Annual Report And Accounts 2021 - Financial Statements - HSBC

Report of Independent Registered Public Accounting Firm to the Board of Directors and Shareholders of HSBC Holdings plc Expected credit losses - Impairment of loans and advances (group) Nature of the key audit matter Determining expected credit losses (‘ECL’) involves management judgement and is subject to a high degree of estimation uncertainty. Management makes various assumptions when estimating ECL. The significant assumptions that we focused on in our audit included those with greater levels of management judgement and for which variations had the most significant impact on ECL. These included assumptions made in determining forward looking economic scenarios and their probability weightings and estimating material management judgemental adjustments. The impact of Covid-19, including the nature and extent of government support, supply chain constraints and increasing energy prices, and more recent factors, including developments in China’s commercial real estate sector, have resulted in unprecedented economic conditions that vary between territories and industries, leading to uncertainty around judgements made in determining the severity and probability weighting of macroeconomic variable (‘MEV’) forecasts across the different economic scenarios used in ECL models. The modelling methodologies used to estimate ECL are developed using historical experience. The impact of the unprecedented economic conditions has also resulted in certain limitations in the reliability of these methodologies to forecast the extent and timing of future customer defaults and therefore estimate ECL. In addition, modelling methodologies do not incorporate all factors that are relevant to estimating ECL, such as differentiating the impact on industry sectors of economic conditions. These limitations are addressed with management judgemental adjustments, the measurement of which is inherently judgemental and subject to a high level of estimation uncertainty. Management makes other assumptions which are less judgemental or for which variations have a less significant impact on ECL. These assumptions include: The methodologies used in quantitative scorecards for determining customer risk ratings (‘CRRs’); Estimating expected cash flows and collateral valuations for credit impaired wholesale exposures; Model methodologies themselves; and Quantitative and qualitative criteria used to assess significant increases in credit risk. Matters discussed with the Group Audit Committee We held discussions with the GAC covering governance and controls over ECL, with a significant focus on the continuing impact of Covid-19 and other economic conditions, including recent developments in China’s commercial real estate sector. We discussed a number of areas, including: The severity of MEV forecasts in economic scenarios, and their related probability weightings, across territories; Management judgemental adjustments and the nature and extent of analysis used to support those adjustments; The criteria and conditions used to assess to what extent management judgemental adjustments continue to be needed; Management’s policies, governance and controls over model validation and monitoring; and The disclosures made in relation to ECL, in particular the impact of adjustments on determining ECL and the resulting estimation uncertainty. How our audit addressed the Key Audit Matter We assessed the design and effectiveness of governance and controls over the estimation of ECL. We observed management’s review and challenge in governance forums for (1) the determination of MEV forecasts and their probability weightings for different economic scenarios, and (2) the assessment of ECL for Retail and Wholesale portfolios, including the assessment of model limitations and any resulting management judgemental adjustments. We also tested controls over: Model validation and monitoring; Credit reviews that determine customer risk ratings for wholesale customers; The identification of credit impaired events; The input of critical data into source systems and the flow and transformation of critical data from source systems to impairment models and management judgemental adjustments; and The calculation and approval of management judgemental adjustments to modelled outcomes. We involved our economic experts in assessing the significant assumptions made in determining the severity and probability weighting of MEV forecasts. These assessments considered the sensitivity of ECL to variations in the severity and probability weighting of MEVs for different economic scenarios. We involved our modelling experts in assessing the appropriateness of the significant assumptions and methodologies used for models and management judgemental adjustments. We independently reperformed the calculations for a sample of those models and management judgemental adjustments. We further considered whether the judgements made in selecting the significant assumptions would give rise to indicators of possible management bias. In addition, we performed substantive testing over: The compliance of ECL methodologies and assumptions with the requirements of IFRS 9; The appropriateness and application of the quantitative and qualitative criteria used to assess significant increases in credit risk; A sample of critical data used in ECL models and to estimate management judgemental adjustments as at 31 December 2021; Assumptions and critical data for a sample of credit impaired wholesale exposures; and A sample of CRRs applied to wholesale exposures. We evaluated and tested the Credit Risk disclosures made in the Annual Report. Relevant references in the Annual Report and Accounts 2021 Credit risk disclosures, page 137. GAC Report, page 245. Note 1.2(d): Financial instruments measured at amortised cost, page 321. Note 1.2(i): Impairment of amortised cost and FVOCI financial assets, page 323. 300 HSBC Holdings plc Annual Report and Accounts 2021

Impairment of investment in associate - Bank of Communications Co., Ltd (‘BoCom’) (group) Nature of the key audit matter At 31 December 2021, the fair value of the investment in BoCom, based on the share price, was US 15.1bn lower than the carrying value (‘CV’) of US 23.6bn. This is an indicator of potential impairment. An impairment test was performed by management, with supporting sensitivity analysis, using the higher of fair value and value in use ('VIU'). The VIU was US 1.2bn in excess of the CV. On this basis, management concluded no impairment was required. 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: The discount rate; Short term assumptions for operating income growth rate, cost-income ratio, expected credit losses and effective tax rates; Long term assumptions for profit and asset growth rates, expected credit losses, and effective tax rates; and Capital related assumptions (risk-weighted assets, capital adequacy ratio and tier 1 capital adequacy ratio). Matters discussed with the Group Audit Committee We discussed the appropriateness of the VIU methodology and significant assumptions with the GAC, giving consideration to the macroeconomic environment, the outlook for the Chinese banking market and the fair value, which has been lower than the carrying value for approximately 10 years. We also discussed the disclosures made in relation to BoCom, including reasonably possible alternatives for the significant assumptions, the use of sensitivity analysis to explain estimation uncertainty and the changes in certain assumptions that would result in the VIU being equal to the CV. How our audit addressed the Key Audit Matter 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 appropriateness of the significant assumptions and, where relevant, their interrelationships; Obtaining evidence for data supporting significant assumptions including 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 certain significant assumptions, both individually and in aggregate; 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; and Assessing whether the judgements made in deriving the significant assumptions give rise to indicators of possible management bias. We observed the quarterly meetings in March, May, September, and November 2021 between management and BoCom management, held specifically to identify facts and circumstances impacting assumptions relevant to the determination of the VIU. Representations were obtained from management that assumptions used were consistent with information currently available to the group. . We evaluated and tested the disclosures made in the Annual Report in relation to BoCom. Relevant references in the Annual Report and Accounts 2021 GAC Report, page 245. Note 1.2(a): Critical accounting estimates and judgements, page 320. Note 18 Interests in associates and joint ventures, page 359. Financial statements HSBC Holdings plc Annual Report and Accounts 2021 301

Report of Independent Registered Public Accounting Firm to the Board of Directors and Shareholders of HSBC Holdings plc Impairment of investments in subsidiaries (company) Nature of the key audit matter The macroeconomic and geopolitical environment continues to be challenging, impacting both 2021 and the outlook into 2022 and beyond. These external factors, as well as HSBC’s strategy, impact the financial position and performance of subsidiaries within the group. These factors were considered by management in determining if there were potential indicators of impairment that required an impairment assessment for investment in subsidiaries. Management compared the net assets to the carrying value of each direct subsidiary of HSBC Holdings plc. 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 a partial reversal of an impairment charge of US 3.1bn in relation to the investment in HSBC Overseas Holdings (UK) Limited (‘HOHU’). This resulted in investment in subsidiaries of US 163bn at 31 December 2021. The methodology 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 strategic planning cycle for 2022 to 2026 including revenue forecasts and cost reduction targets, regulatory capital requirements, long term growth rates and discount rates. Matters discussed with the Group Audit Committee We discussed the partial reversal of the impairment charge for HOHU, the appropriateness of methodologies used and significant assumptions with the GAC, giving consideration to the macroeconomic outlook and HSBC’s strategy. We considered reasonably possible alternatives for significant assumptions. How our audit addressed the Key Audit Matter 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 tested 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 strategic planning cycle and the prospects for HSBC’s businesses, as well as considering the achievement of historic forecasts; 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 in relation to investment in subsidiaries. Relevant references in the Annual Report and Accounts 2021 Note 19: Investments in subsidiaries, page 362. Valuation of defined benefit pensions obligations (group) Nature of the key audit matter The group has a defined benefit obligation of US 42.8bn, of which US 32.3bn relates to HSBC Bank (UK) pension scheme. The valuation of the defined benefit obligation for HSBC Bank (UK) pension scheme is dependent on a number of actuarial assumptions. Management uses an actuarial expert to determine the valuation of the defined benefit obligation. The valuation methodology uses 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. Matters discussed with the Group Audit Committee We discussed with the GAC the methodologies and significant assumptions used by management to determine the value of the defined benefit obligation. How our audit addressed the Key Audit Matter We tested governance and controls in place over the methodologies and the significant assumptions, including those in relation to the use of management's experts. 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, we used our actuarial experts to understand the judgements made by management and their actuarial expert in determining the significant assumptions and compared these assumptions to our independently compiled expected ranges based on market observable indices and the knowledge and opinions of our actuarial experts. We evaluated and tested the disclosures made in the Annual Report in relation to the defined benefit pension obligation. Relevant references in the Annual Report and Accounts 2021 GAC Report, page 246. Note 1.2(k): Critical accounting estimates and judgements, page 327. Note 5: Employee compensation and benefits, page 331. 302 HSBC Holdings plc Annual Report and Accounts 2021

How we tailored the audit scope We performed a risk assessment, giving consideration to relevant external and internal factors, including Covid-19, climate change, geopolitical and economic risks, relevant accounting and regulatory developments, HSBC’s strategy and the changes taking place across the group. We also considered our knowledge and experience obtained in prior year audits. As part of considering the impact of climate change in our risk assessment, we evaluated management's assessment of the impact of climate risk, which is set out on page 45, including their conclusion that there is no material impact on the financial statements. In particular, we considered management’s assessment of the impact on ECL on loans and advances to customers, the financial statement line item we determined to be most likely to be impacted by climate risk. Management’s assessment gave consideration to a number of matters, including the climate stress testing performed in 2021. Using our risk assessment, 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, taking into account the structure of the group and the company, the accounting processes and controls, and the industry in which they operate. We continually assessed risks and changed the scope of our audit where necessary. Our risk assessment and scoping identified certain entities (collectively the Significant Subsidiaries) for which we obtained audit opinions. We obtained full scope audit opinions for the consolidated financial position and performance of Hongkong and Shanghai Banking Corporation Limited, HSBC Bank plc, and HSBC North America Holdings Limited. We also obtained full scope audit opinions for the company financial position and performance of HSBC UK Bank plc, HSBC Bank Canada and HSBC Mexico S.A. We obtained audit opinions over specific balances for HSBC Bank Middle East Limited - UAE Operations. The audits for HSBC Bank plc and HSBC UK Bank plc were performed by other PwC teams in the UK. All other audits were performed by other PwC network firms. We continued with our 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. HSBC Bank Malaysia was removed from the scope of The Hongkong and Shanghai Banking Corporation Limited audit for 2021 and India was included. Group-wide audit approach HSBC has entity level controls that have a pervasive influence across the group, as well as other global and regional governance and controls over aspects of financial reporting, such as those operated by the Global Risk function for expected credit losses. A significant amount of IT and operational processes and controls relevant to financial reporting are undertaken in operations centres run by Digital Business Services ('DBS') across different locations. Financial reporting processes and controls are performed centrally in HSBC’s Group Finance function and the four Finance operations centres, including the impairment assessment of goodwill and intangible assets, the consolidation of the group’s results, the preparation of the financial statements, and management’s oversight controls relevant to the group’s financial reporting. For these areas, we either performed audit work ourselves, or directed and provided oversight of the audit work performed by PwC teams in the UK,

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 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 2021 and of the group's and