Morgan Stanley 1998 Annual Report Download - page 42

*FORTY
-SIX *
MORGAN STANLEY DEAN WITTER *1998 ANNUAL REPORT
systems and processes affected by EMU and also communicated
extensively with its clients and counterparties regarding the impli-
cations of EMU. The Company considers that the initial redenomi-
nation exercise that took place between January 1 and January 3,
1999 was successful from the perspective of its internal systems and
books and records. Despite certain initial issues with the settlement
of euro payments, as of January 31, 1999 it appears that the
changeover to the euro has been successful across Europe.
Based upon current information, the Company esti-
mates that the costs associated with reviewing, amending and test-
ing its information technology systems to prepare for EMU for fiscal
1998 and through the project’s completion will be approximately
$76 million. Substantially all of such costs were incurred by the end
of fiscal 1998. These costs have been and will continue to be
funded through operating cash flow and are expensed in the period
in which they are incurred.
REGULATORY CAPITAL REQUIREMENTS
Dean Witter Reynolds Inc. (“DWR”) and MS&Co. are registered broker-
dealers and registered futures commission merchants and, accord-
ingly, are subject to the minimum net capital requirements of the
Securities and Exchange Commission (“SEC”), the New York Stock
Exchange and the Commodity Futures Trading Commission. MSIL, a
London-based broker-dealer subsidiary, is regulated by the Securities
and Futures Authority (“SFA”) in the United Kingdom and, accord-
ingly, is subject to the Financial Resources Requirements of the SFA.
Morgan Stanley Japan Limited (“MSJL”), a Tokyo-based broker-dealer,
is regulated by the Japanese Ministry of Finance with respect to reg-
ulatory capital requirements. DWR, MS&Co., MSIL and MSJL have con-
sistently operated in excess of their respective regulatory requirements
(see Note 11 to the consolidated financial statements).
Certain of the Company’s subsidiaries are Federal
Deposit Insurance Corporation (“FDIC”) insured financial institutions.
Such subsidiaries are therefore subject to the regulatory capital
requirements adopted by the FDIC. These subsidiaries have consis-
tently operated in excess of these and other regulatory requirements.
Certain other U.S. and non-U.S. subsidiaries are sub-
ject to various securities, commodities and banking regulations and
capital adequacy requirements promulgated by the regulatory and
exchange authorities of the countries in which they operate. These
subsidiaries have consistently operated in excess of their applica-
ble local capital adequacy requirements. In addition, Morgan Stanley
Derivative Products Inc., a triple-A rated subsidiary through which
the Company conducts some of its derivative activities, has estab-
lished certain operating restrictions which have been reviewed by
various rating agencies.
EFFECTS OF INFLATION AND CHANGES
IN FOREIGN EXCHANGE RATES
Because the Company’s assets to a large extent are liquid in nature,
they are not significantly affected by inflation. However, inflation may
result in increases in the Company’s expenses, which may not be
readily recoverable in the price of services offered. To the extent infla-
tion results in rising interest rates and has other adverse effects upon
the securities markets, on the value of financial instruments and upon
the markets for consumer credit services, it may adversely affect the
Company’s financial position and profitability.
A portion of the Company’s business is conducted in
currencies other than the U.S. dollar. Non-U.S. dollar assets typi-
cally are financed by direct borrowing or swap-based funding in the
same currency. Changes in foreign exchange rates affect non-U.S.
dollar revenues as well as non-U.S. dollar expenses. Those foreign
exchange exposures that arise and are not hedged by an offsetting
foreign currency exposure are actively managed by the Company to
minimize risk of loss due to currency fluctuations.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company actively offers to clients and trades for its own account
a variety of financial instruments described as “derivative prod-
ucts” or “derivatives.” These products generally take the form of
futures, forwards, options, swaps, caps, collars, floors, swap options
and similar instruments which derive their value from underlying inter-
est rates, foreign exchange rates, or commodity or equity instruments
and indices. All of the Company’s trading-related divisions use
derivative products as an integral part of their respective trading
strategies, and such products are used extensively to manage the
market exposure that results from a variety of proprietary trading activ-
ities (see Note 9 to the consolidated financial statements). In addi-
tion, as a dealer in certain derivative products, most notably interest
rate and currency swaps, the Company enters into derivative contracts
to meet a variety of risk management and other financial needs of
its clients. Given the highly integrated nature of derivative products
and related cash instruments in the determination of overall trad-
ing division profitability and the context in which the Company