HSBC Holdings Regulatory News (HSBA)

Use of non-GAAP financial measures

Our reported results are prepared in accordance with IFRSs as detailed in the Financial Statements starting on page 101. In measuring our performance, the financial measures that we use include those which have been derived from our reported results in order to eliminate factors which distort period-on-period comparisons. These are considered non-GAAP financial measures.

Non-GAAP financial measures that we use throughout this Interim Report 2016 are described below. Non-GAAP financial measures are described and reconciled to the closest reported financial measure when used.

Adjusted performance

Adjusted performance is computed by adjusting reported results for the period-on-period effects of foreign currency translation differences and significant items which distort period-on-period comparisons.

We use 'significant items' to collectively describe the group of individual adjustments that are excluded from reported results when arriving at adjusted performance. These items, which are detailed below, are ones that management and investors would ordinarily identify and consider separately when assessing performance in order to better understand underlying trends in the business.

We consider adjusted performance provides useful information for investors by aligning internal and external reporting, identifying and quantifying items management believes to be significant and providing insight into how management assesses period-on-period performance.

Foreign currency translation differences

Foreign currency translation differences reflect the movements of the US dollar against most major currencies for 1H16. We exclude the translation differences when deriving constant currency data because using these data allows us to assess balance sheet and income statement performance on a like-for-like basis to better understand the underlying trends in the business.

Significant items

The tables on pages 53 to 58 detail the effect of significant items on each of our geographical segments and global businesses during 1H16 and the two halves of 2015.

Reported net interest income of $15.8bn decreased by $0.7bn or 4% compared with 1H15. This included the significant items and currency translation summarised in the table below.

On a reported basis, net interest margin of 1.83% fell by 9 basis points ('bps'), driven by currency movements. On

Excluding the currency impact tabulated above, net interest income rose $0.3bn, as increases in Hong Kong, Mexico and Argentina were partly offset by a reduction in the UK and mainland China. However, net interest spread and margin decreased slightly. This was due to a number of factors, including reduced yields on customer lending in Europe and increased costs of debt issued by HSBC Holdings, although we benefited from lower costs of funds on customer accounts in Hong Kong and increased yields in Mexico and Argentina.

Interest income

Reported interest income fell by $1.0bn compared with 1H15, notably driven by currency movements in Latin

America and Europe. Excluding these, total interest income rose by $0.6bn, notably in Mexico, Argentina and the US. Interest income also rose in our operations in Brazil, although this was more than offset by an increase in interest expense.

Interest income on loans and advances to customers was higher. In Mexico and Argentina, this was due to higher yields following central bank interest rate rises. In Europe, the increase was mainly driven by balance growth in term lending in the UK despite lower yields on mortgages in line with competitive pricing, and the effect of downward movements in market interest rates in the eurozone. In Asia, although yields on lending increased marginally in Hong Kong and Singapore, customer lending income was broadly unchanged as the increase in yields was offset by the impact

of central bank rate decreases in various countries, notably mainland China, and from a decrease in average balances. However, in North America, interest income from customer lending fell from continued run-off and sales in the US CML run-off portfolio.

Interest income on short-term funds and financial investments marginally increased. This was driven by a change in product mix in North America towards higher-yielding, mortgage-backed securities in order to maximise the effectiveness of the portfolio and, to a lesser extent, in Argentina from balance growth. These increases were partly offset by reductions in Europe from lower yields.

Interest income on reverse repurchase agreements - non‑trading was higher, driven by higher balances and market rates in North America.

Interest expense

Reported interest expense fell by $0.3bn compared with 1H15 driven by currency translation, primarily in Latin America and Europe.

Excluding this, interest expense rose $0.4bn as decreases in Asia were partly offset by an increase in cost in North America, Europe and Argentina.

Interest expense on customer accounts fell despite growth in average balances. This reflected a change in mix towards lower cost accounts in Hong Kong and central bank rate reductions in a number of markets, notably mainland China and Australia. This was partly offset by higher interest expense on customer accounts in North America, in line with promotional deposit offerings, and in Argentina from central bank rate rises.

Interest expense on debt issued rose, due to a rise in the cost of funds, despite a fall in average balances as redemptions across the Group were more than offset by issuances of senior debt from HSBC Holdings plc. The increase in the cost of debt was driven by a combination of market sentiment as well as longer maturities and the structural subordination of our new issuances. In addition, Interest expense rose on repos, notably in North America, reflecting higher balances and market rates.

Reported net fee income fell by $1.1bn compared with 1H15, partly reflecting the adverse effects of currency

translation between the periods of $0.3bn, notably in Asia and Europe.

On an adjusted basis, net fee income decreased by $844m, driven by a reduction in Hong Kong, primarily within RBWM. This partly reflected the effect of weaker equity markets and

On an adjusted basis, net trading income from trading activities increased by $1.4bn, primarily driven by favourable movements of $1.3bn in the period compared with adverse movements of $0.6bn in 1H15 on assets held as economic hedges of foreign currency debt designated at fair value. Both these movements were offset by adverse movements on foreign currency debt designated at fair value in 'Net income from financial instruments designated at fair value'.

Excluding these movements, trading income decreased by $0.6bn, primarily in GB&M. Income decreased in Equities and Foreign Exchange, due to market volatility that led to reduced client activity. This was partly offset by an increase in revenue from our Rates business which benefited from increased client activity.

The majority of our financial liabilities designated at fair value are fixed-rate, long-term debt issuances, and are managed in conjunction with interest rate swaps as part of our interest rate management strategy.

These liabilities are discussed further on page 359 of the Annual Report and Accounts 2015.

Reported net income from financial instruments designated at fair value was $0.6bn in 1H16, compared with $2.7bn in 1H15. The former included favourable movements in the fair value of our own long-term debt of $1.2bn due to changes in credit spread, compared with favourable movements of $650m in 1H15.

On an adjusted basis, which excludes changes in our own credit spread and the net adverse effect of currency translation shown above, net income from financial instruments designated at fair value decreased by $2.5bn.

Net income from financial assets held to meet liabilities under insurance and investment contracts of $209m was $1.4bn lower than in 1H15. This was primarily driven by weaker equity markets in France, Hong Kong and the UK.

The $1.4bn change was, however, broadly offset by 'liabilities to customers under investment contracts', and by 'Net insurance claims and benefits paid and movements in liabilities to policyholders' which are described on page 26.

Investment gains or losses arising from equity markets result in a corresponding movement in liabilities to customers. This reflects the extent to which unit-linked policyholders, in particular, participate in the investment performance of the associated asset portfolio.

Where the gains or losses are recorded depends on the contract type. When gains or losses relate to assets held to back investment contracts, the corresponding movement in liabilities to customers is recorded in 'Net income/(expense) from financial instruments designated at fair value'.

When gains or losses related to assets held to back insurance contracts or investment contracts with discretionary participation features ('DPF'), any corresponding movement

in liabilities to customers is recorded in 'Net insurance claims and benefits paid and movement in liabilities to policyholders', which is detailed on page 26.

Other changes in fair value on our long-term debt and related derivatives primarily reflected:

currency debt designated at fair value and issued as part of our overall funding strategy (offset by assets held as economic hedges in 'Net trading income').

This was partly offset by:

In 1H16, gains less losses from financial investments decreased by $0.9bn on a reported basis compared with 1H15. This was driven by the significant items and currency translation tabulated below, notably the non-recurrence of

the gain on the partial sale of our shareholding in Industrial Bank of $1.4bn in 1H15, and in 1H16 a gain on disposal of our membership interest in Visa Europe.

On an adjusted basis, excluding all significant items and currency translation tabulated above, gains less losses from financial investments decreased by $102m, driven by GB&M.

This was primarily driven by lower gains on equity securities in both Markets and Principal Investments.

On an adjusted basis, excluding the effects of currency translation, net insurance premium income fell by $92m or 2%. This was largely driven by the disposal of our UK pensions business in 2H15, following our decision to exit the UK commercial pension market in 2014, and lower participating contract premiums in France.

Reported other operating income decreased by $192m from 1H15. This included the effects of the significant items recorded in the table below.

The lower favourable movement in PVIF in 2016 was primarily driven by decreasing yields in France, partly offset by the favourable effects of changes to interest rate assumptions in Singapore.

In addition, 1H15 included a change in interest rate assumption in France which had the effect of increasing PVIF.

Reported net insurance claims and benefits paid and movement in liabilities to policy holders were $1.1bn lower

than in 1H15, in part reflecting the currency translation movements of $0.2bn.

Excluding the effects of currency translation, net insurance claims and benefits paid and movements in liabilities to policyholders were $0.8bn lower than in 1H15.

This reduction was primarily in Europe, and to a lesser extent Hong Kong, reflecting a decrease in returns on financial assets supporting liabilities to policyholders where the policyholder is exposed to investment risk. This decrease in returns reflected weaker equity market performance in France, Hong Kong and the UK.

Other drivers were reduced surrenders in Hong Kong and the impact of the sale of the UK pensions business in 2015. These reductions were partly offset by increases in liabilities to policyholders in Singapore, as a result of changes to interest rate assumptions.

The gains or losses recognised on the financial assets designated at fair value that are held to support these insurance contract liabilities are reported in 'Net income from financial instruments designated at fair value' on page 23.

Reported loan impairment charges and other credit risk provisions ('LICs') of $2.4bn were $927m higher than

Excluding the effects of currency translation, LICs were $1.1bn higher than in 1H15. This was due to an increase in Brazil (up by $346m) reflecting a deterioration in local economic conditions, as well as higher individually assessed charges in a small number of countries, notably in the oil and gas sector.

On an adjusted basis, individually assessed LICs were $1.3bn, an increase of $822m compared with 1H15. This primarily reflected increases in our GB&M and CMB businesses and included the following:

On an adjusted basis, collectively assessed LICs rose by $173m, mainly in RBWM and, to a lesser extent, in CMB. The increase arose from:

This was partly offset by:

in 1H15. Both primarily related to asset-backed securities ('ABSs') in our UK GB&M business.

On an adjusted basis, operating expenses of $15.9bn were $0.7bn lower than in 1H15, despite inflationary pressures and increases in regulatory programmes and compliance costs. This primarily reflected transformational cost savings of $0.9bn achieved in 1H16. On a run-rate basis, we are now approximately 40% of the way towards achieving the cost savings target we committed to in our Investor Update in June 2015.

Run-the-bank costs of $14.6bn were $0.3bn lower than in 1H15 and change-the-bank costs of $1.5bn were $0.3bn lower than in 1H15. This reflected the following factors:

Included within the above, our total expenditure on regulatory programmes and compliance, comprising both run-the-bank and change-the-bank elements, was $1.5bn, up $0.2bn or 14% from 1H15. This reflected the continued implementation of our Global Standards programme to enhance our financial crime risk controls and capabilities, and to meet our external commitments.

Excluding investment in regulatory programmes and compliance, and credits relating to the prior year bank levy in both periods, adjusted operating expenses declined by $0.8bn or 5% compared with 1H15.

The number of employees expressed in FTEs at 30 June 2016 was 251,336, a decrease of 3,867 from 31 December 2015. This was driven by reductions in global businesses and global functions, partly offset by investment related to financial crime risk of 540 FTEs, and cost-to-achieve FTEs of 3,918.