Patton Cheung Gurjeet Sandhu - PowerPoint Presentation

1. Patton CheungGurjeet SandhuKezheng LiJustin “Bieber” Ling

2. AgendaCompany OverviewRisk Management ActivitiesCompensation Practices

3. Overview Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations, governments, financial institutions, and individuals. Morgan Stanley also operates in 36 countries around the world, with over 600 offices and a workforce of over 60,000.

4. Global OfficesHeadquartered in New York City, US

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6. Company History

7. Company History

8. Company History

9. Financial CrisisMorgan Stanley Trading Price from 2001-2011

10. Financial CrisisConverted to bank holding companyRegulated by the Federal ReserveNo longer a securities firm Morgan Stanley borrowed $107.3 billion from the Fed during the 2008 crisis$ 9 billion invested by Mitsubishi UFJ Financial GroupBought Smith Barney from Citigroup Joint venture with CitigroupNo.1 in customer service among full-service brokerage firms

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13. IndustryThe company operates in three business segments Institutional Securities Global Wealth Management Group Asset Management.

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16. 5 Year Net Revenue

17. Business Mix

18. Business Mix

19. Operating Committee

20. James P Gorman CEO

21. Ruth Porat CFO

22. Keishi Hotsuki CROBachelor’s degree in Economics from Hitotsubashi UniversityMasters of Science in Industrial Administration from Carnegie Mellon University

23. Risk Management Philosophy Five Key PrinciplesComprehensivenessIndependenceAccountabilityDefined risk toleranceTransparency.“Management believes effective risk management is vital to the success of the Company’s business activities”“The cornerstone of the Company’s risk management philosophy is the execution of risk-adjusted returns throughprudent risk-taking that protects the Company’s capital base and franchise.”

24. Risk Governance Structure Board of DirectorsAudit Committee and the Risk Committee of the BoardSenior management oversight (including the Chief Executive Officer, the Chief Risk Officer, the Chief Financial Officer, the Chief Legal Officer and the Chief Compliance Officer)Internal Audit DepartmentIndependent risk management functions (including the Market Risk Department, Credit Risk Management, the Corporate Treasury Department and the Operational Risk Department)Company control groups (including the Human Resources Department, the Legal and Compliance Division, the Tax Department and the Financial Control Group)

25. Risk Committee OverseesRisk governance structureRisk management and risk assessment guidelines and policies regarding market, credit and liquidity and funding riskRisk tolerancePerformance of the Chief Risk Officer

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28. Fair Value EvaluationLevel 1—Valuations based on quoted prices in active markets for identical assets or liabilities that the company has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 Level 2—Valuations based on one or more quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

29. Fair Value Evaluation

30. Balance Sheet

31. Balance Sheet

32. Balance Sheet

33. Income Statement

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36. Cash Flow

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39. Risk Factors

40. Type of Risks Operational riskRisk of losses arising from insufficient controls on people, resources, and processes and external factors such as compliance riskLegal/Regulatory riskRisk of losses in fines, penalties, damages resulting from noncompliance and legal actionsCredit riskRisk of default from borrowers

41. Type of Risks Liquidity and funding riskRisk of difficulty in accessing capital markets, inability to liquidate assets in a timely manner, and threats to going concern in satisfying financial obligationsMarket riskRisk of losses arising from changes in market prices, rates, volatility, and correlations

42. Type of Risks Competitive environment riskRisks from competitionInternational riskRisks of losses from global operationAcquisition riskRisk of losses from acquisitions, minority stakes, forming joint ventures, and strategic alliances

43. Sources of riskIncreasingly complex and large volume of transactions processed in various markets and currenciesInternal risks from employees and control systems, and external risks from financial intermediaries and other third partiesTerrorist activities, diseases, and natural disasters  contingency planningOperating Risk

44. Operational risk Oversight CommitteeChaired by CRO, provides oversight of operational riskOperational risk managerMonitors, measures, analyzes and reports on operational riskIndependent of business segmentsBusiness ManagerMaintain processes and controls designed to manage operational riskOperating Risk Management

45. Business Continuity ManagementContingency planning to ensure continuity of operations in case of disasterExternal vendorsRisk managed through service level, contractual agreements, service and quality reviewsOperating Risk Management

46. Extensive supervision from the Fed and regulatory agenciesPossibly stricter capital requirements and leverage limits coming as soon 2010Risk related to commodities activitiesEngages in production, storage, and transportation of several commodities including metals, agricultural and energy productsContamination may create liability even if MS is not at faultLegal Risk

47. Fiscal and monetary policyVarious policies from central banks have effect on cost of funds for lending, capital raising and investment activitiesConflict of interestsCan result in enforcement by governing agenciesCan result in public scrutiny or loss of businessEstimation errorsFor legal proceedings which involve substantial stake and are in early stages, costs are hard to estimateLegal Risk

48. Legal and Compliance Division“Develops various procedures addressing issues such as regulatory capital requirements, sales and trading practices, new products, potential conflicts of interest, structured transactions, use and safekeeping of customer funds and securities, credit granting, money laundering, privacy and recordkeeping”Legal Risk Management

49. Corporate lendingRelationship-driven expand business relationshipsEvent driven lending commitments for events such as acquisition and mergers by clientsSecuritized productsStructuring, underwriting, and trading collateralized securities Risk borrower not performing according to agreement and devaluation of collateralCredit Risk Institutional Securities Activities

50. Derivative contractsDealer in OTC derivatives“Generally represent future commitments to swap interest payment streams, exchange currencies, or purchase or sell commodities and other financial instruments on specific terms at specified future dates”Credit Risk Institutional Securities Activities

51. DerivativesDerivative Instruments are used for trading, foreign currency exposure management and asset and liability managementRisk mitigation strategies include diversification of risk exposure and hedgingRisk is managed on a company-wide basis, worldwide trading division level and on an individual product basis

52. Derivative Products

53. OTC Derivative Products

54. Derivative Products

55. Hedge AccountingThe Company applies hedge accounting using various derivative financial instruments and non-U.S. dollar-denominated debt to hedge interest rate and foreign exchange risk arising from assets and liabilities not held at fair value as part of asset and liability management and foreign currency exposure management.The Company’s hedges are designated and qualify for accounting purposes as one of the following types of hedges: exposure to changes in fair value of assets and liabilities being hedged (fair value hedges) and foreign operations whose functional currency is different from the reporting currency of the parent company (net investment hedges).For all hedges where hedge accounting is being applied, effectiveness testing is performed at least monthly.

56. Fair Value Hedges – Interest Rate RiskConsist primarily of interest rate swaps designated as fair value hedges of changes in the benchmark interest rate of fixed rate senior long-term borrowingsNet Investment HedgesForward foreign exchange contracts and non-U.S. dollar-denominated debt used to manage the currency exposure relating to its net investments in non-U.S. dollar functional currency operationsHedge Accounting

57. Value of Hedges

58. Derivatives Designated as Fair Value Hedges

59. Derivatives Designated as Net Investment Hedges

60. The table below summarizes gains (losses) on derivative instruments not designated as accounting hedges for 2010, 2009 and the one month ended December 31, 2008, respectivelyDerivative Instruments NOT Designated as Accounting Hedges

61. OTC Credit Derivatives

62. OTC Credit Derivatives

63. Commercial LendingWorking capital lines of credit, revolving lines of credit, standby letters of credit, term loans and commercial real estate mortgagesInvolves the use of independent credit agenciesMargin LendingReviews amount of the loan, the intended purpose, the degree of leverage being employed in the accountCredit Risk Global Wealth Management Group Activities

64. Consumer LendingMortgages, HELOCEvaluation of capacity and willingness to payFICO scores, debt ratios, borrower’s reserves Credit Risk Global Wealth Management Group Activities

65. Credit Risk Management DepartmentCredit Limits FrameworkCredit Risk Management

66. Credit Risk Management is responsible forEvaluating, monitoring and controlling credit risk for each business segmentEnsuring transparency of material credit risks, compliance with established limits, approving material extensions of credit, and communicating with senior management regarding risk concernsCredit Risk Management

67. Transactions and creditworthiness of borrowers reviewed regularlyAt three levels: transaction, counterparty and portfolioProduces credit ratings similar to external servicesBB+ below considered non-investment gradeAnalyzing Credit Risk

68. Through management of key risks elements such as size, financial covenants and collateralSell, assign or sub-participate funded loans to other financial institutionsEnter master netting agreements and collateral arrangements with counterparties to offset obligations, request collateral or liquidate collateralRisk Mitigation

69. Credit Exposure

70. Country Exposure

71. Industry Exposure

72. Liquidity is essential and external sources finance a significant portion of operationsAffected by inability to raise funds in the long/short-term debt/equity capital markets or inability to access secured lending marketsCaused by:Disruption of the financial marketsNegative views about the financial services industryNegative perception of long or short term financial prospectsLarge trading losses, downgraded or negative watch by rating agencies, decline in business activity, action by regulators, employee misconduct or illegal activity, and other reasonsWould have to liquidate assets to meet maturing liabilities and may have to sell at a discountLiquidity and Funding Risk

73. Liquidity Risk ManagementThe principal elements of the company’s liquidity and funding risk management framework are the Contingency Funding Plan (CFP) and the Global Liquidity ReserveUses Tier 1 common ratio and the balance sheet leverage ratio as indicators of capital adequacy

74. Liquidity

75. Liquidity

76. Contingency Funding PlanThe company’s primary liquidity and funding risk management toolOutlines response to liquidity stress and uses stress tests across multiple scenarios across various time horizons to set forth a course of actionAssumptions incorporated into the CFP:No government supportNo access to unsecured debt marketsRepayment of all unsecured debt maturing within one yearHigher haircuts and significantly lower availability of secured funding

77. Global Liquidity ReserveLiquidity reserves used to cover daily funding needs and meet liquidity targets sized by the CFPHeld within parent company and major operating subsidiariesComprised of cash and cash equivalents, securities reserved or borrowed on an overnight basis, and pools of federal reserve eligible securitiesAll assets are unencumbered and not pledged as collateralDoes not include other unencumbered assets that are availableThe vast majority of the assets can be monetized on a next-day basis and the remainder of the assets can be monetized within two to five business days.

78. Global Liquidity Reserve

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80. Funding Management PolicyAttempt to ensure tenor of liabilities equals or exceeds the expected holding period of the assets being financedDiversify funding sourcesSubstantial portion of assets as liquid marketable securities in order acquire secured financingObtain longer-term secured financing for less liquid assetsStagger maturity for long-term borrowings to mitigate refinancing risk

81. Funding Management PolicyCredit rating affects ability to acquire fundingCFP accounts for downgrade in credit rating

82. Changes in Capital Funding

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84. Changes in Capital Funding

85. Off-Balance Sheet ArrangementsGuarantees:

86. Off-Balance Sheet ArrangementsCommitment and Contractual Obligations

87. Basel IIINew capital standards that raise the quality of capital, strengthen counterparty credit risk capital requirements and introduces a leverage ratio as a supplemental measure to the risk-based ratioNew capital conservation buffer which imposes a common equity requirement above the new minimum that can be depleted under stress

88. Basel III Implications

89. Basel III Implications

90. Basel III Implications

91. Market RiskPrimary Market Risk ExposureCredit Risk SpreadEquity Prices VolatilityForeign ExchangeCommodityHedging

92. Market Risk DepartmentResponsibilities:Ensuring transparency of material market riskMonitoring compliance with established limitsEscalating risk concentrations to appropriate senior managementHow responsibilities are carried out:Monitor risk against limits on aggregate risk exposuresPerform risk analysesReport risk summariesMonitor risk through various measuresVARPosition sensitivityRoutine stress testing

93. Value at Risk (VAR)Used to measure, monitor and review market risk exposures of its trading portfoliosVaR estimated by using a model based on historical simulation for major market risk factors and Monte Carlo simulation for name-specific risk in corporate shares, bonds, loans and related derivativesHistorical simulation involves constructing a distribution of hypothetical daily changes in the value of trading portfolios based on two sets of inputsHistorical observation of daily changes in key market indices or other market risk factorsInformation on the sensitivity of the portfolio values to these market risk factor changesThe company’s VaR model uses four years of historical data to measure it’s 95%/one-day VaR which corresponds to the unrealized loss in portfolio value that would have been exceeded with a frequency of 5% or 5 times in every 100 trading days if the portfolio were held constant for one day

94. VaR Benefits and LimitationsBenefitsPermits estimation of portfolio’s aggregate market risk exposureReflects risk reduction due to portfolio diversification or hedging activitiesLimitationsPast changes in market risk factors may not yield accurate predictionsChanges in portfolio value may differ from responses calculated by a VaR modelDoesn’t fully capture market risk of positions that cannot be liquidated or hedged within one day using a one day time frameLimited insight into losses that could occur in unusual market conditionsUnderstates risk associated with severe events

95. 2010 95%/One-day VAR

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97. 95% and 99% Average Trading VaR with Four-Year / One-Year Historical Time Series

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101. Interest Rate Risk Sensitivity

102. Investments

103. Strong competition from other financial services firmsCompetition for qualified employee Automated trading markets may adversely affect business and may increase competitionCompetitive Environment Risk

104. Subject to numerous political, economic, legal, operational, franchise and other risks In many countries, the laws and regulations applicable to the securities and financial services are uncertain, it is difficult to determine the exact requirements of local laws in every market.Various emerging market countries have experienced severe political, economic and financial disruptions, including significant devaluations of currencies, capital and currency exchange controls and high rates of inflationInternational Risk

105. Unable to fully capture the expected value from acquisitions, joint ventures, minority stakes and strategic alliancesNeed to combine accounting and data processing systems and management controls and to integrate relationships with clients and business partnersConflicts or disagreements between MS and its joint venture partners may negatively impact the benefitsAcquisition Risk

106. Compensation practices are subject to oversight by the Federal ReserveThe Company is subject to the compensation-related provisions of the Dodd-Frank ActIn June 2010, the Federal Reserve and other federal regulators issued final guidance in accordance with compensation principles and standards designed to encourage sound compensation practices established by the Financial Stability BoardCompensation Practices

107. Attract and Retain Top Talent. The Company competes for talent globally with commercial banks, brokerage firms, hedge funds and other companies offering financial services. Long-term incentive awards encourage executives not to leave the Company for a competitorDeliver Pay-for-Performance. Executive compensation program emphasizes variable incentive compensation that is linked to Company and individual performanceAlign Executive Compensation with Shareholders’ Interests. The Company delivers a significant portion of long-term incentive compensation in equity to align employee interests to increased shareholder valueEvaluate Risk-taking and Compensation Arrangements. The CMDS Committee works with the Company’s Chief Risk Officer and the CMDS Committee’s independent consultant to help ensure that the structure and design of compensation arrangements do not encourage unnecessary and excessive risk-takingCompensation Objectives and Strategy

108. The accounting guidance for stock-based compensation requires measurement of compensation cost for equity-based awards at fair value and recognition of compensation cost over the service period, net of estimated forfeituresEmployee Stock-Based Compensation Plans

109. Deferred Stock Awards

110. Stock Awards

111. THANK YOU