Morgan Stanley 2010 Annual Report Download - page 104

comprehensively measures the Company’s market and credit risks, was further refined and is now an important
metric used in establishing the Company’s risk appetite and its capital allocation framework. S-VaR simulates
many stress scenarios based on more than 25 years of historical data and attempts to capture the different
liquidities of various types of general and specific risks. Additionally, S-VaR captures event and default risks that
are particularly relevant for credit portfolios.
Risk Management Process.
The following is a discussion of the Company’s risk management policies and procedures for its principal risks
(capital and liquidity risk is discussed in “Management’s Discussion and Analysis of Financial Condition and
Results of Operations—Liquidity and Capital Resources” in Part II, Item 7 herein). The discussion focuses on the
Company’s securities activities (primarily its institutional trading activities) and corporate lending and related
activities. The Company believes that these activities generate a substantial portion of its principal risks. This
discussion and the estimated amounts of the Company’s risk exposure generated by the Company’s statistical
analyses are forward-looking statements. However, the analyses used to assess such risks are not predictions of
future events, and actual results may vary significantly from such analyses due to events in the markets in which
the Company operates and certain other factors described below.
Market Risk.
Market risk refers to the risk that a change in the level of one or more market prices, rates, indices, implied
volatilities (the price volatility of the underlying instrument imputed from option prices), correlations or other
market factors, such as market liquidity, will result in losses for a position or portfolio. Generally, the Company
incurs market risk as a result of trading, investing and client facilitation activities, principally within the
Institutional Securities business segment where the substantial majority of the Company’s VaR for market risk
exposures is generated. In addition, the Company incurs trading related market risk within the Global Wealth
Management Group. Asset Management incurs principally Non-trading market risk primarily from capital
investments in real estate funds and investments in private equity vehicles.
Sound market risk management is an integral part of the Company’s culture. The various business units and
trading desks are responsible for ensuring that market risk exposures are well-managed and prudent. The control
groups help ensure that these risks are measured and closely monitored and are made transparent to senior
management. The Market Risk Department is responsible for ensuring transparency of material market risks,
monitoring compliance with established limits, and escalating risk concentrations to appropriate senior
management. To execute these responsibilities, the Market Risk Department monitors the Company’s risk
against limits on aggregate risk exposures, performs a variety of risk analyses, routinely reports risk summaries,
and maintains the Company’s VaR and scenario analysis systems. These limits are designed to control price and
market liquidity risk. Market risk is also monitored through various measures: statistically (using VaR and
related analytical measures); by measures of position sensitivity; and through routine stress testing, which
measures the impact on the value of existing portfolios of specified changes in market factors, and scenario
analyses conducted by the Market Risk Department in collaboration with the business units. The material risks
identified by these processes are summarized in reports produced by the Market Risk Department that are
circulated to and discussed with senior management, the FRC, the BRC, and the Board of Directors.
Sales and Trading and Related Activities.
Primary Market Risk Exposures and Market Risk Management. During 2010, the Company had exposures to
a wide range of interest rates, equity prices, foreign exchange rates and commodity prices—and the associated
implied volatilities and spreads—related to the global markets in which it conducts its trading activities.
The Company is exposed to interest rate and credit spread risk as a result of its market-making activities and
other trading in interest rate sensitive financial instruments (e.g., risk arising from changes in the level or implied
volatility of interest rates, the timing of mortgage prepayments, the shape of the yield curve and credit spreads).
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