Morgan Stanley 2014 Annual Report Download - page 152

(1) Net inventory represents exposure to both long and short single-name and index positions (i.e., bonds and equities at fair value and CDS
based on notional amount assuming zero recovery adjusted for any fair value receivable or payable). As a market maker, the Company
transacts in these CDS positions to facilitate client trading. At December 31, 2014, gross purchased protection, gross written protection
and net exposures related to single-name and index credit derivatives for those countries were $(261.7) billion, $259.6 billion and $(0.2)
billion, respectively. For a further description of the triggers for purchased credit protection and whether those triggers may limit the
effectiveness of the Company’s hedges, see “Credit Exposure—Derivatives” herein.
(2) Net counterparty exposure (i.e., repurchase transactions, securities lending and OTC derivatives) takes into consideration legally
enforceable master netting agreements and collateral.
(3) At December 31, 2014, the benefit of collateral received against counterparty credit exposure was $11.9 billion in the U.K., with 98% of
collateral consisting of cash, U.S. and U.K. government obligations, and $14.1 billion in Germany with 98% of collateral consisting of
cash and government obligations of Germany, France, Belgium and Netherlands. The benefit of collateral received against counterparty
credit exposure in the other countries totaled approximately $15.4 billion, with collateral primarily consisting of cash, U.S. and Japanese
government obligations. These amounts do not include collateral received on secured financing transactions.
(4) Amounts represent CDS hedges (purchased and sold) on net counterparty exposure and funded lending executed by trading desks
responsible for hedging counterparty and lending credit risk exposures for the Company. Based on the CDS notional amount assuming
zero recovery adjusted for any fair value receivable or payable.
(5) In addition, at December 31, 2014, the Company had exposure to these countries for overnight deposits with banks of approximately
$5.1 billion.
Operational Risk.
Operational risk refers to the risk of loss, or of damage to the Company’s reputation, resulting from inadequate or
failed processes, people, and systems or from external events (e.g., fraud, theft, legal and compliance risks or
damage to physical assets). Operational risk includes legal and compliance risk. Operational risk relates to the
following risk event categories as defined by Basel II: internal fraud; external fraud, employment practices and
workplace safety; clients, products and business practices; business disruption and system failure; damage to
physical assets; and execution, delivery and process management. The Company may incur operational risk
across the full scope of its business activities, including revenue-generating activities (e.g., sales and trading) and
support and control groups (e.g., information technology and trade processing). Legal and compliance risk is
included in the scope of operational risk and is discussed below under “Legal and Compliance Risk.”
The Company has established an operational risk framework to identify, measure, monitor and control risk across
the Company. Effective operational risk management is essential to reducing the impact of operational risk
incidents and mitigating legal and reputational risks. The framework is continually evolving to account for
changes in the Company and respond to the changing regulatory and business environment. The Company has
implemented operational risk data and assessment systems to monitor and analyze internal and external
operational risk events, business environment and internal control factors and to perform scenario analysis. The
collected data elements are incorporated in the operational risk capital model. The model encompasses both
quantitative and qualitative elements. Internal loss data and scenario analysis results are direct inputs to the
capital model, while external operational incidents, business environment internal control factors and metrics are
evaluated as part of the scenario analysis process.
Primary responsibility for the management of operational risk is with the Company’s business segments, the
control groups and the business managers therein. The business managers maintain processes and controls
designed to identify, assess, manage, mitigate and report operational risk. Each of the Company’s business
segments has a designated operational risk coordinator. The operational risk coordinator regularly reviews
operational risk issues and reports to the Company’s senior management within each business. Each control
group also has a designated operational risk coordinator and a forum for discussing operational risk matters with
the Company’s senior management. Oversight of operational risk is provided by the Company’s Operational Risk
Oversight Committee, regional risk committees and senior management. In the event of a merger; joint venture;
divestiture; reorganization; or creation of a new legal entity, a new product or a business activity, operational
risks are considered, and any necessary changes in processes or controls are implemented.
The Company’s Operational Risk Department is independent of the Company’s divisions and reports to the
Company’s Chief Risk Officer. The Company’s Operational Risk Department provides oversight of operational
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