesale term debt maturity profile

The maturity profile of our wholesale term debt obligations is set out in the table on page 161, 'Wholesale funding principal cash flows payable by HSBC under financial liabilities by remaining contractual maturities'.

The balances in the table do not agree directly with those in the consolidated balance sheet as the table presents gross cash flows relating to principal payments and not the balance sheet carrying value, which includes debt securities and subordinated liabilities measured at fair value.

Analysis of on-balance sheet encumbered and unencumbered assets and off-balance sheet collateral

On-balance sheet encumbered and unencumbered assets

The table on page 163, 'Analysis of on-balance sheet encumbered and unencumbered assets', summarises the total on-balance sheet assets that are capable of supporting future funding and collateral needs and shows the extent to which these assets are currently pledged for this purpose. The objective of this disclosure is to facilitate an understanding of available and unrestricted assets that could be used to support potential future funding and collateral needs.

Under 'Off-balance sheet collateral' below we discuss the off-balance sheet collateral received and re-pledged, and the level of available unencumbered off-balance sheet collateral.

The disclosure is not designed to identify assets which would be available to meet the claims of creditors or to predict assets that would be available to creditors in the event of a resolution or bankruptcy.

The table has been significantly updated since 2014 following the issuance of a 'Dear CFO' letter by the PRA, and acknowledgement by the Enhanced Disclosure Task Force that its Recommendation 19 and Figure 5 could be met without providing disclosure that has the potential to reveal the use or non-use of emergency liquidity assistance provided by central banks on a confidential basis. There are two key changes. The first is to segregate out any assetspositioned with central banks for the specific purpose of emergency liquidity provision irrespective of whether any liquidity has actually been drawn and assets encumbered. The second is to include an analysis of the source of encumbrance for those assets reported as encumbered.

An asset is defined as encumbered if it has been pledged as collateral against an existing liability and, as a result, is no longer available to the Group to secure funding, satisfy collateral needs or be sold to reduce our funding requirement. An asset is therefore categorised as unencumbered if it has not been pledged against an existing liability. Unencumbered assets are further analysed into four separate sub-categories: 'Readily realisable assets', 'Other realisable assets', 'Reverse repo/stock borrowing receivables and derivative assets' and 'Cannot be pledged as collateral'.

For a summary of our policy on collateral management and definition of encumbrance, see the Appendix to Risk on page 209.

Off-balance sheet collateral

Off-balance sheet collateral received and pledged for reverse repo, stock borrowing and derivative transactions

The fair value of assets accepted as collateral that we are permitted to sell or repledge in the absence of default was $228bn at 31 December 2015 (2014: $257bn). The fair value of any such collateral actually sold or repledged was $150bn (2014: $176bn). We are obliged to return equivalent securities. These transactions are conducted under terms that are usual and customary to standard reverse repo, stock borrowing and derivative transactions.

The fair value of collateral received and repledged in relation to reverse repos, stock borrowing and derivatives is reported on a gross basis. The related balance sheet receivables and payables are reported on a net basis where required under IFRSs offset criteria.

As a consequence of reverse repo, stock borrowing and derivative transactions where the collateral received could be but had not been sold or repledged, we held $78bn (2014: $81bn) of unencumbered collateral available to support potential future funding and collateral needs at 31 December 2015.

Analysis of on-balance sheet encumbered and unencumbered assets