Morgan Stanley 2015 Annual Report Download - page 138

MORGAN STANLEY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company may apply a concentration adjustment to certain of its OTC derivatives portfolios to reflect the additional cost
of closing out a particularly large risk exposure. Where possible, these adjustments are based on observable market
information, but in many instances, significant judgment is required to estimate the costs of closing out concentrated risk
exposures due to the lack of liquidity in the marketplace.
During 2014, the Company incorporated funding valuation adjustments (“FVA”) into the fair value measurements of OTC
uncollateralized or partially collateralized derivatives and in collateralized derivatives where the terms of the agreement do
not permit the reuse of the collateral received. The Company’s implementation of FVA reflects the inclusion of FVA in the
pricing and valuations by the majority of market participants involved in its principal exit market for these instruments. In
general, FVA reflects a market funding risk premium inherent in the noted derivative instruments. The methodology for
measuring FVA leverages the Company’s existing credit-related valuation adjustment calculation methodologies, which
apply to both assets and liabilities.
Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific
measure. Therefore, even when market assumptions are not readily available, assumptions are set to reflect those that the
Company believes market participants would use in pricing the asset or liability at the measurement date. Where the
Company manages a group of financial assets and financial liabilities on the basis of its net exposure to either market risks or
credit risk, the Company measures the fair value of that group of financial instruments consistently with how market
participants would price the net risk exposure at the measurement date.
See Note 3 for a description of valuation techniques applied to the major categories of financial instruments measured at fair
value.
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.
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 Market Risk Department (“MRD”) and, where appropriate, the 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
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