Morgan Stanley 2014 Annual Report Download - page 167

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis. Certain of the Company’s assets and
liabilities are measured at fair value on a non-recurring basis. The Company incurs losses or gains for any
adjustments of these assets to fair value. A downturn in market conditions could result in impairment charges in
future periods.
For assets and liabilities measured at fair value on a non-recurring basis, fair value is determined by using
various valuation approaches. The same hierarchy for inputs as described above, which maximizes the use of
observable inputs and minimizes the use of unobservable inputs by generally requiring that the observable inputs
be used when available, is used in measuring fair value for these items.
Valuation Process. The Valuation Review Group (“VRG”) within the Company’s Financial Control Group
(“FCG”) is responsible for the Company’s fair value valuation policies, processes and procedures. VRG is
independent of the business units and reports to the Chief Financial Officer (“CFO”), who has final authority
over the valuation of the Company’s financial instruments. VRG implements valuation control processes to
validate the fair value of the Company’s financial instruments measured at fair value, including those derived
from pricing models. These control processes are designed to assure that the values used for financial reporting
are based on observable inputs wherever possible. In the event that observable inputs are not available, the
control processes are designed to ensure that the valuation approach utilized is appropriate and consistently
applied and that the assumptions are reasonable.
The Company’s control processes apply to financial instruments categorized in Level 1, Level 2 or Level 3 of the
fair value hierarchy, unless otherwise noted. These control processes include:
Model Review. VRG, in conjunction with the Company’s Market Risk Department (“MRD”) and, where
appropriate, the Company’s Credit Risk Management Department, both of which report to the Chief Risk
Officer, independently review valuation models’ theoretical soundness, the appropriateness of the valuation
methodology and calibration techniques developed by the business units using observable inputs. Where
inputs are not observable, VRG reviews the appropriateness of the proposed valuation methodology to
ensure it is consistent with how a market participant would arrive at the unobservable input. The valuation
methodologies utilized in the absence of observable inputs may include extrapolation techniques and the use
of comparable observable inputs. As part of the review, VRG develops a methodology to independently
verify the fair value generated by the business unit’s valuation models. Before trades are executed using new
valuation models, those models are required to be independently reviewed. All of the Company’s valuation
models are subject to an independent annual VRG review.
Independent Price Verification. The business units are responsible for determining the fair value of financial
instruments using approved valuation models and valuation methodologies. Generally on a monthly basis,
VRG independently validates the fair values of financial instruments determined using valuation models by
determining the appropriateness of the inputs used by the business units and by testing compliance with the
documented valuation methodologies approved in the model review process described above.
VRG uses recently executed transactions, other observable market data such as exchange data, broker-dealer
quotes, third-party pricing vendors and aggregation services for validating the fair values of financial
instruments generated using valuation models. VRG assesses the external sources and their valuation
methodologies to determine if the external providers meet the minimum standards expected of a third-party
pricing source. Pricing data provided by approved external sources are evaluated using a number of
approaches; for example, by corroborating the external sources’ prices to executed trades, by analyzing the
methodology and assumptions used by the external source to generate a price and/or by evaluating how
active the third-party pricing source (or originating sources used by the third-party pricing source) is in the
market. Based on this analysis, VRG generates a ranking of the observable market data to ensure that the
highest-ranked market data source is used to validate the business unit’s fair value of financial instruments.
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