Morgan Stanley 2014 Annual Report Download - page 256

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company has obligations under certain guarantee arrangements, including contracts and indemnification
agreements, that contingently require a guarantor to make payments to the guaranteed party based on changes in
an underlying measure (such as an interest or foreign exchange rate, security or commodity price, an index, or
the occurrence or non-occurrence of a specified event) related to an asset, liability or equity security of a
guaranteed party. Also included as guarantees are contracts that contingently require the guarantor to make
payments to the guaranteed party based on another entity’s failure to perform under an agreement, as well as
indirect guarantees of the indebtedness of others. The Company’s use of guarantees is described below by type of
guarantee:
Derivative Contracts. Certain derivative contracts meet the accounting definition of a guarantee, including
certain written options, contingent forward contracts and credit default swaps (see Note 12 regarding credit
derivatives in which the Company has sold credit protection to the counterparty). Although the Company’s
derivative arrangements do not specifically identify whether the derivative counterparty retains the underlying
asset, liability or equity security, the Company has disclosed information regarding all derivative contracts that
could meet the accounting definition of a guarantee. The maximum potential payout for certain derivative
contracts, such as written interest rate caps and written foreign currency options, cannot be estimated, as
increases in interest or foreign exchange rates in the future could possibly be unlimited. Therefore, in order to
provide information regarding the maximum potential amount of future payments that the Company could be
required to make under certain derivative contracts, the notional amount of the contracts has been disclosed. In
certain situations, collateral may be held by the Company for those contracts that meet the definition of a
guarantee. Generally, the Company sets collateral requirements by counterparty so that the collateral covers
various transactions and products and is not allocated specifically to individual contracts. Also, the Company
may recover amounts related to the underlying asset delivered to the Company under the derivative contract.
The Company records all derivative contracts at fair value. Aggregate market risk limits have been established,
and market risk measures are routinely monitored against these limits. The Company also manages its exposure
to these derivative contracts through a variety of risk mitigation strategies, including, but not limited to, entering
into offsetting economic hedge positions. The Company believes that the notional amounts of the derivative
contracts generally overstate its exposure.
Standby Letters of Credit and Other Financial Guarantees Issued. In connection with its corporate lending
business and other corporate activities, the Company provides standby letters of credit and other financial
guarantees to counterparties. Such arrangements represent obligations to make payments to third parties if the
counterparty fails to fulfill its obligation under a borrowing arrangement or other contractual obligation. A
majority of the Company’s standby letters of credit are provided on behalf of counterparties that are investment
grade.
Market Value Guarantees. Market value guarantees are issued to guarantee timely payment of a specified
return to investors in certain affordable housing tax credit funds. These guarantees are designed to return an
investor’s contribution to a fund and the investor’s share of tax losses and tax credits expected to be generated by
a fund. From time to time, the Company may also guarantee return of principal invested, potentially including a
specified rate of return, to fund investors.
Liquidity Facilities. The Company has entered into liquidity facilities with SPEs and other counterparties,
whereby the Company is required to make certain payments if losses or defaults occur. Primarily, the Company
acts as liquidity provider to municipal bond securitization SPEs and for standalone municipal bonds in which the
holders of beneficial interests issued by these SPEs or the holders of the individual bonds, respectively, have the
right to tender their interests for purchase by the Company on specified dates at a specified price. The Company
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