Morgan Stanley 2010 Annual Report Download - page 32

We are exposed to the risk that third parties that are indebted to us will not perform their obligations.
We incur significant credit risk exposure through the Institutional Securities business segment. This risk may
arise from a variety of business activities, including but not limited to entering into swap or other derivative
contracts under which counterparties have obligations to make payments to us; extending credit to clients
through various lending commitments; providing short or long-term funding that is secured by physical or
financial collateral whose value may at times be insufficient to fully cover the loan repayment amount; and
posting margin and/or collateral to clearing houses, clearing agencies, exchanges, banks, securities firms and
other financial counterparties. We incur credit risk in traded securities and loan pools whereby the value of these
assets may fluctuate based on realized or expected defaults on the underlying obligations or loans.
We also incur credit risk in the Global Wealth Management Group business segment lending to individual
investors, including, but not limited to, margin and non-purpose loans collateralized by securities, residential
mortgage loans and home equity lines of credit.
While we believe current valuations and reserves adequately address our perceived levels of risk, there is a
possibility that continued difficult economic conditions may further negatively impact our clients and our current
credit exposures. In addition, as a clearing member firm, we finance our customer positions and we could be held
responsible for the defaults or misconduct of our customers. Although we regularly review our credit exposures,
default risk may arise from events or circumstances that are difficult to detect or foresee.
Defaults by another large financial institution could adversely affect financial markets generally.
The commercial soundness of many financial institutions may be closely interrelated as a result of credit, trading,
clearing or other relationships between the institutions. As a result, concerns about, or a default or threatened
default by, one institution could lead to significant market-wide liquidity and credit problems, losses or defaults
by other institutions. This is sometimes referred to as “systemic risk” and may adversely affect financial
intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which we
interact on a daily basis, and therefore could adversely affect us.
Operational Risk.
Operational risk refers to the risk of financial or other loss, or damage to a firm’s reputation, resulting from
inadequate or failed internal processes, people, resources, systems or from other internal or external events (e.g.,
internal or external fraud, legal and compliance risks, damage to physical assets, etc.). We may incur operational
risk across our full scope of business activities, including revenue-generating activities (e.g., sales and trading),
support functions (e.g., information technology and trade processing) or other strategic decisions (e.g., the
integration of MSSB or other joint ventures, acquisitions or strategic alliances). Legal and compliance risk is
included in the scope of operational risk and is discussed below under “Legal Risk.” For more information on
how we monitor and manage operational risk, see “Operational Risk” in Part II, Item 7A herein.
We are subject to operational risk that could adversely affect our businesses.
Our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions
across numerous and diverse markets in many currencies. In general, the transactions we process are increasingly
complex. We perform the functions required to operate our different businesses either by ourselves or through
agreements with third parties. We rely on the ability of our employees, our internal systems and systems at
technology centers operated by third parties to process a high volume of transactions.
We also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing
houses or other financial intermediaries we use to facilitate our securities transactions. In the event of a
breakdown or improper operation of our or a third party’s systems or improper action by third parties or
employees, we could suffer financial loss, an impairment to our liquidity, a disruption of our businesses,
regulatory sanctions or damage to our reputation.
26