Half-year Report 2b of 2

Approach and policy

Our approach to capital management is driven by our strategic and organisational requirements, taking into account the regulatory, economic and commercial environment. We aim to maintain a strong capital base to support the risks inherent in our business and invest in accordance with our strategy, meeting both consolidated and local regulatory capital requirements at all times.

Our policy on capital management is underpinned by a capital management framework and our internal capital adequacy assessment process ('ICAAP'), which helps enable us to manage our capital in a consistent manner. The framework incorporates a number of different capital measures calculated on an economic capital and regulatory capital basis. The ICAAP is an assessment of our capital position, outlining both regulatory and internal capital resources and requirements with our business model, strategy, performance and planning, risks to capital, and the implications of stress testing to capital.

Our assessment of capital adequacy is aligned to our assessment of risks. These risks include credit, market, operational, pensions, insurance, structural foreign exchange, residual risk and interest rate risk in the banking book.

Planning and performance

Capital and risk-weighted asset ('RWA') plans form part of the annual operating plan that is approved by the Board. Revised RWA forecasts are submitted to the Group Management Board on a monthly basis, and reported RWAs are monitored against the plan.

The responsibility for global capital allocation principles rests with the Group Chief Financial Officer. Through our internal governance processes, we seek to maintain discipline over our investment and capital allocation decisions, and seek to ensure that returns on investment meet the Group's management objectives. Our strategy is to allocate capital to businesses and entities to support growth objectives where returns above internal hurdle levels have been identified and in order to meet their regulatory and economic capital needs.

We manage business returns by using a return on tangible equity ('RoTE') measure.

Risks to capital

Outside the stress testing framework, other risks may be identified that have the potential to affect our RWAs and/or capital position. The Downside or Upside scenarios are assessed against our capital management objectives and mitigating actions are assigned as necessary.

We closely monitor and consider future regulatory change. We continue to evaluate the impact upon our capital requirements of regulatory developments, including the amendments to the Capital Requirements Regulation, the Basel III reforms package, and the UK's withdrawal from the EU. There remains a significant degree of uncertainty due to the number of national discretions within Basel's reforms, the need for further supporting technical standards to be developed and the lack of clarity regarding their implementation following the UK's withdrawal from the EU.

Although it remains premature to provide details of an impact, we currently anticipate potential for an increase in RWAs. The primary drivers include changes in market risk, operational risk calculations and credit valuation adjustment ('CVA') methodologies, as well as the potential loss of equivalence for certain investments in funds and the introduction of an output floor.

Further details can be found in the 'Regulatory developments' section of the Group's Pillar 3 Disclosures at 30 June 2019.

Stress testing

In addition to annual internal stress tests, we are subject to supervisory stress testing in many jurisdictions. Supervisory stress testing requirements are increasing in frequency and in the granularity with which the results are required. These exercises include the programmes of the UK Prudential Regulation Authority ('PRA'), the US Federal Reserve Board, the European Banking Authority, the European Central Bank and the Hong Kong Monetary Authority, as well as stress tests undertaken in other jurisdictions. We take into account the results of regulatory stress testing and our internal stress tests when assessing our internal capital requirements. The outcome of stress testing exercises carried out by the PRA also feeds into a PRA buffer under Pillar 2 requirements, where required.

Capital generation

HSBC Holdings is the provider of equity capital to its subsidiaries and also provides them with non-equity capital where necessary. These investments are substantially funded by HSBC Holdings' own capital issuance and profit retention. As part of its capital management process, HSBC Holdings seeks to maintain a prudent balance between the composition of its capital and its investment in subsidiaries, including management of double leverage.

Double leverage is a measure of holding company leverage, and reflects the extent to which equity investments in operating entities are funded by holding company debt. Where Group capital requirements are less than the aggregate of operating entity capital requirements, double leverage can be used to improve Group capital efficiency provided it is managed appropriately.

HSBC manages double leverage having close regard to rating agency and regulatory constraints, notably PRA policy in this area. As a matter of long-standing policy, the holding company retains a substantial portfolio of high-quality liquid assets (currently in excess of $12bn) to mitigate holding company cash flow risk arising from double leverage and underpin the strength of support the holding company can offer its subsidiaries in times of stress. Further mitigation is provided by additional tier 1 ('AT1') securities issued in excess of the regulatory requirements of our subsidiaries.

*     The references identify the lines prescribed in the EBA template.