Report on Transition to IFRS 17 'Insurance Contracts'

HSBC Holdings plc

Report on Transition to IFRS 17 'Insurance Contracts'

Comparatives for the financial year ended 31 December 2022

Issued 2 May 2023

The financial information on which this Report is based is unaudited and has been prepared in accordance with the significant accounting policies of HSBC Holdings plc (together with its subsidiary undertakings referred to as 'HSBC' or 'the Group') as described in the Annual Report and Accounts 2022, and, for those policies impacted by HSBC's adoption of IFRS 17 'Insurance Contracts' within the 'Significant accounting policies' section of this Report. The financial information does not constitute financial statements prepared in accordance with International Financial Reporting Standards ('IFRSs'), is not complete and should be read in conjunction with the Annual Report and Accounts 2022 and other reports and financial information published by HSBC.

Contents

• Introduction

• Transition impacts

• Significant accounting policies

• Key assumptions and judgements
  10 Transition process
  11 IFRS 17 core financial information
  17 Alternative performance measures
  18 Cautionary statement regarding forward-looking statements
  20 Glossary

Introduction

On 1 January 2023 the Group adopted IFRS 17 'Insurance Contracts' and as required by the standard applied the requirements retrospectively with comparatives restated from the transition date, 1 January 2022. This Report on Transition to IFRS 17 'Insurance Contracts' ('the Report') provides the restatement impact on the 1 January 2022 and 31 December 2022 consolidated balance sheets, income statement and financial performance of our global businesses, as well as the effect on financial targets, market guidance and key metrics. The restated comparative consolidated financial statements are prepared on the basis of the Group's significant accounting policies set out on page 7 of the Report. As comparative information prior to the transition date has not been restated, comparatives for the year ended 31 December 2021 continue to be presented on an IFRS 4 'Insurance Contracts' basis. This includes 2021 comparatives provided within the Group's Form 20F filing.

Under IFRS 17 there is no present value of in-force business ('PVIF') asset recognised. Instead, the measurement of the insurance contract liability is based on groups of insurance contracts and includes fulfilment cash flows ('FCFs'), as well as the contractual service margin ('CSM'), which represents the unearned profit. The impact of transitioning to IFRS 17 on the consolidated financial statements of the Group was a reduction to total equity of $10,459m and to tangible equity of $2,393m at 1 January 2022. In contrast to the Group's IFRS 4 accounting where profits are recognised upfront, under IFRS 17 they are deferred within the CSM which is systematically recognised in revenue as services are provided over the coverage period of groups of insurance contracts. Losses resulting from the recognition of onerous contracts are not deferred but recognised in the income statement as they arise. Further details of the impact on the balance sheet and income statement are included on pages 4 to 6 of the Report.

IFRS 17 is not expected to change the economics of the insurance business or the level of profits expected to be earned over the coverage period of the group of contracts. It has no impact on the regulatory capital of the Group as insurance subsidiaries are not included in the Group's prudential scope of consolidation; instead they are accounted for as significant investments using the equity method, and are subject to threshold deductions. In regulatory reporting, the change in equity associated with transition to IFRS 17 does not impact the Group's CET1 ratio as it is negated by a corresponding change in the deduction for significant investments because the Group exceeds the associated combined threshold test as a result of other equity holdings within the wider Group. The expected level of cash and dividend generation by insurance manufacturing subsidiaries is expected to be unaffected as this is primarily driven by the capital position of each subsidiary as determined by local insurance regulatory requirements. The Group does not expect a significant impact to the level of ongoing retuon tangible equity ('RoTE'), albeit its volatility is expected to reduce compared with IFRS 4 based RoTE.

In conjunction with the implementation of IFRS 17 the Group has made use of the option to re-designate to fair value through profit or loss assets that were previously held at amortised cost asset totalling $55,050m, and assets previously held at fair value through other comprehensive income totalling $1,068m. For these re-designated assets, under their historical presentation interest income earned of $2,233m was reported in net interest income. To the extent that this interest income was shared with policyholders, the corresponding policyholder sharing obligation was previously included within the 'net insurance claims and benefits paid and movement in liabilities to policyholders' line. Following re-designation to fair value through profit or loss, gains and losses from changes in the fair value of underlying assets, together with interest income earned, are both reported within 'Net income/(expense) from assets and liabilities of insurance businesses, including related derivatives, measured at fair value through profit or loss'. Similar to an IFRS 4 basis, IFRS 17 accounting provides for an offset. While this offset was reported within the claims line under IFRS 4, under IFRS 17 it is reported within the 'Insurance finance income/(expense)' line.

IFRS 17 provides the first internationally consistent basis for financial reporting for insurance, replacing IFRS 4 which was based on previously grandfathered local practices. Relative to previous reporting, the standard has significantly higher technical, modelling and operational complexity. The Group established a multi-year programme to oversee the implementation activities by bringing together actuarial, finance and IT teams across multiple entities and locations. The implementation included oversight from a Group Steering Committee chaired by the Group Insurance Chief Executive Officer.

IFRS 17 introduces new concepts and measures including the need to model the fulfilment cash flows and CSM which differs by measurement model and has increased disclosure requirements. Existing models used for projecting best estimate cash flows were enhanced to meet IFRS 17 requirements. Data from multiple sources including finance and actuarial systems have been integrated and new information requirements have been sourced in line with the governance framework established. An overview of the Group's transition approach and elections is provided within the Report.

Report on Transition to IFRS 17 'Insurance Contracts'

Transition impacts

Group equity

The impacts to total equity and tangible equity on transition are summarised below. At transition, Group total equity reduced by $10,459m (or 5.1%), and Group tangible equity reduced by $2,393m (or 1.5%). The primary drivers of the change included: the removal of IFRS 4 based balances including the PVIF intangible asset recognised under the Group's historical accounting convention and IFRS 4 based insurance assets and liabilities; re-designation of eligible financial assets to fair value through profit or loss in order to achieve more symmetrical accounting with the related insurance contract liabilities measured under the variable fee approach, increasing the carrying amount of assets; recognition of the contractual service margin under IFRS 17; and establishment of the remaining IFRS 17 assets and liabilities including the best estimate of future cash flows and risk adjustment. These changes are also adjusted for the effect of tax.

Insurance equity plus CSM net of tax amounted to $14,706m and represents a measure of our insurance manufacturing operations' net asset value plus the future earnings from in-force business. It is calculated as the IFRS equity for insurance manufacturing operations of $6,859m plus the CSM of $9,554m less tax of $1,707m.

Reported profit before tax

The impact of transition on the 2022 profit before tax for the insurance manufacturing operations and for the Group is shown below. While the profit over the life of an individual insurance contract under IFRS 17 will be unchanged from the IFRS 4 basis, its emergence will be later. The Group's share of the investment experience and assumption changes will be absorbed by the CSM and released over time to profit or loss under the variable fee approach ('VFA'), which represents over 90% of the Group's life insurance contracts. Under the previous IFRS 4 reporting there was greater income statement volatility as the impact of market condition updates was immediately recognised in the income statement. For contracts measured under the general measurement model ('GMM'), the Group's share of the investment volatility generated by underlying assets is recorded in profit or loss as it arises. Further information about these measurement models is provided on page 8. Under IFRS 17 reported operating expenses will be lower as directly attributable costs will be incorporated in the CSM and recognised in the insurance service result over the duration of the associated insurance contracts.

Group profits under IFRS 17 in the table below include the following key components:

• Ongoing revenue is recognised for the release over time of the CSM associated with the in-force business, which was released at a rate of approximately 9% during 2022.
• Onerous contract losses are recorded for loss making contracts, and include offsets for any reversals of previously recorded losses. Onerous contract losses of $186m were recorded in the year, primarily for some contracts in our mainland China, Singapore and Hong Kong businesses.
• Net investment result represents fair value gains or losses on underlying assets and interest income on shareholder funds, less the IFRS 17 insurance finance expense.
• Profit before tax includes a reduction to reported operating expenses of $629m as directly attributable costs are incorporated in the CSM and insurance service result.
• Group reported profit before tax under IFRS 17 of $17,058m was $470m lower than under IFRS 4. This exceeded the reduction to insurance manufacturing operations profit before tax of $420m, to $607m. The additional reduction of $50m to profit before tax at Group level arose on consolidation because of the inclusion of a wider range of cash flows including those arising from distribution of insurance policies within our Group banking operations.

• HSBC Holdings plc Report on Transition to IFRS 17

• Unless otherwise stated, regulatory capital ratios and requirements are based on the transitional arrangements of the Capital Requirements Regulation in force at the time. These include the regulatory transitional arrangements for IFRS 9 'Financial Instruments'. Leverage ratios are reported based on the disclosure rules in force at that time, and include claims on central banks. Current period leverage metrics exclude central bank claims in

accordance with the UK leverage rules that were implemented on 1 January 2022. References to EU regulations and directives (including technical standards) should, as applicable, be read as references to the UK's version of such regulation or directive, as onshored into UK law under the European Union (Withdrawal) Act 2018, and as may be subsequently amended under UK law.

• Regulatory numbers and ratios are as presented at the date of reporting. Small changes may exist between these numbers and ratios and those subsequently submitted in regulatory filings. Where differences are significant, we will restate in subsequent periods.

• The liquidity coverage ratio is based on the average value of the preceding 12 months. The net stable funding ratio is based on the average value of four preceding quarters.

Report on Transition to IFRS 17 'Insurance Contracts'

Transition impact on the Group consolidated balance sheet at 1 January 2022

Transition drivers

Removal of PVIF and IFRS 4 balances

The PVIF intangible asset of $9,453m previously reported under IFRS 4 within 'Goodwill and intangible assets' arose from the upfront recognition of future profits associated with in force insurance contracts. PVIF is no longer reported following the transition to IFRS 17, as future profits are deferred as unearned revenue within the CSM. Other IFRS 4 insurance assets (shown above within 'all other assets') and insurance contract liabilities are removed on transition, to be replaced with IFRS 17 equivalents.

IFRS 9 asset re-designation

Loans and receivables and debt securities supporting policyholder liabilities of $55,050m were re-designated from an amortised cost classification to fair value through profit and loss, and $1,068m from fair value through other comprehensive income to fair value through profit or loss. The re-designations were made in order to more closely align the asset accounting with the valuation of the associated insurance liabilities. The re-designation of amortised cost assets generated a net increase to assets of $4,873m because the new fair value measurement on transition was higher than the previous amortised cost carrying amount.

Recognition of the IFRS 17 fulfilment cash flows

The measurement of the insurance contracts liabilities under IFRS 17 is based on groups of insurance contracts and includes a liability for fulfilling the contractual obligations associated with the insurance contract, such as premiums, expenses, insurance benefits and claims including policy holder returns and the cost of guarantees. These are recorded within the fulfilment cash flow component of the insurance contract liability, together with the risk adjustment.

Recognition of the IFRS 17 CSM

The CSM is a component of the insurance contract liability and represents the future unearned profit associated with insurance contracts which will be released to the P&L over the insurance coverage period.

Tax effect

The removal of deferred tax liabilities primarily results from the removal of the associated PVIF intangible, and new deferred tax assets are reported, where appropriate, on temporary differences between the new IFRS 17 accounting balances and their associated tax bases.

• HSBC Holdings plc Report on Transition to IFRS 17